Roblox: Meta´s Younger Sibling.

Update

Edited by Brian Birnbaum and an update of my original Roblox deep dive.

New! You can now listen to my write ups on Spotify, for free. The podcasts go live some days after the write ups, so stay tuned for the Roblox update.

Roblox has captivated 50%+ of kids in the US and its influence is extending over seas, with daily active users in countries like India and Japan growing at lightning speed.

The way kids interact on this platform is almost incomprehensible to adults, but with the average user getting older, Roblox is poised to be a highly relevant sub-domain of the virtual economy in the coming decades.

20 years ago instant messaging came into the scene and changed the way we socialize forever. Immersive experiences like Roblox are likely to do the same. The market thinks of this company as a dying, silly platform for children. But it is likely actually a global, virtual reality social network in its early stages.

1.0 Roblox is Headed in the Right Direction

During this quarter, Roblox has launched immersive ads and the cohort of older users is now growing faster than the younger cohort. The former also spend more money.

In my original Roblox deep dive earlier this year I essentially pointed out the following:

1. The Metaverse is not a fad. All over the world, a growing number of young individuals are immersing themselves in virtual platforms to self-actualize.

2. Roblox stands out as the primary platform in this sense for kids in the US, with an impressive growth trajectory. As of Q2 2023, Roblox has 65.5M daily active users, which is actually down from last quarter.

   

3. Roblox now has an opportunity to meaningfully enhance its operating leverage, by bringing immersive ads to the platform. This is effectively a whole new category of ads inventory which, if engagement levels on the platform are as high as they same, may yield unit economics far superior to the industry average. In case of success, the resulting cash flow would quite accretive to the bottom line.

   

4. If over time Roblox manages to age up, it can become a far larger and more impactful social network. The platform is so vastly different to what we adults are used to seeing, that this is hard to visualize. But these kids have a totally different way of interacting online. Our instant messaging habits have persisted to this day and it would not surprise me to see the same thing happen for their generation.

After its Q2 2023 earnings report, Roblox stock got hammered and it is currently down to $27.7, from its recent high of $45.54 before the report. The price to sales ratio is now at 6.8, with the stock entering an attractive valuation. Further, despite the initially disappointing cash from operations and free cash flow print in the quarter, at a fundamental level I see the company making good progress.

Here is a condensation of what I am seeing.

International Growth

First, Roblox continues to exhibit rapid YoY DAU growth in cultures far removed from that which it originated:

1. Brazil: 38%.

2. India: 40%.

3. Japan: 107%.

The ability to attract and retain widely varying cultures is characteristic of great American enterprises. Together, with its overall DAU growth, this speaks very well of Roblox´s ability to listen to customers and give them what they want.

Roblox is Ageing Up

Secondly, the platform is aging up, as you can see in the graph below. The number of users over the age of thirteen is now larger than those under that age. According to management, YoY the DAUs from the former cohort are growing at 36% while those in the latter are growing at 33%. Further, management said in the conference call that older users “consistently show higher bookings,” which is a development more than welcome to the bullish thesis.

This is far from the end vision of having adults use this platform all day, but it is great progress. Previously, it seemed that the platform was destined to become irrelevant as its younger users aged over time. But today–and each forthcoming day–the median and mean ages of Roblox users increases. 

Further, to become more relevant to users´ lives, Roblox is making an active effort to become a daily utility. As of Q2 2023 Roblox has 2M voice DAUs worldwide, which use an internal audio messaging service to talk to each other. The service has grown 30%+ in the last six months. This will likely help the platform age up over time, as it widens its scope of use cases.

Immersive Ads are Now Live

19% of the top experiences on the platform now have live ad units. Advertisers that have joined Roblox this quarter include H&M, Spotify, NASCAR, and iHeartRadio. Roblox is currently:

1. Pricing the ads “gently”.

2. In the process of building out a marketplace for these ads to be sold programmatically.

I have no direct experience in the ad-tech space, but I grasp its complexity from my studies of Digital Turbine and, notably, how the ad-tech platform Xandr has been serially acquired despite seemingly being a world class asset.

