Roblox Stock: Falling Bookings Raise Concerns
Conviction is a critically important virtue of an effective leader. You must believe what you say when you say it. There’s no room for misinterpretation when you’re commanding the troops. This same principle extends to the investing world. We often make fun of the term “cautious optimism” because it epitomizes how many pundits are afraid to speak with conviction and have an actual strong opinion about an investment. That’s because when you’re wrong, people will come out of the woodwork to point out what a short-sighted buffoon you are. When you’re right, it’s the sound of crickets.
To mitigate this problem, simply formulate a strong opinion based on evidence you neatly gather and present to support your thesis while also considering both sides. If you end up being wrong, just do what every MBA learns to do in bee school – shift the blame to someone else and quickly change the subject.
Today, we want to formulate an opinion about Roblox (RBLX), a possible play on “the metaverse.”
The Roblox Business Model
Just over a year ago we looked at how Social VR Brings People Together in Virtual Worlds and said “Roblox may well be worth a deep dive for our premium readers in the future, with so few attractive stocks in the current VR/AR metaverse.” Since then, shares of Roblox have fallen 47% compared to a Nasdaq loss of 10% over the same time frame. If you liked Roblox a year ago, you must love it today at these prices. So, is this a quality company that might find a spot in our own tech stock portfolio?
We always start by looking at what we’re already holding that might provide comparable exposure. Unity Software (U) is a company that has plenty of gaming exposure, but one that can’t be compared to Roblox because the former is more durable than the latter. Unity doesn’t care which mobile games are popular on which platforms because their platform was used to develop 71% of them. Roblox offers a closed-loop system which is only as popular as their brand is. 100% of people who play Roblox know what Roblox is. A fraction of people who play the world’s most popular mobile games know who Unity Software is. You can read more about Unity in our recent piece titled Unity Software Stock Plummets. Is it a Buy Now?, but today we’ll be breaking down the Roblox business model in its most basic form.
We generate substantially all of our revenue through the sale of virtual items on the Roblox Platform. Users can purchase and spend Robux to obtain virtual items to enhance their social experience on the Roblox Platform.Credit: Roblox
That’s easy to understand. Nearly all the company’s revenues come from platform users buying a virtual currency called Robux which they use to fund in-game purchases.
Roblox and Robux
If your kid creates an avatar in Roblox and tells you they need to pay for some imaginary item made of ones and zeroes so they can appear cool in a virtual world, and you go along with it, then you deserve what’s coming to you. Here are your options:
|USD||Robux||Robux Per $1|
Now your kid can go to the virtual Nike store and hand over your hard-earned money to a large corporation and receive nothing in return. There’s also a monthly subscription, but we’ll get to that in a minute. Just be certain that whatever money you’ve just spent you’ll never see a dime of unless you do what Nike does – engage in child labor.
How Robux Leave Roblox
Now, let’s look at how money can exit the platform.
While anyone can use Roblox Studio to learn to code, create experiences to enjoy with their friends, and even earn some Robux, only some developers will be able to meet the high requirements (described below) to earn real money through DevEx. Reaching this level of success typically requires a lot of time and talent.
First, you need to have accumulated 50,000 Robux. If you purchased 50,000 Robux at the cheapest possible price point that would cost you $500 ($100 x 10,000 Robux X 5). But if you do that, you just spent $500 on literally nothing. There is no system in place to transfer items or Robux between accounts and withdrawals are only allowed for developers who earn their money through the creation of in-game virtual items.
When you go to withdraw Robux you’ll need to be 13 years old, have an IRS form W-9 (for U.S. taxpayers) or W-8 (for non-U.S. taxpayers) on file with Roblox, adhere to their Terms and Conditions, and only withdraw Robux that have been earned. Robux obtained from a membership plan or referral bonus, a purchase of Robux or gift card, or trading/selling virtual goods that you did not create are not “Earned Robux.” (The company reviews this prior to allowing the withdrawal.) Once you’ve jumped through all the hoops and the stars are aligned and you hear sirens calling in the distance you can then get your $175 (minus fees) that some irresponsible child funded with $350 of their parent’s hard-earned money. Around 550 developers made more than $100,000 in 2021 by selling things that don’t exist to a very small fraction of Roblox’s daily active users (DAUs).
Venture capitalists love to talk about DAUs and MAUs – monthly active users – as these metrics show engagement. Earlier this year, Facebook’s DAUs fell for the first time in the company’s 18-year history. (Queue photograph of Zuckerburg with a deranged look on his face.)
Shares of the company fell 20% on the news with $200 billion erased, all because DAUs came in at 1.29 billion, not 1.3 billion. Roblox only has a fraction of that number with DAUs of 58.5 million as of last month – about 2.7% of Facebook’s number. Of those 58.5 million DAUs, only 685,000 were paying users – about 1.3% of all platform users.
Booking vs. Revenues
The average paying user spends 25 months on Roblox before they learn one of life’s hard lessons – pissing away your hard-earned money on conspicuous consumption is pointless because the people you’re trying to impress could care less if you lived or died. Roblox addresses revenue recognition with this in mind using the following formula for someone who spends $27 on vaporware:
- Total Revenue recognized ($3) + Deferred Revenue ($24) = Bookings ($27)
In other words, bookings reflect the money being poured into the purchase of Robux which fuels the entire operation. Bookings reflect the money being spent in any given quarter, and it’s actually been on a decline for the past two quarters compared to the year prior. (Note that Q4 for any given year is always a boom because kids spend more time playing games and they might even receive Roblox gift cards in their stockings.)
