To The Moon

Introduction

Shares of Roblox $Roblox Corporation(RBLX)$ have rebounded some 48% from the June low of $24.70 as markets held onto the belief that inflation may have peaked. While falling prices are indeed a strong 2H22 possibility and would suggesta favorable backdrop for long-duration assets, Roblox's fundamental prospects remain in question given the company was largely a pandemic-driven story. As a result, I believe investors should treat the recent market rally as a selling opportunity given Roblox will likely continue to post disappointing results as the world returns to normalcy.

All good things come to an end

Roblox's business experienced parabolic growth as soon as the pandemic hit. In 2Q20, the company saw quarterly bookings jumped 229% YoY to $494 million while daily active users (DAUs) increased by 95% YoY to 33.4 million. Understandably, growth across all business metrics leveled off throughout the next 6 quarters, with bookings reaching a record $770 million (+20% YoY) and DAUs expanding to 49.5 million (+33% YoY) in 4Q21. That said, Roblox's stock almost doubled at one point during the fourth quarter of 2021 when Wall Street and Co. turned its attention to the metaverse.

Like all businesses that benefited significantly from the pandemic, all good things must come to an end. In 1Q22, Roblox's metrics began lapping insurmountable prior year comps, with bookings down 3% YoY to $631 million despite DAUs still grew 28% to 54.1 million. While hours engaged were up 22% YoY to 11.8 billion, average bookings per DAU (ABPDAU) saw a sharp 25% contraction from $15.48 in 1Q21 to $11.67. In short, Roblox was able to grow its user base in a post-pandemic world, but users were not spending as much on the platform as they once did (see table below).

Following 1Q22 results, Roblox's metrics in subsequent months exhibited further signs of weakness. In April, bookings of $223 million saw a back-to-back 9% YoY decline while ABPDAU of $4.19 was down 26% YoY. In May, bookings of $198 million were down 11% MoM and 9% YoY, and ABPDAU again was reduced $3.92, down 6% MoM and 23% YoY. Essentially, lower bookings imply lower future revenues, as Roblox doesn't immediately recognize sales when a player buys say $10 worth of Robux (Roblox's in-game currency). Instead, the $10 is initially recorded as bookings and recognized as revenue over the next 25 months.

Company data

2Q22 metrics likely unachievable

With April and May metrics extending Q'1 weakness, it's difficult to imagine a strong summer for Roblox when kids will likely be traveling rather than staying at home. Interestingly, Street estimates haven't quite adjusted to this reality as 2Q22 bookings are expected to be $641 million (-3.7% YoY vs. -3% in 1Q22). This implies bookings of $221 million in the month of June, up 12% MoM and 9% YoY (vs. -11% MoM and -9% YoY in May), a sudden acceleration that doesn't seem to make much sense. As a result, I think Q2 results will likely be underwhelming, with Q3 and Q4 numbers also at risk of downward revisions.

Why is the stock down so much?

In my view, shares of Roblox are down 76% from their 4Q21 peak for two reasons. First, valuation was driven by immense speculation, reaching unsustainably high levels (>24x forward EV/sales) in November 2021 when the concept of metaverse took over every news headline. Second, despite reporting $1.9 billion in record revenue in 2021 (more than doubled 2020 sales), Roblox continued to be a money-losing business with an operating margin of -26%. When the tide goes out, investors simply have no patience for unprofitable businesses that promise to make money somewhere down the road.

This is the part where management usually asks analysts to refer to adjusted EBITDA and free cash flows. However, a major portion of these profit metrics comes from stock-based compensation. SBC is an efficient way to compensate employees without any initial cash outlays, but it does come with several downsides such as shareholder dilution and employees likely asking for cash compensations when a company's stock suffers a big decline. In short, while SBC could be a virtuous cycle on the way up, it could also be a vicious cycle on the way down.

Sell the rip, fair value of $19

Per Street estimates, Roblox is expected to deliver roughly $3 billion in bookings (+13% YoY) in the next 4 quarters from 3Q22 to 2Q23. This comes down to a forward EV/sales of 6x, which may seem undemanding against previous levels. However, forward estimates are likely to be revised downward as Roblox may already have trouble meeting expectations in the current quarter. This suggests the stock may be overvalued the higher it goes. While comps will be easier in 2H22, 3Q22 and 4Q22 estimates of 6% and 11% YoY bookings growth seem somewhat awkward given Q2 bookings are expected to decline by 4% YoY. Looking further out to 1H23, Q1 and Q2 estimates imply growth re-accelerating to 17% and 20% YoY, respectively. These numbers are quite aggressive, in my view.

Given Roblox's lack of earnings and slowing top-line growth, DAUs seem to be the only metric supporting the stock's valuation. In the likely case where estimates see another round of downward revisions, coupled with a shrinking user base, I see a scenario where Roblox's EV/sales multiple suffers another 50% decline to reach 3x. This implies a target price of $19 a share, a 46% downside from the current price of $35. As a result, I believe investors chasing the rally may face an increasingly negative risk/reward profile.

Of course, there are risks associated with shorting a stock like Roblox. First, there could be acquisition rumors given the stock is down so much, where a larger company looking to enter the metaverse may find Roblox's platform and users valuable. Second, there's no guarantee that retail investors cannot suddenly find interest in pushing up the stock price, as we've seen in cases like GameStop and Revlon. Third, inflation might just come down materially faster than expected. This could quickly spark a positive sentiment or FOMO for most long-duration assets given the level of decline they've experienced.

Roblox doesn't pay a dividend given it's an unprofitable company, so short sellers will only bear the cost of borrowing, which varies between brokers. In terms of the investment horizon, I'd say it largely depends on the price action. From a technical perspective, the stock has closed 13% above its 50-day moving average, with the March low of $36 being a major resistance that will likely hamper further rally given the lack of fundamental support. If the stock fails to break this level and returns back to its previous low of $22, I'd expect most short sellers to cover their positions.