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Roblox IPO – Not for noobs

You might not know Roblox, but most 8 to 16-year-olds do. More than 30 million of them log in daily, about 150 million monthly, more than Minecraft or Fortnite. The Roblox S1 reveals a surprisingly complex company, with revenue recognized over two years, and the Apple/Google tax representing its biggest cost category. Can Roblox grow its users substantially tapping the 24+ segment and APAC? Can it achieve tech style profitability even with the robber-barons controlling the railroads? That will determine if the right price is $15 or $100 per share.

What is Roblox?

Roblox is a unique gaming company. It is not a publisher like Activision Blizzard or Electronic Arts because it has only one title, the namesake Roblox which is not a game is more of a platform. However, it is not a platform like Unity, which is targeted at hard-core developers and is behind many mobile and PC games. It is not precisely like Epic Games, which combines platform (Unreal Engine) and game (Fortnite). However, lately, Epic has been trying to turn Fortnite into a kind of user-generated Roblox. It has similarity to Minecraft, especially around customization and user-generated content, but goes far beyond.

According to their S1, Roblox is a platform in the emerging “human co-experience” category, centered around user-generated content, that draws inspiration from gaming, entertainment, social media, and toys, which “some refer to our category as the metaverse.” Having watched my daughters play Roblox assiduously, I agree with their definition (and my daughters do too).

Roblox is a two-sided platform between creators (of games, events, social media, objects, and much more) and gamers who enjoy that content. The Robox platform’s magic is that it is low-code to start (e.g., my ten-year-old has created a zombie smashing game that my five-year-old plays), but can be extended and built into a full-fledged game (e.g., Bloxburg, Adoptme, Jailbreak). Players can customize their avatar and take it to the different games bringing their friends along and making new ones. Simultaneously, a universe of social media stars has emerged around Roblox, creating a community and a shared content. Roblox, in some sense, has similarities to Youtube, Instagram, or Tiktok as it has made it very easy to create and share games for others to play. In contrast, traditional platforms like Unity or Unreal require professional developers and designers.

Roblox makes money by selling its internal currency, Robux, and a premium subscription feature that allows for cheaper Robux purchases. Robux, in turn, power the whole of the Roblox economy. Players use Robux to buy content and power-ups in games and buy Roblox generated, and creator developed objects for avatars. Creators make Robux from these in-game sales, which can are used for their own gaming or converted back into cash. Robux have been selling at about 1 cent, while creators can convert them back at 0,35 cents.

The platforms’ golden virtuous cycle is already alive and kicking. More players come to play the experiences, which brings more creators who can monetize their creativity. Around this, a community of players and influencers create a conversation that makes the latest game (e.g., Piggy’s latest chapter) or experience (e.g., the Bloxy awards 7th edition) relevant to everyone. Roblox look-alikes are trying better graphics (e.g., Crayta, now in Google Stadia), but it doesn’t seem very easy for them to overcome Roblox’s scale advantage. Roblox low-grade graphics make game creation easier and expand the potential device population that can support the games.

Roblox also has a strong focus on safety. The transfer of Roblox is limited to actual transactions to avoid scams or hacking. Interactions in Roblox seem safe, thanks to an extensive safety staff worldwide.

Roblox performance

According to the S-1, Roblox has reached a substantial scale already. It has over 30 million Daily Active Users (DAUs) and has close to 20 million “experiences” (games and similar). These DAUs have brought in $1.2B in bookings in the first nine months of 2020, about $55 per DAU and year. Both DAUs and monetization have grown considerably (~x3 in bookings and close to x2 in DAUs). The pandemic has accelerated adoption, but the latest quarter shows the gains seem to have consolidated (8.7 billion hours in Q3 vs. 8.6 billion in Q2).

Roblox spends bookings in the following way. Close to 30% go to pay the “railroad tax” that Google and Apple charge for mobile transactions. The second category is creator payouts, which are now at 17% (over $200M). Roblox claims that its key priority is to accelerate creator payouts to power its golden virtuous cycle. The third is compensation at 14%, with technical infrastructure at 8% and other at 4%. Roblox already has reached a 30% margin on its Robux bookings.

