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Roblox: Boundless Potential
Edited by Brian Birnbaum.
Today I bring you my deep dive on RBLX 0.00 , which I believe has vast long term potential. While the narrative surrounding the metaverse is now dire, looking under the hood at Roblox reveals a different story. It has been quite some time since I last found something special and I hope you enjoy this as much as I have.
1.0 The Metaverse is Not Dead
2.0 Developer <> User Flywheel and Operating Leverage
3.0 Safety Concerns and Roblox Has to Age Up
4.0 Roblox is Set to Dominate 5.0 Rising SBCs and Developer Fees
6.0 Management Ownership and Compensation
7.0 Financials 8.0 Valuation and Conclusion
*9.0 What is Roblox?
1.0 The Metaverse is Not Dead
Roblox just keeps on growing and has been doing so for decades. It has a healthy ability to produce cash and management is focused on long term value creation. The financials are also far better than they seem at first glance.
The term “metaverse” is now as tainted with blood, up there with the likes of “internet” in 2001. At the same time, virtual realms with thriving economies are flourishing. These virtual domains are predominantly populated by people under the age of 20, which makes them somewhat invisible and hard to comprehend for the rest of us; but I believe we are witnessing a major event in history. A growing number of young individuals are immersing themselves in these environments to self-actualize, and this should not be taken lightly. What seems like a game today can in fact be the seed for a vast digital world in the decades to come, in which case Roblox is set up to compound substantially.
Note: for a detailed description of Roblox, please refer to Section 9.0 (at the very end).
In Roblox´s case, 50% of the kids under the age of 16 in the US play the game every week and the company, founded in 2004, has a remarkable ability to grow its user base. Below, you can see how DAU growth greatly accelerated during the pandemic before cooling off afterward. This dynamic was further accentuated by the rather fastidious boom and bust of the “metaverse” narrative, but Roblox now seems to be re-accelerating its DAU growth, regardless of the market´s pessimism. If you look at the next graph, you will appreciate that the company has been doing this for decades and, thus, there are reasons to suspect that something special is happening here.
The other thing that caught my attention is that Roblox has a seemingly natural tendency to produce cash. While the company is not profitable, since the company released its first financial reports to the public in September 2020, Roblox has exhibited buoyant levels of cash from operations and free cash-flow, particularly if you remove the recent capex ramp up from the equation. As you can see, this increase in capex is not intended to accommodate the pandemic traffic boom which occurred during 2020-2021, but rather it is voluntary and this tells us a lot about the way the company is managed. Management seems to be focused on long term value creation, not fearing the short term repercussions of dampening financials in the present to create a better future for the company.
In the TTM, Roblox has a net income of ($1,032.5M), but much of it is due to SBC of $662.1M and a change in unearned revenue of $689.4M (more about this in section 5.0): if you add the two back to net income, that is how you get a positive cash from operations. The latter component is the result of Roblox recognizing revenue over the lifetime of the average user (now 28 months), instead of doing so at the time of purchase. Roblox accounts for revenue this way because the items that users purchase within the platform are considered durable and this is why the company´s net income is shockingly red, but then equates to attractive cashflows. Naturally, excessive SBCs are not desirable and this is always a complicated topic, but the point is that Roblox´s income statement is far better than it seems at first glance.
During the company´s earnings calls, CEO David Baszucki and CFO Michael Guthrie explain numerous times that their philosophy consists of letting many product improvements amount to organic growth down the line. While it is very easy to get on the phone and say something like this, Roblox´s trajectory suggests that this has in fact been the case; their highly intentional iterative essence that underpins today´s top companies also does Roblox’s formidable growth trajectory. Further, the gaming space is full of attractive options that cost hundreds of millions of dollars to develop, like FIFA, Call of Duty and NBA 2K but kids are defaulting to this platform which to the outside observer seems to not have much going for it: this makes the above all that more exceptional and cultish.
“It's a consistent investment in things that made the business great and differentiated.
[…] never trying to accelerate a user base and letting the product drive the user base that we deserve, and confident investment and innovating, and expanding our lead cost of investment in the developer community so that content is growing and getting better all the time”. - CFO Michael Guthrie, during Q1 2023.
