RBLX - Roblox

[Krapdivad]

Taking a look at this company before its direct listing. Not really my typical investment, but more of a bet on the opportunity to own a potential compounder with a passionate founder, in a niche market with a long runway for global expansion, producing positive free cash flow, and a flywheel for strengthening its network moat.

 

Betting on the Jockey: Passionate and long-term focused founder CEO:

Roblox was an idea that was formed by its founders after their initial physics simulation software in 1989 and has been their main focus ever since 2004 with the creation of Roblox. The remaining founder David Baszucki has been singularly focused on creating a shared 3D virtual space aka Metaverse to bring people together by doing things together online. Baszucki owns 12% of Roblox and 70% of the voting power (strongly aligned with the success of the company). 
If David Baszucki left for any reason or died, it would be a huge hit to the company.

 

Network Effect of Users and Flywheel of User Developed Content

Roblox is able to compete against other companies because of their network effect. They have captured the majority of the 12 and under group and so it’s harder for users to switch to another platform when all their friends are already on Roblox.

Roblox doesn’t need to create any content themselves. They have a self generating content engine powered by their users. These developers and creators can be paid well and are incentivized by Roblox’s large user base, which further incentivizes more users to join the platform.

The effectiveness of this flywheel is apparent in Roblox’s growth numbers, which have been increasing exponentially. Currently 31 M daily active users over 180 countries.

DAU’s have been increasing 50-80%

Hours engaged have been increasing 50-120% (2.6 hours a day - the most among any social app)

Bookings growing from 40-170%

 

Robux is the revenue generator of this ecosystem where it’s purchased by the users who want to personalize their avatars and pay for experiences, and in turn is used to pay the developers.

This model has proven to produce free cash flow for the company and high growth margins. Roblox is focused on expanding this ecosystem globally, and into a wider variety of experiences (i.e. concerts) which gives it a large runway to expand into adjacent markets. They’re currently focused on growth mode, and are paying the game developers very well. There are about 2 trillion people under the age of 15 in the world (so 31 M current users is a drop in the bucket).

 

Risk of Future Competition

Roblox has only a segment of the demographic for online gameplay. In addition to all the other online video game makers and competitors where users can spend their time, Facebook has been way ahead of Roblox in terms of developing the hardware (VR) for the future of immersive online experiences. Facebook also has a much larger demographic and more experience with tailoring content to individual users. Facebook has recently been putting a lot of money and effort into blocking harmful content for their users. This is in direct competition with Roblox’s focus on safety and civility. There is a risk that Roblox users will switch over to Facebook if Facebook creates a similar ecosystem with their already massive user base.

Roblox is operating in a very fast changing industry, and there is risk that either competition or regulation can slow down their growth rate.

 

Roblox could turn out like MySpace where it enjoyed a network effect but lost the competitive advantage once Facebook proved to be a superior platform and it didn’t adapt fast enough.


Roblox is paying 30% of their revenue’s to Apple & Google for their app stores. If apple decides to change or add more privacy and data collection requirements to Roblox’s business, it would hurt the business. 70% of users come from Apple’s App Store or Google Play store

 

Risk of Loss of Users and Regulation

Since the majority of Roblox’s user base are children, a hack into Roblox to compromise the safety and civility aspects of the company would be devastating to the company. Parents would pull their kids off Roblox if there was any hint of it being unsafe for children. Perhaps even a widely spread false rumor could trigger a mass exodus from the platform or heavy governmental scrutiny.

Future governmental regulation may be imposed onto Roblox because of too much screen time, or safety concerns and would slow Roblox’s growth. 
Covid was a tailwind to Roblox’s growth and this may not be sustainable.

Any lapse in services could also detract users into joining a different platform.

Robux are purchased regularly by a very small percentage of the total users. If this group were to stop purchasing Robux, it would be very harmful to the company.

