Roblox Builds The Metaverse

seekingalpha2021-03-12

Summary Roblox is not a game, but a platform for both designing and playing games. Like other gaming companies, they are trying to build a metaverse that blends real and persistent virtual worlds. ...

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jac_tb
2021-03-16
jac_tb
Go go go!Buy and keep. Revisit again next quarter.

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That cannot be matched after Q1 2021.\nAs such, I think a better price will be available later in the year.\n\n\nNobody Knows Anything\n\n Nobody knows anything. Not one person in the entire motion picture field knows for a certainty what’s going to work. Every time out it’s a guess — and if you’re lucky, an educated one.\n\n\n - William Goldman,Adventures in the Screen Trade\n\nI live in LA, and many of my friends and neighbors are in the film and TV industry, and I even once worked at Warner Brothers TV, Warner's TV production arm. Even if they don’t know where it came from, that three-word phrase, “nobody knows anything,” is one everybody knows, and is as close to gospel as you get in Hollywood.\nOne of the greatest screenwriters of all time, Goldman’s point was that it is impossible to ever know exactly what audiences are going to want, and even the smartest, cagiest, most creative executives are frequently wrong. Complicating that is the very long time it takes to go from screenplay to screen. What may have been perfect cultural timing at conception may already be stale by the time people can see it.\nI see this exact problem in game studios as well, prominently in that last part about timing. Especially in the AAA game world, development times can extend for years. Creators get immersed in the world they are building, and meanwhile outside the walls of the studio, the world is changing. I think Apple TV+’s Mythic Quest, a comedy about a fictional MMORPG studio, dramatizes a lot of this very well.\nRoblox’s (RBLX) model solves the Nobody Knows Anything Problem in the way YouTube (GOOG)(NASDAQ:GOOGL)solved it for video. Roblox is not really a game, but a platform for designing and playing games. It gets frequently compared to Minecraft (MSFT), because they both rely on user creativity, but it is more akin to Unreal Engine, Epic’s game development platform. But that’s for developers. Roblox brings game publishing to the masses the way YouTube democratized video broadcasting.\nThe YouTube model is that most of their content is terrible, but that there is so much of it, there is also a huge volume of good stuff that rises to the top and gets monetized, especially when we are talking about niche audiences. That Roblox graphic above, “Millions of Experiences” is the same model in a three-word slogan.\nRoblox does not have to come up with the Next Big Thing, and the one after that, and the one after that. They are counting on their users to do it for them. Amongst millions of worlds, thousands are going to be of interest to players.\nBut as much as I like the model, I can’t recommend the stock for two reasons. In the first place, they have already seen huge pandemic-related growth, and even they are predicting user engagement will be flattish or down in 2021. But more to the point, Roblox closed its first day of trading with a market cap over $40 billion. The stock price was up to over $70 aftermarket after listing at $45. The problem is this:\nData by YCharts\nThat valuation does not make a ton of sense right now for a company with under a billion in GAAP revenue. But that aside, this is one to keep an eye on. I believe a better price will come later in the year as the report soft comps with pandemic quarters.\nIt’s A Game Development Platform, Not A Game\nMany companies like to refer to their IP stack as a “platform” to imply that a lot can be built upon it. Most of the time, that’s just management buzzwording. But Roblox is genuinely a gaming platform for both creators and users, which makes it distinct.\nDeveloping games is not as simple as they’d like to make out, but it is much simpler than any other method.\nRoblox Studio screenshot\nRoblox comes with a huge library of modifiable characters, environments and objects. While much can be scripted, games can be authored without writing a single line of code, using built-in scripts and behaviors. It also has a plugin architecture, and there are many which add functionality or ease-of-use to the development environment, or add game content. They have 35 million of these in their developer store. This is a full stack development tool that even beginners can use.\nThere are thousands of these videos on YouTube. More complex gameplay and objects require scripting in Roblox’s Lua language, but it tends to be much simpler than alternative languages. My point here is that a wide range of game designers - from kids to professionals - can use this thing and create something very simple, or something very complex.