- Roblox is a global platform where millions of people gather together to imagine, create, and share experiences with each other in immersive, user-generated 3D worlds
- Roblox plans to IPO before Christmas, so we take a look at the rumored valuation of $8bn
- Covid-19 has generated a huge boost to traffic with Daily Active Users ((DAUs)) growing 82%, hours engaged growing 122%, revenue growing 68%, bookings growing 171%, and a large $292.6 mm in free cash flow in the nine months ended Sept 30, 2020
- The valuation story depends on Roblox’s ability to continue growing once the Covid pandemic is in the rear-view mirror
When Roblox was first brought to my attention, I thought they were some sort of gimmick legos. Full disclosure, I have never played this game, but I did play Runescape many, many years ago. Chopped the hell out of some Yew trees. This makes me not the least qualified to gauge Roblox as a video game, but we are gauging it’s potential as a stock instead.
Roblox Business and Technology: Roblox was founded in 2003 and has hit many milestones before the planned IPO launch. The most important recent developments being the Joint Venture with Tencent to establish Roblox China and re-launching Roblox Premium to develop a subscriber base with steadier cash flows.
The Roblox business model is based on the underlying technology and infrastructure that support the 31.1 million average DAUs. Roblox defines a DAU as “a user who has logged in and visited Roblox through our website or application on a unique registered account on a given calendar day. If a registered, logged in user visits Roblox more than once within a 24-hour period that spans two calendar days, that user is counted as a DAU only for the first calendar day” (source: company S-1).
This business is based on three elements:
- Roblox Client: The underlying app that allows users to explore 3D worlds
- Roblox Studio: The toolset that enables developers and creators to build, publish, and operate 3D experiences and content
- Roblox Cloud: The services and infrastructure that power the platform
The Roblox platform and the key technology characteristics are as follows:
- Identity: The Roblox avatar system allows users to create and personalize their unique 3D identities. There are a wide variety of character styles.
- Friends: The Roblox Client allows users to connect through various means, including detecting nearby players or meeting in the Roblox world. The social graph created by these connections is stored in the Roblox Cloud. The Roblox Platform supports text-based chat among users sharing the same 3D experience and between users connected through the social graph.
- Immersion: The Roblox platform allows developers to build deeply immersive 3D environments where users can share experiences.
- Low friction: Users have the ability to interact with experiences almost instantly, on most popular client devices, and from anywhere in the world over existing broadband and cellular networks. When a user joins an online experience, the Roblox Cloud assigns that user to a particular game instance based on the user’s social graph, geographic location, spoken language, and age group.
- Variety of content: Roblox provides developers with reference material, tutorials, community forums, and analytics to build their creations. Developers and creators build nearly all of the content for the Roblox Platform. Once content is built, it can be replicated and shared across multiple experiences giving developers the ability to scale their efforts and make rapid updates. There were over 18 million experiences on Roblox as of Sept 30, 2020.
- Global: The Roblox Platform serves a global audience. In the nine months ended September 30, 2020, developers from over 170 countries and users spanning over 180 countries accessed the platform.
- Economy: Roblox has a vibrant economy built on a currency called Robux, which can be purchased. Developers and creators earn Robux by selling access to virtual content or by driving engagement of Premium subscribers through an engagement-based payout system. When Premium subscribers spend time in a developer’s experience, that developer earns a prorated share of the user’s monthly subscription fee.
Developer Incentives: With nearly the entire Roblox online universe being built by the ingenuity of developers and creators, Roblox has developed a system to incentivize natural development expansion.
Roblox currently offers developers and creators four ways to earn Robux:
- The sale of access to their experiences and enhancements to these experiences
- Engagement-based payouts – rewarding developers for the amount for time that Premium subscribers spend in their experiences
- The sale of content and tools between developers
- Sale of items to users through the Avatar marketplace
As users purchase and spend their Robux on Roblox, developers receive 70% of the Robux spent within their experiences and 70% of the items that appear in the Studio marketplace. Creators receive 30% of the Robux spent for their items on the Avatar marketplace.
These earned Robux are deposited into virtual accounts where developers can convert Robux into U.S. dollars at an exchange rate of 1 Robux to $0.0035. In the nine months ended Sept 30, 2020, developers and creators earned $209.2 mm, up from $72.2 mm in the nine months ended Sept 30, 2019. Clearly, the Roblox developers and creators are also benefiting from the massive spike in users on Roblox.