 

Valuation ($30B)

No matter how great the company, we can’t pay an infinite price for it, as Munger says. The company was valued at $4B last year and is now valued at $30B, indicating people are pricing a very optimistic future. Private investors have already seen a huge increase in their ownership and can sell immediately once Roblox goes public. However, the stock may become even more popular after if debuts on the public market. As a fast grower, Roblox will have negative earnings for quite some time because they’re spending to gain marketshare.

However, they do generate positive free cash flow of about $390M / year ($292M for last 9 months *4/3). At a 35% growth rate, you could expect to get back your money in 16 years.

Ideally I would wait for the valuation to fall to $15B to buy with a 50% margin of safety. However, with a company growing this fast and the popularity of IPO’s that opportunity may not come. It may be worth getting a position in the company just to take a ride on their upward growth trajectory.

 

Downside:

If users were to mass migrate to another platform due to a hack, or a competitor’s superior immersive experience from a more experienced and well capitalized competitor (Facebook, Apple, Google, Amazon) it would spell the destruction of Roblox in this winner take all situation.

Paying up to buy Roblox at a very high valuations means that the company has to execute perfectly on its growth strategy. Any misstep or threat of regulation and the share price may crash.

 

Summary

 

I’d be willing to place a small bet (3-5% of my portfolio) on Roblox based on it’s excellent management (a passionate, visionary, Founder-led CEO with a large stake in the company and long term outlook), it’s flywheel growth engine (game developers are attracted to create on the platform because of the strong user base, which attracts more users to the platform), and its potential to spread into adjacent fields of virtual entertainment and advertising (virtual concerts and events). Roblox has an economy where users pay for all the generated content using Robux and the game developers are incentivized to produce the best content and paid in Robux. This kind of business engine allows the company to focus on their improving their tech and engineering (79% of employees are engineers) and allows it to be profitable enough to generate positive free cash flow. The company has a long runway since it can expand globally.

Additionally, it seems like WSB  on Reddit is positive on this company, which can turn it into a “meme stock” and make it take off.


The downside is that the stock is currently priced for perfection so buying at the public price will leave it vulnerable to any bad news I.e. Low guidance in their metrics (DAUs or bookings), a hacking event, or hints of regulation, early private investors deciding to sell out to secure their gains, can all cause the stock to crash.

 

 

[samwise]

Yes this is very popular with 9 year olds currently. But (in the past) so were fidget spinners, hatchimals, lol dolls etc. Why is this different , why won't it fade?

 

If they can maintain their popularity, then they could possibly make money. If they become the platform of choice where developers make games..  like the youtube of games.. thats very valuable.. but how are you confident enough to pay almost 40x revenue on a loss making company, where the SEC is questioning their revenue recognition?

 

Of course, it might go on to be hugely profitable eventually, or the stock may work out despite profits. But I'm not sure how one can be reasonably sure of that now.

[Spekulatius]

I expect user engagement and time spent on the platform to go down once we are past the epidemic. This was a pretty unusual time which has helped gaming platforms for kids tremendously, imo.

It’s a business worth following but not worth buying for $30B imo.

[Krapdivad]

Thanks for your insight, I agree that it's hard to predict if Roblox will become a "fade-defying" business in this fast changing industry.

 

I think what's special about the Roblox game engine is that all the content is user generated and constantly being updated. Therefore, Roblox isn't a static game, but constantly evolving with new games and experiences that users can choose from. This gives it some defense against users becoming bored with it and moving onto a different platform. It's similar to Youtube where Google just focuses on improving the engineering behind the platform while the users provide the ever expanding and changing content. This new content then attracts new users and new content creators.

 

Yes this is very popular with 9 year olds currently. But (in the past) so were fidget spinners, hatchimals, lol dolls etc. Why is this different , why won't it fade?

 

If they can maintain their popularity, then they could possibly make money. If they become the platform of choice where developers make games..  like the youtube of games.. thats very valuable.. but how are you confident enough to pay almost 40x revenue on a loss making company, where the SEC is questioning their revenue recognition?

 

Of course, it might go on to be hugely profitable eventually, or the stock may work out despite profits. But I'm not sure how one can be reasonably sure of that now.