Notable growth companies all leave a specific pattern in their wake: they excel at incorporating cultures outside their original scope. If you review Netflix´s history, you may appreciate that this was one of the key indicators. Roblox started in the US, but it is seeing phenomenal growth in Japan and India–two cultures that not only differ significantly from that of the US, but each other as well. As of Q1 2023, Japan (183,000 DAUs in Q1 2022) was growing DAUs 100% YoY; and as of Q1 2022, India (just under 1M DAUs in Q1 2022) was growing at the number of DAUs at 160% YoY.
2.0 Developer <> User Flywheel and Operating Leverage
Immersive 3D advertising and generative AI have the potential to meaningfully increase Roblox´s operating leverage, so long as the developer <> user flywheel keeps on spinning.
Much like Amazon, it seems that Roblox goes through recurrent cycles in which capex is stepped up, which dampens financials in the short term, which then enables the platform to grow and generate more cash, as it regains operating leverage. According to management, we will see the end of the current cycle as we move into 2024 and the recent re-acceleration in DAUs bodes well in that sense: organic DAU and bookings growth is once again tracking product improvement. Pairing the above with the observation I make in Section 1.0, regarding the relationship between net income and cash from operations, Roblox is much better positioned than the market believes.
In the graph below you can see that growth of total hours engaged on the platform is re-accelerating. In Q4 2022 it grew at 18% YoY, while in Q1 2023 it grew at 23% YoY.
Additionally, Roblox has a flywheel which seems to be unique in the gaming industry: it is actually a platform that enables developers to create experiences with decreasing levels of friction and in turn enables users to select from and enjoy a broad range of them, by providing an efficient and secure infrastructure. It continuously makes it easier for developers to make games and for users to immerse and connect with each other. Hence, Roblox does not have to develop games itself, but rather builds tools for developers (which are often initially users) to do their work and then gives them an audience to distribute it to: this gives it a meaningful competitive advantage which I will explore in depth in section 4.0.
The cornerstone of the above flywheel is Robux: the native coin of the Roblox economy. Users buy Robux with real FIAT currencies and then pay developers with Robux to access things like experiences, new fashion items and more. Developers can then sell the Robux in exchange for FIAT currencies and this is ultimately how they make money. In turn, developers have a take rate of ~70%, while Roblox has a take rate of ~30%. Since users can also be developers, the flywheel also yields inordinate amounts of user generated content and, ultimately, has users spending long hours on the platform relative to hours spent on other players in the attention race, as well as with traditional incumbents in the gaming industry. The chart below is worth a thousand words.
Further, having studied Roblox´s history it seems that its relevance is a direct function of its ability to enable the self-actualization of its users–and in a non-obvious way, because the community tends to reject updates that have no cultural fit. The more people find connections and a sense of purpose on the platform, the better the platform does. In essence, Roblox is creating something that resembles the physical world but with much better unit economics, because they only have to provide the tools for others to build whatever permutation of reality they want to build, with direct feedback from Robloxians bringing the cream to the top. As developers build out experiences that enable for higher levels of self-actualization, the higher the users´ level of immersion will be and, thus, the higher ARPU can go.
One example of the above is limited fashion items, which Roblox is working to release in 2023: as of the end of Q1 2023, the company is in the process of “completing a limited marketplace”. Naturally, the question is why would Robloxians want limited items? Because it offers another avenue of self-actualization within the social context of the game. It is fascinating to see that, although kids do not live on Roblox, the platform serves as an alternative reality for certain parts of their lives. Below you can see how those that play Roblox to socialize end up spending more.
Thus, the next quantum leap in operating leverage for Roblox is immersive 3D advertising, which is now in test as of the end of Q1 2023, with over 200 developers participating. Roblox expects to make a small amount of revenue from it in Q2 2023 and, so long as the average level of immersion rises, there is no limit to this business segment. Roblox has already partnered with notable brands like Nike and Gucci to build persistent experiences, so it is not quite a stranger to the advertising world.
Further, generative AI has the potential to meaningfully accelerate half of the flywheel, by essentially turning natural language into virtual reality. Developers will soon be able to create parts of games and eventually entire games by talking to a model and this will likely vastly increase the quality and volume of overall available experiences on the platform. In Q1 2023, Roblox launched two generative AI accelerators for creators:
A material generator that “allows developers to create 3D material purely by saying a few words.”
