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Roblox (RBLX) has been punished along with the broader tech sector and recently received an extra blow from FB’s earnings disappointment.
Given that RBLX has yet to turn a GAAP profit and in fact is expected by analysts to generate a GAAP loss of over $84 million in 2021 and then see that GAAP loss blow up to over $500 million per year on average through 2025, it is getting hammered on rising interest rate fears. Investors are fleeing the speculative unprofitable high-growth tech stock space (ARKK) in droves and are seeking refuge in profitable dividend paying stocks (DIV) like those we focus on at High Yield Investor:
Now that Meta (FB) reported its first-ever sequential decline in daily active users and missed expectations on other metrics – causing the stock to shed over a quarter of its market cap (over $200 billion) in a single day – RBLX’s future outlook is even bleaker. Many thought that RBLX could ride FB’s coat-tails as the latter led the way by leveraging its massive employee brainpower and enormous global user network in creating the core of the metaverse, in which RBLX could monetize its 3-D user experience technology and gaming platform.
However, now that some of the wind seems to be coming out of FB’s sales and with the market worried about potentially spiking interest rates, RBLX’s investment thesis looks gloomier than ever.
That said, before investors lose heart and throw in the towel on RBLX due to the frustration with its plummeting stock price and lack of profitability, they might want to consider that there still remains a compelling case to own the stock.
In case you have forgotten in the midst of the head-spinning stock price crash: RBLX already has a strong core video gaming business with good growth prospects. This means If the Metaverse turns into a big hit, RBLX could turn out to be a big winner, and if the Metaverse turns out to be little more than a daydream, RBLX still presents decent value at current prices. Let’s take a look at the core video gaming business:
RBLX Stock Is Backed By A Strong Core Business
Back when we last heard concrete numbers from RBLX when it discussed its Q3 results, the market was raving about the stock. Daily active user growth had soared to 47 million, with tremendous momentum at 31% year-over-year growth. Meanwhile, engagement was also up by a nearly as impressive 28% year-over-year to a stunning number of over 11 billion hours. Think about that for a moment: the global population in 2021 was estimated to be 7.8 billion. That means that the average person across the globe – including infants and elderly – spent nearly an hour and a half on RBLX’s platform. Given that its business is largely concentrated in North America, this shows just how much of a grip it has on its customer base, implying a powerful moat and high user satisfaction.
Despite management stating on the latest earnings call that they are focused on engagement and user experience over monetization at this point:
The long view is we have focused primarily to date on the engagement and the satisfaction of our users more than monetization on the platform and we’ve built systems, including our virtual economy and engagement-based payout that have already created a very rich and vibrant developer community with large businesses. Some of our developers making tens of millions of dollars a year.
Advertising is an enormous opportunity, and at the same time our vision for advertising is immersive, it’s native, it’s around high-quality experiences and over time, we’ll be working on rolling out. But the standards around this, how this is supported globally and we do think there’s an interesting and big future and at the same time, a very high-quality branded advertising type future. So super, super optimistic about that.
… revenue is still growing rapidly. For example, bookings increased by 28% to $638 million in Q3 and revenue is expected to have grown by 44.7% in 2021, with more double digit growth expected in the years to come. As RBLX gradually shifts from growing the platform mode to increasing monetization via advertising and an increased assortment of services, this growth rate should accelerate even more. If the metaverse takes off, this will add another massive growth runway, but it ultimately is not needed for RBLX to see strong revenue growth.
RBLX Stock’s Core Business Is Reasonably Priced
Assuming the Metaverse does not become a big factor in RBLX’s business, it still looks like a reasonable value here. EBITDA is expected to come in at $681.5 million in 2021, while revenue is supposed to be over $2.7 billion in 2021. RBLX’s enterprise value is $36.6 billion. That puts its EV/Revenue ratio at 13.5x and its EV/EBITDA ratio at 53.7x.
Despite not prioritizing monetization, RBLX’s gross margin is still around 75%, while FB’s is nearly 80%. As RBLX scales further and begins emphasizing monetization, we see no reason why it cannot achieve that level of profitability either. How this translates to EBITDA margins becomes even clearer. RBLX’s current EBITDA margin is ~25% while FB’s is ~50%. If we value RBLX at a 50% EBITDA margin, its EV/EBITDA is only 27x, which is actually remarkably reasonable given the massive growth momentum the business is seeing and expects to see for the foreseeable future.
