To The Moon

‌$Roblox Corporation(RBLX)$  ‌

If you have children, or if you are a gamer yourself, there is a good chance that you might have heard about the popular game Roblox. In fact, over the past couple of years since making its inception in 2006, Roblox has been making waves in the gaming community and its popularity has skyrocketed among both the kids under 13 and young adults.

Roblox is one of the beneficiaries that resulted from the pandemic growth as gaming took stage centre, but it has fallen by more than 70% since hitting the peak at $134.7 back in Nov 2021. Is there value at this company after falling so much, and what is the projector trajectory growth going forward? Let’s deep dive to find out.

Roblox Business Model and Platform Stickiness:‌

Roblox’s main core mission is to build a human co-experience platform that enables shared experiences among billions of users.

One of the many reasons why it has been so successful is because it has been reimagining the way people come together as a community.

Roblox developed their own developer exchange economy ecosystem about seven years ago. The main philosophy was to create a system that connects the gamers that play on their platform with their developers which in turn allow developers themselves to create further amazing content, and to monetize it.

This is the reason why one of Roblox’s main expenses today are developer exchange fees because for every revenue they earn, a portion of that goes back to its developers as a form of profit sharing.

Platform stickiness is a virtue to the company because you get to retain your users for longer periods which lead to increase sales and lifetime value of the users.

Using my own case study as an example, I have seen my own two children (aged 6 and 9 respectively) played this game and spent on average about 2-3 hours/weekday on the game. The hours spent increased to about 4-5 hours when it is weekend or public holiday. As committed paying users ourselves, we are familiar with just how addicted this gaming platform can be and the entertainment impact to us.

How Roblox Makes Money?

Roblox generates money through a combination of in-game purchases, advertising, and premium membership subscriptions.

Anyone can register and start playing the game for free but to obtain a more sophisticated user experience that allows them to deepen their networking with other people, they would have to usually purchase a virtual currency called Robux. These “Robux” coins allow users to purchase virtual items, get to deeper levels, and interact with more seasoned players.

Roblox recognizes revenue in two different stages:

• For Consumable Virtual Items, Revenue is recognized immediately upon consumption.

Consumable Virtual Items refer to things such as potion, power-ups, and boost – which typically lasts within a few hours, and they had to be consumed when playing as a character.

• For Durable Virtual Items, Revenue is recognized over lifetime of paying user.

Durable Virtual Items refer to things such as avatar, which they can equip with them and display it on their profile or character.

Prior to Q3 2022, the average lifetime user was 25 months. But due to the stickiness of the ecosystem, the average lifetime for a paying user has increased to 28 months since then.

What this means is that for bookings related to durable virtual items, that amount is deferred and amortised over the number of lifetime paying user, which currently stands at 28 months. This explains why you might see deferred revenue as one of the balance sheet items.

Key Operating Metrics:

Because of the way the company is reconciling its revenue and cost due to GAAP requirement, it is more useful to look at other business key operating metrics such as Booking Dollars.

This allows investors to look at how much bookings that the paying user has purchased in relation to the period, even though some of that portion may be deferred over time.

As you can see from the graph appended below, the company registered most of their year-on-year booking growth during the pandemic era and but even so, the company continued to perform impressively over the past couple of quarters registering 10%, 17%, and 23% YoY growth in the last three quarters.

Other than bookings, one other critical key operating metrics that we also have to look at is the Daily Active Users (DAUs) and the Number of Hours engaged. Keeping users engaged and spending longer hours in the ecosystem are important aspects of a successful flywheel effect.

Based on the graph appended below, it looks like the company has been doing very well in growing their active users as well as keeping them engaged for longer hours.

One important growth aspect which Roblox can take advantage of (which I think they are already moving towards that direction) is to engage the older crowd into the platform.

As you can see from the graph appended below, Roblox started off a couple of years ago with predominantly users which are under the age of 13. However, the demographics have shifted over time to younger adults who are over the age of 13.

This is important for the company because older users are likely to have higher purchasing power since they have either higher allowance from their parents or for those who have started working, they can afford to spend more.

Threats & Risks:‌

The biggest risks to the company, especially when pivoting to older gamers is the fight for hours span and attention – competition.

In today’s era where popular MOBA games such as League of Legends, Dota, Fortnite, Brawl Stars, Pokémon Unite and many more exist – where I play most of the games myself listed above – there are strong competitions to attract the short attention span of these gamers. When that happens, we could see active users moving from one game to another and this can bring down the total daily active users and number of hours engaged in the gaming platform.

The other risks that I see that could pose a problem stem from the choppy cashflow that the company is generating right now. As you can see from the last 4 quarters, 3 quarters have been in negative free cash flow territory, as the company decided that it was in their best interests at that time to spend more on acquisitions, servers, infrastructure, and tenant improvements as the company aimed to return to higher growth.

For company’s valuation, I am using the discounted cash flow methodology across the next few years and have the total sum discounted back to its present value today. That will give me the enterprise value of the company.

I have then added back their cash and investment portion and subtract the debt to arrive at the equity value.

A discount rate sensitivity of between 8-10% are used in the model.

Since Roblox is a growth company, we’ll be using the terminal cashflow multiple of between 20x to 30x, with 25x the median multiple.

This is almost an equivalent of Price to Sales multiple of 5x, assuming margin is roughly at 1/5 or 20%.

2021 actual numbers were an isolated anomaly growth as the company saw an expansion in DAU and Bookings rapidly during the pandemic. It has since normalised to a more reasonable level. In the past 4-5 quarters, the company has been spending heavily on acquisitions, improving their servers & infrastructure, and increasing their retention on users. As a result, the company registered negative free cash flow in 2022. I believe the capex spend should normalize soon and the company will be able to return to positive free cash flow once that happens.

From 2023F cashflow, I have used the Q1 actuals and annualize it across for the year. A 30% growth was then applied from 2024-2026.

Outstanding shares are expected to increase at roughly 4% increment every year due to stock based compensation.

With a 25x terminal cashflow multiple at a discount rate of 9%, this equates to an equity value of $15.3b or $23.2 per share.

Conclusion:

While Roblox remains a competitive and fun platform for both kids and younger adults to use, I believe the company is currently overvalued at the moment by about 67% as of writing. I will only be considering or initiating a position once it hits below my intrinsic value of $23.2 per share.