A code generator that “will not just help people auto-complete, but really helps create and script on Roblox.”
The combination of generative AI with immersive 3D advertising has the potential to meaningfully augment Roblox´s operating leverage and, thus, transform the company´s financial statements for good over the coming years.
3.0 Safety Concerns and Roblox Has to Age Up
The young user base presents a hazard, which Roblox nonetheless seems equipped to deal with. Further, Roblox must retain users as they grow up, in order to be a long term success.
The major issue with Roblox is most of the users are very young and this presents itself as a potential hazard: in order to sustain the platform´s growth, Roblox has to engage in a great deal of content moderation and, still, the risk of disruption is material. Roblox has four key areas of cost:
infrastructure, trust, and safety
investment in the development community
Thus, the company actually places a great deal of focus on safety. The term “safety” appears 88 times in Roblox´s 2022 10-K, while it only appears 23 times in Meta’s. Qualitatively, I feel like the company is run with a great deal of empathy for the kids that use it and, further, the above four components of cost seem to be very much the focus of the iterative nature of the company that I describe in section 1.0. Through its history, Roblox has not engaged much in disruptive modifications of its platform, but seems to have rather been a kaizen apprentice, which greatly derisks their young user base.
Having said that, in order to be a long term success Roblox has to retain its users as they grow up, without alienating any age demographic. Otherwise, it will become a leaky bucket: difficult to populate older age demographics while staying appropriate for kids, and vice versa. Doing so requires showing a different Roblox to each age group. The company´s ability to modulate search and discovery will be paramount. While it is still very early to assess whether Roblox can do this or not, I see two promising signs:
The 17 to 24 year old segment is growing fast:
“As we improve the quality of search and discovery, we are seeing more and more developers and creators start creating experiences that are exciting for people all over the world. 17 to 24 is growing very, very rapidly.” - CEO David Baszucki during Q1 2023 ER.
“ […] also 17 through 24 is our fastest-growing cohort growing at 41% year-on-year.” - CEO David Baszucki during Q3 2022 ER.
“I want to highlight the 17 to 24-year-old growth has been a continuous improvement over the last three to four years. And our whole stack is contributing to this. We continue to make exceptional gains in search and discovery, both cold start [new user] and warm start [existing user], which means when an older player signs up and joins Roblox, they see more and more experiences that are tailored to them”- CEO David Baszucki during Q3 2022 ER.
The developer community seems to be working on experiences for older age cohorts:
I have found developers like @1231551RBLX and @murjarquitecto (thanks to @monteczumaATL) that are working on multiplayer battle-arena video games, which are among the most popular types of games for adults:
Although management has shared no data on experiences being developed for adults, qualitative measures note the 17 to 24 cohort developers are beginning to create this flywheel: “We are seeing developers respond with more and more content that is interesting and applicable for older players.” - CEO David Baszucki during Q3 2022 ER.
“We are seeing experiences like Frontlines which [have] really been funded by our creator fund and are driving much more high quality type experiences that older players are flocking to.” - CEO David Baszucki during Q3 2022 ER.
Note the Roblox Creator Fund, also known as the Developer Incentive Program, is a fund set up by Roblox Corporation to incentivize and reward creators for developing popular and engaging games and experiences on the platform.
Developers earn money based on how much engagement their games generate among players, including factors like how many people play their games and how long they spend playing them.
This payout is made in the form of Robux, which can then be converted into real-world currency through the Developer Exchange (DevEx) system, provided the developer meets certain eligibility requirements.
4.0 Roblox is Set to Dominate
The space Roblox inhabits is highly dynamic, but the platform is differentiated and its flywheel will likely act as a strengthening moat over time.
Roblox competes in the attention economy, which in turn englobes a great range of types of operations. I have identified three broad buckets of competition for Roblox:
Social media platforms like Youtube, Instagram and TikTok.
Pure metaverse players like Fortnite and Minecraft.