Current Roblox Business Profile: When users sign up for Roblox, they can create an avatar and explore the vast majority of experiences for free, although the business model for any experience is ultimately up to the developer. Users can purchase Robux either as one-time purchases or via Roblox Premium, a subscription service billed monthly.
For one-time purchases, users can purchase the virtual currency through various channels including the Apple App Store, Google Play Store, credit cards, prepaid cards, Microsoft app store, PayPal, and others. For the nine months ended September 30, 2020, 34% and 18% of Roblox revenue was generated on Apple App Store and Google Play Store, respectively. For operations through both the Apple App Store and Google Play Store, Roblox must pay the customary 30% to Apple or Google.
Roblox has managed to rapidly expand its DAU base.
Roblox has grown its DAU count by 94.9% and 96.9% in Q2 and Q3 of this year, respectively. DAUs are up in every geographic region with the Rest of the World segment growth being particularly impressive. However, Roblox acknowledges that this upsurge in growth during the pandemic may not be sustainable when they say, “We do not expect these activity levels to be sustained, and in future periods we expect growth rates for our revenue to decline, and we may not experience any growth in bookings or our user base during periods where we are comparing against COVID-19 impacted periods” (source: company S-1).
The growth profile and future look of Roblox as an attractive investment hinges on their ability to keep the surge in DAU growth they’ve experienced as a result of the pandemic and then continue to grow their DAUs (albeit at a slower pace compared to 2020).
The DAU metrics show that 55.6% of DAUs in the nine months ended Sept 30, 2020 are under the age of 13.
DAUs drive spending, and Roblox has seen the average bookings per DAU increase as well. Bookings are defined as “equal to the amount of virtual currency purchased by users in a given period of time” (source: company S-1). Therefore, we can expect bookings to be the most widely watched metric every quarterly earnings release, not revenue. DAUs and average bookings per DAU growth are the primary drivers in our valuation model.
Roblox Cost Profile: The major Roblox operating costs consist of
- Cost of revenue – 3rd party payment processing such as Apple and Google app stores – 12.5% of Bookings YTD
- Developer exchange fees – amount earned by developers and creators on the Roblox platform – 16.9% of Bookings YTD
- Infrastructure – Data centers and technical support – 19.8% of Bookings YTD
- R&D, G&A, and Sales and marketing – 19.8% of Bookings YTD
As you can see from the chart above, the Loss from Operations has widened significantly the past 4 quarters. However, this is slightly misleading because the company is cash flow positive and the company has been generating more cash flow, not less.
The reason for this is the method the company uses to recognize revenue vs bookings. On revenue recognition, “We generally recognize revenue from users ratably over the average lifetime of a paying user, which for the years ending December 31, 2018 and 2019 was 23 months. Therefore, much of the revenue we report in each quarter is the result of purchases of Robux during previous periods” (source: company S-1). And bookings – “Substantially all of our bookings are generated from sales of our virtual currency which we record as deferred revenue and then recognize that revenue over the estimated average lifetime of a paying user” (source: company S-1).
So these accounting losses don’t necessarily matter because the company is free cash flow positive. As we can see in the table of bookings and revenue, revenue as a % of bookings declined from 70% in 2019 to 38.4% and 48.8% in Q2 and Q3 2020 respectively.
Roblox Growth strategy: Roblox is focused on four core strategies in order to achieve growth:
- Platform extension: Roblox is continually investing in the platform including in avatars, experiences, technology, and other social features. These efforts can further drive bookings per DAU.
- Age demographic expansion: Roblox and developers are working on building higher quality experiences and content that appeal to an older age demographic. These efforts can drive DAU growth as well as bookings per DAU as older people don’t have to beg mom and dad for their credit card.
- International growth: The JV with Tencent in China is a testament to Roblox’s ability to grow internationally into new markets.
- Further monetization: Roblox is working with their developer community actively to help improve monetization. Efforts such as Roblox premium being introduced in August 2019 as well as working with leading brands to build unique marketing opportunities on the Roblox platform can further drive monetization.