[Krapdivad]

That's true, the pandemic was definitely a tailwind for the company.

 

I'm looking at the company though the long term lens that Mohnish recently gathered from Nick Sleep's investing letters. If you're able to identify a company that can compound with a long and wide runway, valuation almost takes a back seat. I think Roblox has been one of the first to figure out this emerging market space of 3D virtual "metaverse" experience which has been made possible by improving technology. They've created a sustainable engine of content creation whose magnitude can grow considerably larger than it is now.

 

I agree that short term bad news on falling engagement numbers will hurt the stock price. However, I'm also thinking it's quite rare to find a company that contains this perpetual growth engine powered by its own users.

 

Appreciate the feedback, and looking forward to thinking about this some more.

 

 

I expect user engagement and time spent on the platform to go down once we are past the epidemic. This was a pretty unusual time which has helped gaming platforms for kids tremendously, imo.

It’s a business worth following but not worth buying for $30B imo.

[Spekulatius]

the Motley Fool Industryfocus podcast had an episode about Roblox recently that is worth a listen.

Another thing I failed to mention is that the lifetime value of Roblox zu stones is limited by the fact that they outgrow the game whe they get about 12-13 years old.

My son is 15 and I asked him about this game and he was well aware or it. But mentioned that nobody in his age group plays this any more. So this is a GME that is payed by 6-12 years old mostly. now if Roblox can extend the duration, it could be a huge leap to increasing the franchise value, but I not sure there is much evidence they can pull this off. This is not an evergreen game like Minecraft in terms of players age.

[spartansaver]

There are not 2 trillion people under the age of 15 in the world. Roblox has an age rating of 7+ so I don't think it is that popular among infants. So if we take the 7 to 15 year old population in the world, we get a total addressable market of about 1B people. I've now cut your TAM by 99.5%.

 

A 35% growth rate over a 16 year time horizon is off the charts. You're talking about the top half percent of companies. A 35% growth rate over 16 years for the current user pool implies nearly 4B kids are playing Roblox in 2037 (around 50% of the population). Now maybe they get some growth in hours played per day (there are only so many hours in a day), and pricing, but I hope this puts some stuff in perspective.

 

Why is it properly valued at $30B and at $15B it has a 50% margin of safety? Was $26B in value created over the course of a year?

 

Your FCF number is nearly entirely dependent on unearned revenues. The change in unearned revenues is roughly equivalent to the revenue generated over the past 12 months. Is that really sustainable?

 

Why did MySpace fail while Facebook succeeded? It had a so called network effect. It went in reverse when people started leaving. Not every network effect business has some amazing moat.

 

 

[Krapdivad]

Excellent points. Looks like Roblox will have a difficult time capturing the 12+ year old market. They’re hoping that as kids age, the users will begin to develop more sophisticated games.

35% growth is indeed very aggressive. Facebook was able to grow its revenues by 37% the last 5 years, but Roblox doesn’t have the same demographics.

Seems like MySpace failed because they were too focused on marketing and advertising and let the technical side of the business lag behind the competition. It looks like at Roblox, they have the opposite stance, with very little towards marketing and with most of the employees being engineers.

 

How would you value the company? Is this something that would go in your “too hard pile”?

I thought the free cash flow metric would be useful in calculating a potential valuation.

I do know that roblox’s revenues are a lagging indicator because they way they amortize the bookings over 2 years. So the free cash flow may even be a conservative amount.

 

 

There are not 2 trillion people under the age of 15 in the world. Roblox has an age rating of 7+ so I don't think it is that popular among infants. So if we take the 7 to 15 year old population in the world, we get a total addressable market of about 1B people. I've now cut your TAM by 99.5%.

 

A 35% growth rate over a 16 year time horizon is off the charts. You're talking about the top half percent of companies. A 35% growth rate over 16 years for the current user pool implies nearly 4B kids are playing Roblox in 2037 (around 50% of the population). Now maybe they get some growth in hours played per day (there are only so many hours in a day), and pricing, but I hope this puts some stuff in perspective.