The GAAP picture of all of this is tricky to understand. Roblox recognizes revenue and associated costs over the next 23 months after the purchase. Consequently, revenue lags bookings, and under GAAP, Roblox still recognizes losses. However, its cash dynamic is exceptionally positive, with $345M positive operating cash flow over the last nine months. Roblox doesn’t need the money from the IPO. It is going public to give its shareholders liquidity.

Roblox potential

Roblox’s potential depends on its revenue potential and profitability. Let us take profitability first. Roblox is already at 30% of bookings. ~45-50% of its revenues are payments to Google and Apple and payments for creators. We can expect those to stay constant, as Roblox has pledged it will give creators any improvements it achieves with Google and Apple. The other 20-25% of costs are employees, infrastructure, and general expenses. These costs would benefit from improved operational leverage and could be potentially reduced to at least the 15-20% range, if not further. Consequently, we could consider a bull case of 40% margin (45%+15%) and a bear case of staying at 30% (50%+20%).

Estimating topline potential is far trickier. It depends on the user base and revenue per user. Current revenue per user is about $50-55 per DAU per year, far higher in the US & Canada (>$100). However, the cohort curves shared in the S1 show that Roblox is getting much better at monetizing across regions. We could consider 2030 bookings per DAU at $12/month, in line with best practices like WoW subscribers. $12/month/DAU would take the current 5 cents per hour to 15 cents per hour, still very cheap entertainment.

In terms of users, there are 36M average DAUs in Q3 2020. A bull case could take it to x7 over the next decade, to over 200M average DAUs, around 800-900M MAUs. This scale is only reachable in a 1.5B+ addressable market and with dominant market reach. This requires Roblox to expand successfully in two ways:

  • Demographics. Currently, demographics are pretty concentrated. More than half are in the core Roblox user group of 7-13. According to the S-1, Roblox is managing to expand effectively in the 13-24 user group. Roblox’s key challenge is that the 7-24 demographic in medium and high-income countries will stagnate over the next decade. Getting to over 200M average DAUs would require to break into the 24+ demographic to expand their addressable market beyond 1 billion people. Roblox just acquired the assets and critical talent of Imbellus, a gaming developer for learning and evaluation. Imbellus has famously developed Mckinsey’s gamified interviewing first round. The Imbellus acquisition could extend the platform beyond the 24-year range and the pure gaming use case. 
  • Geographically, Roblox has a similar presence in Europe and North America (~65% between the two), with 25% in the Rest of the World and only 15% in APAC. All regions are growing between 60-90%. However, APAC is a relatively underpenetrated region. Roblox is working on this with increased penetration in Korea and a partnership with Tencent in China. Getting to 200M+ DAUs would require an at-scale APAC presence.

Putting together all the pieces in terms of potential would take Roblox to the $25-30B bookings range with approximate cash conversion of those bookings of $10-15B by 2030. This size would be a 15-20x potential growth from today.

Roblox valuation

Rumors point to a Roblox valuation in the $8 billion range, double its last private market valuation at $4B. If this were to be accurate, it would look like a bargain. With a potential 2020 operating cash flow of over $500M, a 20x multiple would already support a $10B valuation based on current cash flow generation. If you believe Roblox is a platform and not a game and given its current growth rates and competitive moats, this would be a very attractive valuation.

A bull case takes us far beyond this. Starting with the 2030 $10-15B cash flow generation potential and a 15-20x EV multiple, we could be talking about a ~$200B valuation for Roblox in 2030 if everything pans out. Bringing it back to today at 10% cost of capital, we could justify a $50-70B valuation today.

CNBC put forward a middle of the road scenario comparing Roblox to Unity, which is already public and has more than doubled since its stockmarket debut some months ago. It puts Roblox at $37B valuation.

If we assume the offering brings the number of shares to ~600M (about 20% dilution on the current ~500M), the base value would be a $15 share price range, CNBC would be at about $60, while the bull case would take us to $100.

Roblox is relatively unknown in a category that is still not familiar to investors. Its accounting is complex, and there is no clarity on its addressable market. Even relatively sophisticated investors like Jason Calacanis fail to see it as a platform. Consequently, it is difficult to see investors piling on to this one and elevating it to its bull scenario as it has happened with Snowflake. Roblox could be a slow burn that gradually builds value as its incredible growth potential plays out over time.

From the Roblox perspective, this would make it smart to do a small raise, given they don’t require the cash infusion. Enough to create liquidity and free-float, but as little dilution as possible at an arguably low valuation.

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