Incumbents of the gaming industry like Activision Blizzard (Call of Duty, Warcraft), EA Games (FIFA) and Take Two Interactive (Grand Theft Auto), together with the consoles that support them, like PlayStation and Xbox.
Roblox and its competitors in bucket two are giving social media platforms a run for their money in terms of acquiring the attention of younger generations. How this scenario unfolds depends on the evolution of the cultural norms of those 13 and under. Currently, older generations prefer to interact via apps like Instagram, but it is perfectly possible that Roblox will take over this role in the coming decades with future adults–however incomprehensible this may seem to us adults now. An intermediate scenario in which the platforms are complimentary is quite likely.
The games in bucket three are marvels of engineering, while the games in bucket two are perhaps not so much. But what enables bucket two to gain traction against all odds is the superior social features native to younger generations, which make these platforms highly meaningful for them. At first glance bucket two and bucket three seem similar, but they are in fact highly differentiated–although the overall gaming space is not exempt of lateral movements (see Section 5.0). Thus, perhaps the thesis doesn’t rely so much on discerning how Roblox and other metaverse players will compete with those in the other two buckets, but how they will do so with each other and, ultimately, which will be the dominant metaverse player.
The largest platforms in bucket two are Roblox, Minecraft and Fornite, in that order. But historically the only one that has had a flywheel such as described in Section 2.0 is Roblox. In the case of Minecraft, users have to pay to play and the game is not open for third party developers. On the other hand, Fortnite launched Fortnite Creative in 2018 and just a few months ago launched Fortnite Creative 2.0, which allows anyone to develop new maps within the game.
However, both Minecraft and Fortnite are franchises and highly specific games which depend on their continued popularity going forward, much like is the case with the game studios in bucket three. This is a far riskier capital allocation strategy than Roblox, which operates a system that can potentially output an infinite number of games, perhaps more efficiently molding to the requisites imposed by the demand side. I also note that by iterating Fortnite Creative, Fortnite may be able to move towards a platform format, so it is worth keeping an eye on it despite its currently smaller scale.
At the beginning of this write up, I wrote that what now seem like harmless games can turn into vast digital worlds. In essence, we need Roblox to snowball into an entire civilization–and by that, I mean an ontology in which people do things beyond playing. This does not mean that Take Two´s Grand Theft Auto or Activision´s Call of Duty are not one of them, or, for that matter, that there will not be many such environments. But Roblox (and especially relative to its more direct competitors) is looking like something quite noteworthy: again, so long as it can stay relevant to its users as they grow up.
The concept of the metaverse has been somewhat distorted and now most of the population uses it to refer to a persistent and dystopic virtual reality that we are plugged into all the time. However, in a different light this post can be seen as part of a metaverse. In aggregate, all the financial writers that have gone online in the past few years can be seen as forming a financial system 2.0 that exists purely online. This does not mean that I am plugged into this virtual reality constantly, but it means that I can work here instead of going to an office–and I love that.
Roblox has the potential to become an environment in which people from all over the world learn new things every day and engage in constructive relationships. Meanwhile, Grand Theft Auto has the potential to become an environment in which people channel their inner criminal. To a large extent, this is already the case for both. Further, it is fascinating to see how the concept of self-actualization is permeating the gaming space. In the graphs below you can see how, in the case of Activision, Take Two, and EA, most of their revenue comes from users buying things inside the games.
5.0 Rising SBCs and Developer Fees
Roblox is right to share the value it creates with employees and developers since that will keep the flywheel spinning, but it must be vigilant for this generosity to not erode shareholder returns. Hypothetical gains in operating leverage should make the task easier going forward.
Roblox´s seemingly advantageous competitive position comes at a cost. To maintain and amplify their platform, Roblox must share its revenue with two of the key stakeholders of the platform:
Developers: it must share revenue with them so that they keep developing new and better experiences.
Employees: without generously empowering employees via SBCs, it would be very hard for the company to build the infrastructure required to support the flywheel.
Developer fees and SBCs are rising as a percentage of bookings and revenue, but perhaps more clearly as a percentage of bookings In Roblox´s accounting, bookings refers to the virtual currency (Robux) sales during a particular period, while revenue is the portion of the bookings that Roblox recognizes as actual revenue. In other words, revenue is bookings spread over 28 months.