 

Why is it properly valued at $30B and at $15B it has a 50% margin of safety? Was $26B in value created over the course of a year?

 

Your FCF number is nearly entirely dependent on unearned revenues. The change in unearned revenues is roughly equivalent to the revenue generated over the past 12 months. Is that really sustainable?

 

Why did MySpace fail while Facebook succeeded? It had a so called network effect. It went in reverse when people started leaving. Not every network effect business has some amazing moat.

[Ballinvarosig Investors]

I bought my kid $15 worth of Roblox credit as a treat last week for good behaviour. I asked her yesterday how much credit she had left, she said she spent it all and would like some more. All her friends play it, and likewise are pestering their parents for Roblox credit. It looks a great business model and it's going to continue growing for awhile yet.

 

Looing at valuation, Microsoft paid $2b for Minecraft, but that seems to have a different business model. It seems to be more a one-off purchase (I bought my key for it off Ebay for $2). Whereas Roblox on the other hand is free, but makes a lot more on the in-app purchases. Roblox is still very much in its infancy in terms of revenue generation. I can see them getting into licencing, merchandising, and who knows what else. I have yet to see it making the same sort of penetration like Minecraft has done on that front yet.

 

The valuation is racy, but I can see how Roblox can grow into it, certainly a lot more so than the likes of DoorDash or Uber for example. Also, in terms of valuation, $30b is nothing in the grand scheme of things. I can see the likes of Facebook or Google being very interested in this company, it's target market is 6-12 year olds, and these are EXACTLY the types of people you want to be integrating into your eco-system.

 

So yea, all in all, I think I would buy this at $30b, but my guess is that the day this IPO's, it will probably open up at like 50% up.

[Spekulatius]

^ Yes, that’s how it works. FWIW, Minecraft has its own ecosystem that may actually be undermonitized. I know a tech at work who builds models of European castles in Minecraft and he is part of a online Minecraft group that is exchanging models, but outside of the Minecraft ecosystem. I kind rolled myself eyes when he talked to me about the details they go through to generate models so he stopped talking. I probably have listen longer to find out what is going on and the implications of this for business like this.

 

As far as Roblox is concerned, I do think they may have tough comps next year as parents crack down on screentime more when regular kids activities resume. Last year was a disaster as most sports were cancelled or severely curtailed and school went partly online so screentime went through the roof.

Smaller kids access is more controlled by parents (or should be) so I expect some reversal to the mean in terms of online games.

 

 

[Krapdivad]

Came across an interesting blog article that describes Apple’s App Store effect on Roblox margins and the hole it puts Roblox in. Is the solution to just invest in Apple?!

 

https://www.matthewball.vc/all/applemetaverse

 

“Consider the illustrative $100 in iOS Roblox revenue (an estimated 75-80% of all revenues). $30 goes to Apple off the top, while $31 is consumed by Roblox’s core infrastructure and safety costs, and another $11 is taken up by overhead. This leaves a total of $28 in pre-tax gross margin dollars for Roblox to reinvest in its platform. This reinvestment spans three categories: research and development (which makes the platform better for users and developers), user acquisition (which grows network effects, value for the individual player, and revenues for developers), and developer payments (which leads to the creation of better games on Roblox). Today, Roblox reinvests 23% of revenues in R&D, 7% on sales and marketing, and the aforementioned 24.5% on developer payments. As a result, it currently operates at a roughly -25% margin.

 

Roblox has doubtlessly enriched the digital world and led to hundreds of thousands of new digital creators. But for every $100 it creates, it loses $25, developers collect $24.5 in net revenue (i.e. before all of their development costs), and Apple collects roughly $30 in pure profits despite putting nothing at risk. The only way for Roblox to increase developer revenues today is to deepen its losses or halt its R&D, which would in turn harm both Roblox and its developers over the long-term.