\nThe majority of users will never download Roblox Studio. They counted 33 million daily active users in 2020, and 8 million “active developers.” 1.5 million earned something from their creations, so that’s probably a more realistic number. Only 300 earned more than $100,000, so it’s still a small and growing opportunity for game developers. Developers are paid 70% of the Robux - the in-game currency - their content earns, which encourages the many small earners to funnel that back into gameplay, and not convert it into real bucks.\nBut most users will only ever experience the mobile app for playing the games. So it is actually very different from Minecraft, to which it gets frequently compared:\n\nSo while there is some general overlap, mostly in the idea that creativity is one of the core parts of the game, they mostly are pretty different. Minecraft is also infinitely modifiable, but it is not millions of games.\nAs 2020 closed, there were 20 million games, which opens up a new challenge: discoverability. Apple’s(NASDAQ:AAPL)struggles with this in the App Store, despite big investments there, highlight what a challenge that is. My own experience is that they are doing pretty well, but have a ways to go, like everyone else that is relying on algorithmic discovery.\nThe Metaverse\nWhat Roblox is building here is something futurists have referred to as a “metaverse,” a term lifted from a 1992 sci-fi novel,Snow Crash. You can think about the metaverse as a combination of persistent virtual worlds, and the real world interacting - the world of the film Ready Player One, but hopefully less awful. Roblox talks about 8 parts of this that make up the metaverse they are building.\n\nThe avatar. How each individual player chooses to represent themselves in virtual worlds. These can be self-designed or purchased.\nFriends. You are interacting with your real-life friends, and new ones you make on the platform. By December, they were processing 2 million chat messages a day. They do not have voice yet, mostly because they are working on a system that enforces their trust and civility standards, which is far easier to do with plain text messages (item 8 below).\n“Immersiveness.” They are working hard on iterating the graphics so 3D worlds can be everything from cartoony to highly realistic. The progress from even 5 years ago is extraordinary, and light years ahead of their original platform, which looked more like the blocky Minecraft world.\nGlobal and mobile. Games dynamically downshift graphics and rendering on older devices, or where internet connections are poor. Localization rollout is very far along, but slowed by their focus on content moderation. Again, this is an artifact of item 8 below. Their China strategy is a joint venture with Tencent.\nVariety. Millions of worlds.\n“Frictionless” movement between worlds in a matter of seconds. Games load incrementally, as data is needed. Users average playing 20 different games per month.\nMonetized via Robux, their in-game currency. Also future potential from ad revenue, but I believe they will limit this because of the next item.\nTrust and civility. This is super key for the long-term growth of the platform - to not let a small minority of trolls ruin the experience for everyone else. After developer payments, the largest line item in their Opex is “Infrastructure and trust & safety.” I view this as a crucial investment.\n\nRoblox is far from the only company trying to put something like this together, but I like their strategy, especially these aspects:\n\nCombining development and gameplay into one platform solves the Nobody Knows Anything Problem.\nTheir emphasis on the social aspects of gameplay.\nTheir emphasis on trust and civility.\nMonetization that is already working, and an untapped advertising stream of revenue in the future.\nThey run their own backend cloud, customized for their needs and ambitions. In some regions, they fall back to AWS (AMZN).\nThey prefer small, autonomous teams to large hierarchical groups, and encourage cross-pollination between groups.\nThe “moat” comes when they reach enough scale. They are not close yet.\nTheir future plans include translating this model focused on engagement with your friends and content creation to other areas like education, work, live events and video. I believe they have a key opportunity to become the preferred work-from-home platform over Zoom (ZM).\n\nThis is a wholistic, Apple-like strategy that is built to last.\nFinancials\nI specified GAAP revenue in the intro because digital goods companies like Roblox have complications, even that far up the operating statement. The big issue is that monetization is done through the sale of Robux, the in-game currency. But until the Robux are spent in-game, they are counted as deferred revenue, and not counted in GAAP revenue. This makes quite the difference.