Of course, it is not appropriate to assume that high of an EBITDA margin in RBLX’s valuation today given that it has a long ways to go to finally get there, but it is still a useful exercise to illustrate how much upside potential is embedded in the stock today when just considering the core business. As a result, we do not think investors are overpaying for RBLX’s core business at the current share price, even if the Metaverse does not end up adding significantly to the business in the years to come.
RBLX Stock’s Risks
While RBLX benefits from high levels of user engagement which imply that it has very sticky products and a moat, nevertheless, the digital entertainment space is highly competitive and is attracting increasing amounts of investment as growth in the space continues to accelerate. As a result, they will need to continue investing aggressively into optimizing the user experience to retain and attract users. It will also need to continue developing products that appeal to multiple age groups in order to retain its large current following among younger consumers as they grow older while retaining its strong appeal to younger users.
Furthermore, regulatory challenges – ranging from keeping content and on-platform engagement age appropriate to avoiding intellectual property infringement by developers without meaningful harming the user experience – could also pose risks to the company, especially as it continues to grow and the industry grows more competitive.
For some investors, the risk of keeping content age-appropriate is already sufficient to take a bearish stance on the company. For example, Bear Cave recently issued a short call on the stock, stating that Roblox is:
the leading platform for pedophiles. Roblox ex-employees, Roblox developers, Roblox award winners, and Roblox users have been linked to a wide array of misconduct. Roblox’s former social media manager ran a pornographic blog while employed by the company. Roblox’s official Twitter account retweeted content made by a self-described pedophile. Multiple major Roblox developers have been banned after being exposed for pedophilia. Moreover, Roblox allegedly shut down its own community forum after it became inundated with links to illegal child porn sites and Roblox’s current head of content moderation previously followed a “furry porn” account. The company has engaged in litigation and intimidation to help conceal allegations of pedophilia on the platform.
and then went on to site numerous specific examples of the platform being abused for sexual purposes.
The company responded with:
Today there was a post about Roblox that presents a wholly misleading, false and irresponsible picture of how our platform and company function, and ignores 17 years of safety and civility being core to our company values. Since the day we were founded, we have always built a safety-first culture with industry-leading features and functionality designed to ensure our platform provides a safe and civil space for our community.
We have zero tolerance for inappropriate content and behavior in our social spaces. In an effort to eliminate unsafe content, we review every single image, audio file, and video before it is published, with a combination of human moderation and state-of-the-art automated machine learning technology. We constantly evolve and improve our platform and policies to create a community where people feel comfortable and safe.
While Bear Cave’s allegations are certainly concerning, it is also true that much of their report is merely alleged and unverified. Furthermore, on a creative platform like RBLX, it is inevitable that some inappropriate content will seep through the cracks. This is part of the pros and cons of an innovative product that is experiencing such rapid growth and involves people across the age spectrum.
That said, it also appears that – as another report on Family Zone reveals – Roblox needs to do more to protect children from being exposed to lewd and suggestive lyrics and imagery. At the very least, they could give parents more control over their child’s user experience. Until they resolve this issue more thoroughly, they run a very real risk of losing some potential usership and potentially even may face some litigation (not to mention continue to expose some minors to inappropriate content and exploitation).
This adds an ethical dimension to investing in RBLX, which could further reduce its potential investor base and demand for the stock.
While RBLX’s online 3D world creation and exploration entertainment platform business model is ideally positioned to profit from the growth of the metaverse, the existing core business is already poised to deliver solid value to shareholders.
Thanks to the dramatic pullback in the share price, RBLX is priced at a very reasonable enterprise value to revenue ratio. While the market may be fretting about the company’s lack of profitability, management has been open about how they are focusing on user engagement and growth instead of profitability at this point and that they will shift towards monetization in the future, following a similar course to that taken by FB itself.
When taking that into account, RBLX actually looks quite reasonably priced here, presenting an opportunity for investors who are willing to overcome the fear of continued short-term negative momentum in the share price.
On the other hand, when taking into account the ethical concerns raised by Bear Cave and others about the platform’s checkered past and risky outlook for exposing minors to inappropriate content, RBLX has some risk and serious ethical challenges that it will need to address as soon as possible. Still, this is not a problem that will be unique to RBLX, as it is industry-wide, and we believe that RBLX is being unfairly penalized by the market for it. As a result, RBLX remains an asymmetric bet on the metaverse in our view.
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