 

Roblox’s economics should improve with scale. Overhead, sales and marketing should grow more slowly than revenues. However, this would unlock only a few percentage points to cover significant losses or marginally increase developer revenue shares. R&D should offer some scale-related margin improvements, too, but fast-growing companies shouldn’t be achieving profitability through R&D operating leverage. The company’s two largest costs, which comprise roughly 61% of revenues, are essentially fixed. Infrastructure, which largely scales with usage and will become more expensive as the platforms expands its concurrency capacity and expands into VR. And Roblox doesn’t control store fees; that’s exclusively up to the platform.

 

In effect, the only way a Roblox developer could collect a substantially greater share of their game revenues would be if (1) Apple built its own Roblox-like platform; (2) all eligible users had and only wanted to use their iOS devices to play Appleblox; and (3) Apple operated Appleblox at break-even (which the App Store was intended to do but doesn’t) or didn’t pay fees to the Apple App Store (which all Apple services do).”

 

 

[Spekulatius]

^ The -25% is mostly due to stock based comp which doesn’t count? If anything, I think Apple is undercharging relative to Android  which has the same take rate. It is also amazing that Apple phones have only roughly a 14% world wide market share, yet generates 75-80% of the revenue. Also, how come this business is still worth ~$30B?  Can‘t have it both ways.

 

But overall, I agree, if Apple can keep this up, the App Store 30% royalty is worth a lot.

[Jurgis]

It makes a lot of sense for Apple to acquire Roblox. Roblox is operating in the grey area of the Apple store ecosystem. Apple would face a huge pushback if it banned Roblox from its Apple store. However, if it does not ban Roblox from the store, it will face pushback from other game platform companies that are not allowed on the Apple store. Acquiring Roblox would be a perfect solution that resolves this. Also it would put Apple into a moaty brandy family friendly ecosystem that IMO matches Apple's brand and company culture.

 

I am going to predict that Apple won't buy Roblox though ( https://finpredictions.com/questions/will-apple-or-another-company-acquire-roblox-end-2021/ ), since Roblox is likely to be very expensive and Apple is quite conservative with acquisitions. Plus Apple infrequently acquires software or gaming companies.

[K2SO]

FWIW, my 9 year old got some Robux for the first time for Christmas and the day after adding them to her account woke up to find her account hacked and her money cleaned out. Dealing with Robux customer service eventually recovered the credits but apparently this a widespread problem. This is a consequence of their young and vulnerable user base, and they will need to invest more in policing it. She now has two factor authentication on her account which is a real hassle because every time she wants to log in to play mom gets a text with a login code.

 

[Jurgis]

FWIW, my 9 year old got some Robux for the first time for Christmas and the day after adding them to her account woke up to find her account hacked and her money cleaned out. Dealing with Robux customer service eventually recovered the credits but apparently this a widespread problem. This is a consequence of their young and vulnerable user base, and they will need to invest more in policing it. She now has two factor authentication on her account which is a real hassle because every time she wants to log in to play mom gets a text with a login code.

 

Yeah, I can imagine having kids as customers is a pain in the neck for e-companies. But still big business.

 

I wonder if Apple could do something extra for validation/authentication, but it's likely most good/feasible solutions are children law privacy nightmares.

[Spekulatius]

Looks like they waited a bit too long to IPO, ARR looks like they flatline in 2021:

 

It will be interesting how this performs out of the direct listing gate. keep in mind, that they tend have 5% dilution annually in shares from SBC.

 

[GrahamKlarman]

This is an interesting thesis. My kids love this game.

[Aurelius]

I have an 8 year old who also loves Roblox.

 

We have a Switch which he hasn't used in months.

He used to play a lot of Fortnite. He only plays it sometimes now.

He likes Roblox.

But what's even better is he spends more time building (scripting) and learning to build his own Roblox games rather than actually playing the games.

He learns scripting through Youtube.

 

He absolutely loves Youtube as well where he has his own channel :P

 

Now he is asking me to give him chores around the house so he can get Roblox Premium -a monthly Robux allowance.

[Broeb22]

I have an 8 year old who also loves Roblox.

 

We have a Switch which he hasn't used in months.