\n\nAs you can see, there were a lot of Christmas Robux still in user accounts at the end of 2020. So I’m going to redo the operating statement with revenue plus deferred Robux, or what Roblox calls “bookings,” as the top line. Bookings are a much more accurate representation of their cash flows from app store owners like Apple and Google.\n\nThe point is this is already a profitable company, despite the negative GAAP earnings, with $524 million in cash flows from operations in 2020 (CFOs count deferred revenue).\nWhat’s more, this is an efficient, mature operation. On every new tech listing, I have a metric I call “the revenue juicer.” Growth companies know analysts focus on revenue growth, so they juice that number with large discounts to customers that get filed away in cost-of-goods, or as a marketing cost. Revenues look larger, even if it doesn’t affect operating income. This metric is a way of catching that. It’s the sum of cost-of-goods and sales/marketing divided by revenue.\nJust to give you an idea of what this looks like, Snowflake (SNOW) is the most egregious recent example. In their last quarter, they spent $1.26 on customer acquisition for every dollar of revenue. Roblox spent $0.32 using GAAP revenue, and $0.28 using bookings as the denominator. They spent particularly little on marketing, only 3% of bookings and 6% of GAAP revenue. Their growth is largely organic, through word-of-mouth. Every parent of young children I know is talking about it. This is a virtuous cycle. As more people become attracted to the platform, more of them decide to make games, and the volume and quality of the games rises, attracting new users.\nTheir administrative expenses are similarly in-line at 5% of bookings and 11% of GAAP revenue.\nThis is a nicely run operation, that also has a big GAAP number coming in the March quarter as users spend down those holiday Robux account balances, and the revenue goes from deferred to GAAP.\nBut they are also expecting a drop-off in engagement from the pandemic highs as people begin to spend more time out of their houses. So let’s talk about user metrics.\nUser Metrics\nWhat we see here is huge growth in user metrics in 2020 that is not sustainable in a post-pandemic environment. Starting with daily active users:\n\nBut I hate DAUs. They tell you nothing about what people are doing while there. Fortunately, Roblox breaks out total hours of usage.\n\nPutting those together, on average, Roblox users spent an extra half hour a day in the app in 2020, after dipping slightly in 2019.\n\nThat extra half hour is the pandemic effect in a nutshell. Users are also spending more every hour.\n\nMy guess is they revert back to 2018-2019 type numbers in 2021 in those last two metrics. The company is also predicting that we could see some negative comps in 2021. Here’s their 2021 guidance from last week:\nThe party ends Q2.\nThe Whale Problem\nI’m a fan of S-1 “Risk Factors” sections. In the first place there’s a lot of information in there. But also, from the tone and language of how it’s written, you can get a sense of how management wants to frame problems. Are they being honest and forthright, and using plain English, or are they using a lot of management doublespeak? If it’sthe latter, it makes me sniff everything twice.\nRight off the bat, in the first paragraph, they made a friend:\n\n We have experienced rapid growth in the three months ended June 30, 2020, September 30, 2020, December 31, 2020, and for a portion of the three months ended March 31, 2020, due in part to the COVID-19 pandemic given our users have been online more as a result of global COVID-19 shelter-in-place policies. For example, our bookings increased 171% from the year ended December 31, 2019 to the year ended December 31, 2020. We do not expect these activity levels to be sustained, and in future periods we expect growth rates for our revenue to decline, and we may not experience any growth in bookings or our user base during periods where we are comparing against COVID-19 impacted periods.\n\nThis is carried through in their 2021 guidance we just looked at. This is a great example of their language in this section — simple, clear, informative. But the thing that stood out to me was something I was looking for, because it’s a thing that bothers me always, the so-called Whale Problem, or the 80-20 Problem. There are many companies in the free-to-play gaming business that get a very large portion of their revenues, around 80%, from a small number of users, around 20%. Those 20% are the “whales.” Roblox’ description:\n\nWe rely on a very small percentage of our total users for a significant majority of our revenue and bookings that we derive from our platform.