Ian Tuttle
When I first looked at Roblox (NYSE:RBLX) In March, I put a “sell” rating on the stock, saying that while I thought it had an attractive fly-wheel business model, I thought the stock was overvalued. With stock down Around -30%, I upgraded the stock to “Hold”. In October, Note that I like the new advertising presentation that the company is introducing, but I feel that the stock-comp is too high and I would like to see more progress with free cash flow. The stock is up about 40% since my upgrade and the company has an analyst day and reports Q3 results since I last saw the stock, I wanted to know the name.
Company profile
As a refresher, RBLX manages the digital community and online gaming. A platform that consists of three components: Roblox Client, Roblox Studio and Roblox Cloud
The Roblox client is its front-end user experience where users explore a 3-D digital world, interact with other users, and play games created by community developers. Users pay for activities and virtual goods using the Robux virtual currency they purchase.
Developers use the company’s free toolset Roblox Studio to create and run games and other virtual experiences in the Roblox universe. Developers make money through the sale of virtual items, while premium subscriptions also get a cut based on how much time subscribers spend on their experiences. RBLX typically receives 30% of every robux spent on its platform, while developers receive 30% of transactions and distributors 40%. Developers and distributors are often the same entity. The sale of robux is recorded as deferred revenue and then as revenue after consumption of consumables. Durable virtual objects are substantially depreciated over the expected lifetime of the user.
The third pillar of the RBLX community is the infrastructure and services used to power the platform, called the Roblox client.
Progress in some areas
In my initial write-up, I said that RBLX’s biggest opportunity is to continue to expand its community, especially with older users. A blow for the company has always been that a large percentage of its users were under the age of 13. This led to negative reports about the safety of the platform and led the company to pour money into trust and safety initiatives.
Between these initiatives and major investments in its infrastructure, the company continues to spend heavily on capex, as well as ongoing expenses. This in turn leads to a lack of free cash flow, something I worried about when I last saw the name.
During the first nine months of the year, RBLX spent $255.5 million on capex while generating $314.8 million in operating cash flow. The company saw little change in Q3, with capital expenditures of just $53.2 million versus $112.7 million. So 47% of its OCF in Q3 went to CapEx. That compares to the first half of the year when essentially 100% of its $202.2 million went to capex.
It appears that the bulk of its infrastructure spending is currently behind it on adding redundancy through core and edge data centers. This should lead to solid free cash flow in the new year.
Leveraging ongoing infrastructure and security costs going forward will also be important. The company saw these costs decline in Q3, falling -1% year-over-year and -6%, respectively.
Currently, that cost is around 15% of bookings and the company hopes to bring it down to around 10% in the next 4-5 years. One way it can do this, especially on the safety front, is by leveraging AI, which is just starting to do.
Discussing safety at its investor day, Chief Product Officer Manuel Bronstein said:
“As you know, safety and stability are core and paramount to what we do at Roblox. It is part of our vision. So we keep innovating in categories to promote it on the platform which makes us more accurate and better in safety and stability. And while doing that, we’re also becoming more efficient at scale. So this year, we’re continuing to improve our automated content moderation. These platforms make it easy through machine learning models to find the right content and automate those flows. We launched something in Q4 that we call descriptive safety reporting. So if you’re in an experience and you’re a user and you feel something bad, you can capture a picture of what actually happened, share it with some commentary. What that does is it makes the process a lot more efficient because if you’re a moderate person and you get that information, it’s a lot easier for you to take action. So it makes our moderators more efficient, and it makes reporting more accurate. And last, but not least, we launched something called stability prompts for voice in Q4. What this does is use our machine learning models and artificial intelligence to detect if I’m having a voice conversation in real time, if I say something that violates our Community Guidelines. And what we do is we prompt the user with some messaging so they know they’re doing something wrong. This is to inspire stability and actually improve their behavior.
This appears to be a good first start for leveraging AI, and as the process improves, it will require fewer people dedicated to these efforts, saving costs.
Stock-based comp was another area of concern for me the last time I looked at RBLX, and it hasn’t improved. It was a whopping $220.0 million in Q3, up 36% year over year. That’s against just $81.1 million in adjusted EBITDA in the quarter, so the stock comp was 2.5x the EBITDA it generated. While non-cash, stock comp is still a real expense. As a result, RBLX’s share count has increased by 44.9 million shares or 7.8% since the end of 2021.