Eventually, this will catch up to the company and we’ll see revenues decline in the same fashion. That is unless they can create other sources of revenues (more on this in a bit).
Investing in a Future Roblox
Much of the appeal investors see in Roblox is what they might be capable of doing in the future. They can raise the percentage of money developers get to incent them to develop more (not sure that would work so well), they can get into more traditional advertising (good luck measuring ROI on that ad spend), or they can start selling all these pre-teen mobile users merchandise when they become adults.
While they wait for the golden egg to hatch, the brand has to fight any fires that pop up in the media about how addictive the platform is for children, how nefarious characters lurk in the shadows, how youthful their development team is, and how most of their customers – and potentially a bunch of their programmers – need to ask their parents permission to use the product.
We see businesses as the ideal end consumer. After that, we’ll settle for retail customers who are fickle and unpredictable. Towards the bottom of the ladder, we’d put children. And at the very bottom of the “desired customers” totem pole would be children from emerging markets. In total, 6 billion people or approximately 85% of the world’s population lives in an emerging market country.
Giving money to your kids for spending on worthless in-game currency is a first-world luxury as evident when looking at where the money comes from. Sure, 73% of Roblox daily active users may live outside of North America, but they only contribute 32% of revenues. It’s the rich kids in North America, the whales (in some cases literally), that are subsidizing the rest of the world by giving Roblox 68% of 2021 revenues. That number is declining over time, but we’re not keen to invest in a firm whose consumer base is a small population of rich kids in developed markets. And for those who believe that the future attention of these individuals can be recaptured when they’re adults, just remember that average 25-month paying user lifespan.
Bulls will correctly argue that’s not the only place where Roblox might find revenue growth, and we could probably write an entire article on possible pivots, but we’re at 2,000 words now and it’s time to sod off to the pub for a pint or seven. Long story short, advertisers have been keen on getting in front of Roblox’s DAUs and names like Nike, NASCAR, and Gucci have made themselves known in the virtual world. Roblox just lets them do their thing and they buy Robux like anyone else does. That’s partially because marketing to kids starts to become an ethical minefield.
That poses a dilemma for brands: How do they market themselves to children who may find it harder to discern between an ad and a regular game? Is a branded game on Roblox an ad by its very nature? Roblox itself offers few answers. The company has largely taken a hands-off approach with brands, offering little in the way of guidance or policy around ad disclosures.Credit: Modern Retail
This could provide an opportunity for Roblox to evolve their advertising platform and capture eyeballs. Some think this is a future gold mine, though a bear market isn’t the best time to be selling ads. When we invest in companies, we do so based on the business model today, not what it might look like tomorrow. In the meantime, Roblox has been burning some serious cash on things like the more than 50,000 servers used to host their platform.
Can Roblox Survive?
In today’s bear market our primary concern is survivability. With $2.1 billion in cash (net of $1 billion in debt) Roblox has about four years of runway burning $500 million a year which is nearly what they went through in 2021. In looking at our second key indicator of survivability, gross margin, things aren’t looking so peachy. When you add up cost of revenue, developer exchange fees, and “infrastructure and trust & safety” you get a gross margin of around 22% in 2021 (up from around 10% in 2020).
Cost of revenue also includes payments made to two of the world’s largest corporations. Last quarter, 32% of revenue was attributable to Robux sales through the Apple App Store and 19% of revenue was attributable to Robux sales through the Google Play Store for which they are obligated to pay up to 30% of any money paid by users. All this boils down to a rather dismal gross margin of 22% in 2021. Contrast that to the 70% gross margin Unity Software pulls down and it’s clear that the platform Roblox provides is costly to build and maintain.
Investors who see a bright future for Roblox may wonder about valuation. Roblox appears to be a bit rich now with a simple valuation ratio of 12. Here’s how that compares to a handful of stocks in our tech stock catalog.
Regardless of how cheaply valued Roblox does or doesn’t come, we wouldn’t invest in this company at any price because their value proposition relies on future potential that hasn’t been made clear yet. Let’s just hope the demand for Robux doesn’t lax because that will be a bad omen. A bull thesis proposed by Value Punks nails the problem concisely as follows:
Roblox taxes all transactions in the virtual economy at 30%. This effectively destroys Robux and takes it out of circulation, meaning that users will eventually have to keep buying Robux to participate in the economy.Credit: Value Punks
Ultimately, someone needs to pony up the money for Roblox to keep the entire platform humming along. Right now, that’s a miniscule percentage of developed market users, many of whom are driven to compete for the same reason kids want to have the latest phone in their pocket. Trying to extract more money from the current population isn’t likely to bear fruit. Trying to increase the age demographic is only helpful if the average time spent on the platform increases which gives you a longer time to milk them. Finding a way to get all the adults who played Roblox as children back onto the platform is one avenue, but it’s a big what-if. So is expecting brands to start throwing advertising dollars at a population of children whose attention spans grow shorter by the hour.
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