Massively Multiplayer Online Gaming Market: The MMO market has increased rapidly and has hit over 16 million total players. (source) We take a look at the market’s growth to get a sense of the growth that Roblox may be able to achieve in the near future and beyond. The total number of players dipped in 2019, but the trend is clear with around a 28.5% CAGR in total MMO players over the past 3 years.
We also take a look at the MMO arguably most similar to Roblox, Minecraft. Minecraft is owned by Microsoft and they have released intermittent data points on the number of active players on the platform. The number of active players on Minecraft has increased from 40 million in June 2016 to 126 million as of May 2020. We have only 5 total data points in this time-frame, but this indicates a 33% CAGR over the period and it has accelerated from October 2018 to May 2020. Can Roblox experience a similar level of growth in active players?
Roblox Forecast: The basis of our valuation is Bookings per user growth, DAU by region growth, and expenses as a % of Bookings.
Bookings per User have grown 68.6% and 52.5% in Q2 and Q3 y/y, respectively. We think they continue to grow at a high pace in Q4 and Q1 of next year. However, growth will then decelerate as the populations are vaccinated and people start to live their lives as normal once again, thus removing a tailwind for online gaming.
We have Bookings per user growing 20.6% in 2021, 10% in 2022, 7.5% in 2023, and 5% in subsequent years. For example, this deceleration in each DAU spend gives us a quarterly spend on over $20 a quarter in 2024.
DAUs have grown rapidly during the pandemic, and likewise we expect this growth to decelerate as the pandemic draws to a close. We forecast that Roblox will consolidate its Covid user-base gains, and grow an additional 12.5% in DAUs in 2021, 7.5% in 2022, and 5% every subsequent year. This means that Roblox will pass 50 million DAUs in 2024 and will have close to 60 million in 2030.
We forecast that Roblox’s costs and expenses will increase, but as a result of scaling will decrease as a % of Bookings in the future. We anticipate that Roblox will be able to consolidate its cost profile so far experienced in 2020 and will have a cost profile ~60% of Bookings in the future, with the largest contributors to cost being cost of revenue, developer exchange fees, and infrastructure where it is more difficult to create efficiencies through scale.
For some scenario analyses of what the company bookings will be in 2025, we look at different ranges of DAU growth and Bookings per user growth. Roblox currently has averaged 31.1mm DAUs in 2020, and we run scenarios from 22mn to 92mm DAUs in 2025. Likewise, we grow average bookings anywhere from 0% to 17.5% a year. We estimate the likeliest bookings range to be $2.9bn to $5.4bn in 2025, compared to the estimated $1.8bn in bookings for full-year 2020.
Valuation: We value Roblox through a Discounted cash flow model with a weighted average cost of capital (WACC) of 8% and a perpetual growth rate of 4%. With these assumptions, we get an equity value per share of around $26.50. With the rumors of Roblox seeking a valuation of ~$8bn (source), we get 114% upside.
Just for fun, we run a scenario where we give Roblox decrease DAUs -5% and give 0% growth in bookings per DAU, while keeping the same cost profile, for the final three quarters of 2021 (when the pandemic winds down). We then grow at an anemic rate in DAUs in the future, 5% in 2022 and 2.5% a year onward, we get a price target of ~$18.30 and an equity value close to $12bn.
Risks to our View:
Younger audience: With 55.6% of DAUs under the age of 13, how likely is it that they stay on the Roblox platform, we don’t have a definitive answer. Kids so young move to the next hottest game very easily and quickly and therefore it is crucial that Roblox continue to capture and keep their attention in order to grow their DAU count.
MMO gaming market competition: An extension of the first risk, the MMO gaming market is incredibly competitive and Roblox will need to continue to innovate and develop its platform to stay ahead of the competition. We aren’t aware of any new releases that directly challenge Roblox’s position as one of the most widely played games in the world, but new video games and revamps of old games happen all the time. We look forward to seeing how Roblox continues to differentiate itself in the gaming market from competitors and whether these efforts will be successful.
Inability to consolidate Covid user-base gains: Once the pandemic ends will the majority of DAUs gained no longer play Roblox or play/spend less? Our model assumes that the company is able to keep the majority of its DAUs and continue to grow, but this is truly a risk without a real precedent.
We share our valuation model here:
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