\n\n\n We generate substantially all of our revenue through the sales of our virtual currency, “Robux,” which players can use to purchase virtual items sold by our developer and creator community on the platform. Only a small portion of our users regularly purchase Robux through subscriptions and pay for experiences and virtual items compared to all users who use our platform in any period.\n\nThe term “whale” comes from the casino business, where much of the house’s take comes from these whales. How this works at casinos is a great example as why I view this as a problem. Some of the highest paid people at casinos are the “hosts,” whose job it is to attract and retain whales. It is a large part of their focus and Opex. The problem is what attracts the whales will not always work on the general public. Casinos solved this problem with the one-on-one marketing of the hosts, and by having separate gaming areas for the whales.\nIn the gaming world, companies can fall into the same trap, but don’t have as clean a solution as the high-roller rooms in casinos. All users, from the whales to the people who never pay a dime, are all mixed together, by design. The trap here is the efforts to attract whales turns off everyone else — the other 80% that provide the network effects, but very little revenue.\nAt some point, management is going to come under pressure to keep revenues growing fast, and that means more whales, but that can also limit total user growth long term. They calmed my fears a bit with another section of Risk Factors:\n\nWe focus our business on our developers, creators, and users, and acting in their interests in the long-term may conflict with the short-term expectations of analysts and investors.\n\n\n A significant part of our business strategy and culture is to focus on long-term growth and developer, creator, and user experience over short-term financial results. We expect our expenses to continue to increase in the future as we broaden our developer, creator, and user community, as developers, creators, and users increase the amount and types of experiences and virtual items they make available on our platform and the content they consume, and as we develop and further enhance our platform, expand our technical infrastructure and data centers, and hire additional employees to support our expanding operations.\n\nThis is the right choice for what they are trying to build. Let’s hope they remember that in a couple of years.\nWrapping Up\nFirst, some summary bullets:\n\nRoblox is not a game, but a platform for both designing and playing games. They have 20 million games on the platform.\nLike other gaming companies, they are trying to build a metaverse that blends real and persistent virtual worlds. Social aspects are key in Roblox, and I believe they are focusing on the right parts of this, putting a lot of emphasis on having a safe, fun environment for all ages.\nThey have what I consider a durable long-term strategy.\nTheir growth up to now has been almost entirely via word-of-mouth.\nWithout a quirk in GAAP reporting, they are actually a profitable company with over a half billion in operational cash flows in 2020.\nLike many gaming companies, their user metrics all saw outrageous growth in 2020 due to the pandemic. That cannot be matched in 2021. Q1 GAAP numbers will be still very large due to high Robux balances at the end of 2020 and the same pandemic conditions, but the party ends Q2.\n\nSo I like what they have brewing here, despite all the long-term challenges of building something so ambitious. But that last bullet leads me to believe there is a better price coming later in the year when the reality of post-pandemic gaming patterns settle in. It looks like they packed a couple of years of growth into one year. As such, at current prices, which puts it with a higher market cap than EA (EA), makes me think there is a much better price coming later in the year. That’s why the neutral rating.\nI’ll circle back when they report Q1.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[{"id":322756110,"gmtCreate":1615836523030,"gmtModify":1704787288032,"author":{"id":"3565449260630555","authorId":"3565449260630555","authorIdStr":"3565449260630555","name":"jac_tb","avatar":"https://static.tigerbbs.com/b9fae92f2169c629ed025d1e5eba727c","vip":1,"crmLevel":2,"crmLevelSwitch":0,"idStr":"3565449260630555"},"htmlText":"Go go go!Buy and keep. Revisit again next quarter.","listText":"Go go go!Buy and keep. Revisit again next quarter.","text":"Go go go!Buy and keep. Revisit again next quarter.","images":[],"top":1,"highlighted":1,"essential":1,"paper":1,"likeSize":1,"commentSize":0,"repostSize":0,"link":"https://ttm.financial/post/322756110","repostId":1144000725,"repostType":2,"isVote":1,"likeStatus":false,"favoriteStatus":false,"reportStatus":false,"tweetType":1,"langContent":"EN"}],"isCommentEnd":false,"newsSizeData":{"likeSize":60,"commentSize":1,"repostSize":0,"favoriteSize":1,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.28.3","shortVersion":"4.28.3","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/1144000725"}