However, the increase of developer fees and SBCs as a percentage of bookings correlates with the plateauing revenue relative to the pandemic comparisons and so, although it is tempting to jump to conclusions about management rewarding developers and employees too generously, this seems like an instance of the natural ebb and flow of the business: to grow you need to invest in people and growth is not linear.
In their public communications, management mentions numerous times that they want Roblox to be a public utility that “pushes as much money back to those creators as possible”. This is the correct strategy in the pursuit of the long term vision outlined in the previous section, but requires very capable management for it not to get out of hand and eat away at the shareholder returns over the next decade, in case of success. I reviewed in Section 1.0 how the income statement takes on a whole different look when adding SBCs and deferred revenues back on, but the former accounts for a whopping 28.2% of revenue in the TTM.
As I have already said, however, the competitive advantage depicted in section 4.0 is not exempt of lateral movements, in which for example the players contained in competitive bucket three somehow supercharge their social features and erode competitive advantage of Roblox, Fornite et al. The best hedge Roblox has against this probable sort of challenge down the line is to continue sending more money to employees and developers. Potentially, as Roblox gains more operating leverage via the catalysts described in section 2.0 (the natural capex cycle, generative AI and 3D immersive ads), it becomes increasingly able to share economies of scale while protecting shareholders.
6.0 Management Ownership and Compensation
Management is highly aligned with shareholders. The overwhelming majority of management compensation is via stock awards, which encourage management to focus on long term value creation. In section 1.0 we saw this philosophy in action.
The management are owners. According to Roblox´s 2022 10-K (page 69), CEO David Baszucki owns 2.1% (12,026,428) of class A shares and 100% of class B shares, giving him 65.1% of total voting power. In turn, CFO David Guthrie owns 1,942,358 class A shares, which definitely aligns him with shareholder interests too.
Further, it seems that management compensation (page 53) is quite heavily skewed towards equity grants, with salaries being relatively low. In 2021, founder and CEO David Baszucki´s annual salary was $800,000 until March 2021, when it was reduced to $0 (remained at this level in FY2022). The same year he received stock awards of $232,185,000 as an RSU under the company´s 2017 plan, which enables him to vest a specific number of RSUs per year if defined stock price goals are met (see below).
Stock price goals for CEO David Baszucki.
In the same philosophy CFO Michael Guthrie received a salary of $550,000 and stock awards of $6,930,000 in 2021. Similarly, in 2022 CTO Daniel Sturman and CMO Barbara Messing both received a salary of $625,000, while the former received stock awards worth $14,287,136 and the latter stock awards worth $8,481,467.
Historically, these equity-based incentives have been granted in the form of stock options or Restricted Stock Units (RSUs). In 2022, Roblox introduced Performance Stock Units (PSUs) to their compensation program for all NEOs (named executive officers), except the CEO. These NEOs received around 20% of their annual equity award value in PSUs and 80% in time-based RSUs.
The performance period for these PSUs runs from April 1, 2022, to March 31, 2025. PSUs can vest if the performance goal is satisfied and if the service-based vesting requirements are met. Between 0% and 200% of the target number of PSUs can vest based on the company's stock price performance, measured on specific dates and contingent on the NEO's continued service. If the NEO in question ceases to be a service provider before the end of the performance period, all unvested PSUs held will be forfeited.
Stock price goals for all NEOs, except the CEO.
The company has a strong balance sheet which given its healthy cash-flows, greatly derisks the investment.
I have explored the income and cash flow statements of the company in depth intertwined with the above qualitative analysis (see section 1.0). I have done it this way for this write up because I believe that the qualitative context turns the numbers into disproportionately richer signals. What is left on the financial side is to comment on the balance sheet.
Prior to its direct listing in March 2021, Roblox issued $520 million in Series H funding as convertible notes in a private financing round in January 2021, which explains the jump in the cash position you can see below from Dec 2020 to Mar 2021. These were set to convert into equity upon the direct listing.