He used to play a lot of Fortnite. He only plays it sometimes now.

He likes Roblox.

But what's even better is he spends more time building (scripting) and learning to build his own Roblox games rather than actually playing the games.

He learns scripting through Youtube.

 

He absolutely loves Youtube as well where he has his own channel :P

 

Now he is asking me to give him chores around the house so he can get Roblox Premium -a monthly Robux allowance.

 

Does this make you Daddy Robux?

[KCLarkin]

I have an 8 year old who also loves Roblox.

 

We have a Switch which he hasn't used in months.

He used to play a lot of Fortnite. He only plays it sometimes now.

He likes Roblox.

But what's even better is he spends more time building (scripting) and learning to build his own Roblox games rather than actually playing the games.

He learns scripting through Youtube.

 

He absolutely loves Youtube as well where he has his own channel :P

 

Now he is asking me to give him chores around the house so he can get Roblox Premium -a monthly Robux allowance.

 

Not sure if these anecdotes make RBLX a good investment, but similar for my sons (8/10). They basically play Roblox/Minecraft with their friends. And then watch youtube videos about Roblox/Minecraft. They used to play Pokemon Go too and I assume that will return when the weather gets better. Our switch goes unused months at a time.

[Ice77]

Ben Thompson makes a persuasive case for the uniqueness and transformative nature of Roblox, a metaverse in itself, that wasn't possible in the pre-internet era.

 

"Roblox isn’t a game at all: it is world in which one of the things you can do is play games, with a persistent identity, persistent set of friends, persistent money, all disconnected from the device that you use to access the world. That is the transformational change"

 

"..by controlling everything Roblox can bring all of the disparate parts of gaming into one place; instead of one app for social interactions, another app for purchases, and a different app for every different game, everything is all in the same place. This also makes Roblox easier to develop for: by constraining graphics to a consistent toolbox it is very easy to build something new"

 

"This creates the conditions for the interlocking feedback loops that characterize transformational products; by reducing the prominence and feature set of games, Roblox made it possible to create something bigger. A microverse. This actually fits the patterns of other transformational products"

[Pelagic]

Isn't there a big risk here that another Fortnite like game comes around and captivates this age range's gaming time/budget? I don't think Epic/EA/Activision etc. are sitting on their hands - they know the younger gamer market exists and Epic saw how valuable it was with Fortnite during its heyday, Roblox's success validates the value of the market as well. Successful games in this age range (or any other range) are a winner take most enterprise where once they catch on "everyone" plays them while they're hot because it's what their friends play. And then the herd shifts to a new title.

 

I think from an investment perspective we have to assess the risk of another dominant game like Fortnite coming around from a competitor that captures a majority of users.

[no_free_lunch]

I know some little people who are also addicted to the Roblox. Lol.

 

Pelagic, it's not a game it's a platform. Certainly still risks but the kids are playing it to access this huge catalog of user generated content. They also are making said user generated content.

 

I guess one issue I see is there are rumors the revenue sharing with content creators is not great.  However some of the top ones do make millions and many people do it more as a hobby.

 

What makes it such an ideal investment is they just have to do revenue share with content creators. If there content sucks they don't cost anything. If they make a hit they are still only getting a fraction  One of the biggest risks with games is dice rolling on content. You don't have that here.

 

If we weren't in the middle of an epic tech bubble I would buy it in a heartbeat.

[fareastwarriors]

What kind of pop should we expect here?

[perulv]

Like many others here, I have an 11 year old that did her (my) first online purchase in Roblox. I would normally not consider buying something with this valuation/fundamentals, but I am thinking of buying a few shares for my kids. Perhaps it could get them interested in investing at some point. Since I really don´t have any idea of the intrinsic value, and half the world might want to buy this for the lolz today, what would be a good (eh) price to set the buy-order(s) at? I know this sounds like a crazy question at a value investing forum, but this is also a very different "trade" for me. I guess I can see the order book before the markets open, but I am thinking it might make sense to have an order or two in that order book by the time I can see it :o