Thus, while I do believe that immersive inventory has a structural advantage in the online advertising space, I do not take for granted (yet) that Roblox will build out the necessary infrastructure so that advertisers can measure their return on investment. Roblox investors and prospective investors must keep their finger on the pulse of this development.

Key AI Models Have Shipped

Each month, Roblox hosts 5B hours of human interaction. The resulting data is fed into proprietary AI models, with more than 70 machine learning training stacks live at the moment.

The material and code generation models shipped this quarter. The former helps developers make surfaces and objects within Roblox, and the latter helps them code things like GitHub Copilot does. 

In my deep dive, I discussed how generative AI can make the creation of new experiences on Roblox easier. If successful, the new models should translate into more and better experiences created per developer, which should increase engagement and, ultimately, the platform´s operating leverage.

Management’s vision seems similar to that of Meta’s with regards to the deployment of AI. With an unparalleled cache of human interaction on the platform that mimics offline interaction, merely by remaining relevant, they have unlimited material with which to train AI models–creating a virtuous cycle of improving platform experiences. The upside is simply tremendous.

Longer term, look for us to build bigger and more sophisticated models, first around voice, text and language supporting safety and stability, look for bigger and more interesting advanced models for us for 3D generation and ultimately, look for models from us on general human simulation and PCs.

- CEO and co-founder, David Baszucki, during the Q2 2023 conference call.

2.0 Financials

The Q2 decline in cash from operations and free cash flow are a non signal.

A sharp decline in Q2’s cash from operations and free cash flow spooked market participants. As illustrated below, Q2 cash flow represents the annual nadir. This is due to the Roblox’s business model. The company tends to receive payments from customers in Q4 and accrue expenses in Q2.

From what remains of the fiscal year, I believe Roblox will return to its otherwise buoyant cash flow levels.

Q2’s free cash flow print was anomalously negative, but it is in fact a non-signal, since the network’s key performance indicators are doing fine. For instance, gross margin this quarter was 18.78% when last quarter, it was 16.79%. In turn, operating income was (46.12%)% this quarter and (44.23)% the last quarter. This implies that there has been no major change on the income statement side and thus it seems that the free cash flow delta is a result of timing.

Remember that, as I outlined in my deep dive, Roblox´s income statement is much better than it seems. This is because, if you add stock based compensation and changes in unearned revenue back, the company's actual cash flows are largely positive. Roblox does not recognize revenue immediately as a user buys Robux, but rather recognizes it over 28 months and that is why in its income statement it removes unearned revenue. 

The free cash flow print in the quarter was anomalously negative, but for the reason explained above it is in fact a non signal, together with the fact that the network’s key performance indicators are doing fine:

1. Bookings are up 20% YoY.

   

2. Daily active users are up 25% YoY.

   

3. Hours engaged are up 24% YoY.

   

4. Average bookings per DAU are down 3% YoY, which actually imply a re acceleration. Bear in mind that the comparisons with the pandemic years are tough.

   

Further, the balance sheet remains in phenomenal shape although as always in this sort of company, investors pay the price via the dilution brought about by stock based compensation.

“Short-term and long-term investments include corporate debt securities, commercial paper, U.S. Treasury securities, U.S. agency securities, foreign government securities, and certificates of deposits.” - Roblox 10-Q, Q2 2023

$RBLX Stock Based Compensation, $.

3.0 Conclusion

I like this company.

I have now had more time to digest my original Roblox deep dive and I quite like the way the long term thesis is evolving. I am particularly encouraged by:

1. The launch of immersive ads.

2. The rising age of the average user.

3. The 2M voice DAUs on the platform.

With the stock down at enticing levels, I am more inclined to start a position in this company. Before I do, however, I need to see more quarters on continue progress in the above three domains.

Until next time!

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