Now RBLX posted very good underlying numbers when it reported its Q3 results in November. Revenue rose 38% to $713.2 million, while bookings rose 20% to $839.5 million. Active daily users were up 20% to 70.2 million, with monthly active unique payers up 14% and average bookings per monthly unique payer up 5% to $19.02. Importantly, users aged 13 and over grew 25% to 40.0 million, as the company tries to shift its demographic towards older users.
Advertising was an opportunity I was excited about for RBLX, and the company is making progress on that front and will introduce several new ad types, including video ads, in 2024. It also looks like it will test real-world commerce in its virtual world this year and fully roll it out in 2025.
At its investor day, Chief Product Officer Christina Wooten said:
“We want to take you now to surfaces beyond our experiences that receive millions of impressions every day. So typically, people come to the homepage or the Discover page on our platform and we’ll allow brands to actually bid on these experiences, these premium placements through the ad manager. And we’re going to make this even better. So we’re making it more prominent on these pages, and we’re seeing amazing results so far. So by testing 2x conversions from this premium placement positioning. We are also working on making targeting better. So today, brands can target across gender, geo, age and device. But we know that advertisers want more precision on who sees their ads to increase ad effectiveness. And that’s why we’re enabling genre-based targeting for all of our ad units starting in the first half of 2024. So brands want to target their ads based on genre. This allows them to reach specific genres like action, role play, sports and fashion. exactly So let’s move on to the second pillar of our strategy going forward, which is video ads. Brands have been asking us for video ads for years now, and we’re excited that it’s coming in 2024. This will make it easier for brands and advertisers to come to Roblox and for us to scale our advertising business. . Portal and Sponsor Experiences are for brands that already have an existing experience on Roblox. Video ads can be for anyone with or without experience.”
Advertising and e-commerce look like two attractive potential growth drivers for RBLX in the coming years. This is a huge opportunity for the firm, although execution will be key. However, given the company’s small demographic, we’ll also have to see how this plays out.
Delivering ads to under 13s and making e-commerce available can be a little tricky. Users under the age of 13 still represented 42% of its DAU in Q3. North American users, meanwhile, accounted for 22% of its base. In general, North American ARPU is very high when it comes to social media advertising-based businesses. If the percentage of users over the age of 13 were the same across geographies, the core advertising market targeting NA users over the age of 13 would probably be about 9 million or about 13% of RBLX’s DAUs. So the chance may not be as big as expected.
evaluation
The revenue estimates reported on most sites (including Seeking Alpha and Finbox) for RBLX are actually booking estimates. Actual revenue will be around 75-77% of bookings.
Using the midpoint of that formula, RBLX currently trades around an EV/S multiple of 8.3x based on consensus 2024 revenue of $3.0 billion and 5.9x based on consensus 2025 revenue of $4.2 billion. Billing growth is expected in the mid-teens over the next two years.
RBLX’s valuation is higher than its entertainment peers on an EV/S basis and significantly higher on an EV/EBITDA basis. While RBLX can be valued on a revenue basis, when considering its developer exchange fees and infrastructure and security fees, its margins don’t really justify being valued by that method. At the same time, given its huge stock comp expense, its valuation EV/EBITDA method is also not ideal.
As such, I will try to value the company based on Netflix (NFLX) subs vs. DAU base. NFLX is valued at around $880 per sub, with an ARPU that is 3.4x higher than RBLX. However, its all-in gross margin is almost double that of RBLX (42% vs 22%), making its gross profit per sub 6.4x higher. That would value RBLX on a DAU basis at roughly the equivalent of $13.
conclusion
While I like some of the initiatives at RBLX, such as its advertising opportunity, and the company should have a much improved cash flow position next year, it continues to have issues I don’t like. Its stock comp remains out of hand and continues to dilute shareholders. Meanwhile, its ongoing infrastructure and security costs remain high. I think it could start using AI to take advantage of these costs, but right now it’s really a drag on the business.
At the same time, valuation remains a big issue. Given its stock comp and low all-in gross margin, there’s no better way to value the stock. The DAU base isn’t perfect, but it’s the right way to value it. On that front, even if the stock trades at a premium given its growth and operating leverage potential, it appears to be highly overvalued. As such, I’m going to downgrade the stock to “Sell” following its recent run-up.