On March 10, 2021 Roblox went public using a direct listing method instead of a traditional initial public offering (IPO): note that Roblox did not raise any capital via its direct listing, because the procedure simply consists in selling existing shares held by insiders to the public. The reference price for Roblox's direct listing was set at $45 per share, and it ended its first day of trading at $69.50, giving the company a market cap of around $38.26 billion. The valuation implied by the closing share price was significantly higher than the $4 billion valuation the company had in its last funding round in February 2020: this was a great deal for existing shareholders.
It then issued a further $990M in debt (callable) in Dec 2021, which explains the jump you can see below from Sep 2021 to Dec 2021. The decline from Dec 2022 to Mar 2023 is due to Roblox moving $1,412.9M in cash to short term investments.
The decline in equity seems to be due to the accumulation of net loss over time, since the number of shares outstanding remains relatively stable.
8.0 Valuation and Conclusion
Roblox´s valuation has been meaningfully compressed over the last 27 months and today stands at a market cap of $25.56B and 10.9 times sales. Although this does not yield an entirely asymmetric situation, like a price to sales ratio of 2 would (Spotify), the long term potential of the company is vast and thus, a hypothetical investment feels attractive to me. Roblox just keeps on growing, has produced buoyant levels of cash-flow elegantly, and has a very strong balance sheet.
I have a blind spot in the thesis, however, and that is that although I have been playing the game for a month now, I am not the target demographic (I am 30 years old now), and I have not been in close proximity with avid users: although I see the cultish nature of Robloxians in the numbers and, more importantly, in the way the numbers ebb and flow, I lack the kind of experiential insight that currently stands between me and a conviction. I need to see people using the product and to what degree it really taps into their self-actualization and that of those around them.
Lastly, I have really enjoyed this deep dive. I have spent this winter studying some of the world´s top companies to learn about the stuff they are made of, and I have missed analyzing this type of “early” stage company. The reason that I chose to do a deep dive on Roblox is that I have heard many parents over the last two years saying how much their kids love it and, at the same time, expressing how perplexed they are as to just why they love it at all.
This is a really special company, and I look forward to continuing to learn about it. You can really tell that David Baszucki has kids and that he runs the company like the compassionate and caring father that he seems to be.
*9.0 What is Roblox?
I generally do not like to include information in my deep dives that is widely available on the internet, but since Roblox is quite foreign to adults, I have dedicated this section to a detailed description of the company. Before moving on with that, however, I encourage prospective investors to download the game and try it out first hand, since there is no substitute for that.
Roblox is a platform that allows users to create, share, and play games and experiences created by other users. Essentially, it is both a game development platform and an online multiplayer system.
Here is a detailed description of Roblox and its various aspects:
Roblox as a Game Development Platform
Roblox uses a proprietary engine that can render in 3D and is powered by a programming language known as Lua. The Lua language allows for the creation of scripts that can manipulate the environment, create complex gameplay mechanics, and establish interactions between players and the game world. Roblox Studio, which is the toolset that Roblox provides to its users, is where creators can develop and publish their games.
The visual design of games made in Roblox can vary greatly, but many use a somewhat blocky aesthetic, not dissimilar to Minecraft. The style can be adapted in numerous ways, and combined with the scripting possibilities, it enables creators to make virtually any kind of game or experience - be it an obstacle course, a role-playing game, a simulation, or even an educational program.
Roblox as a Multiplayer Platform
Once games are created, they can be published on the Roblox platform, where other users can play them, usually for free. The platform supports multiplayer games, so players can interact with each other within these games.
The social aspect of Roblox is quite significant. The platform features chat systems and friend lists, allowing for a communal gaming experience where players can meet new people, chat, and collaborate on creative projects.
Monetization and Economy
Roblox uses a virtual currency known as Robux. Players can earn or buy Robux to purchase items, avatar accessories, and additional capabilities within user-created games. Developers can also monetize their games using Robux. For instance, they can implement paid features or items in their games, which can then be bought by players.
Developers can earn real money from their successful games. They can convert the Robux they earn from their games into real money through the Developer Exchange (DevEx) system. The more successful a game is, the more potential for earning real-world money.
Safety and Moderation
Given that a large portion of Roblox's user base is young children and teenagers, Roblox has implemented several safety features. This includes a system of chat moderation and filters to prevent inappropriate content and personal information sharing. Parents can also use various controls to limit and supervise their child's activity.
Until next time!
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