Updated: Jan 17, 2021
John Chapter 8 verses 31-32 state, "To the Jews who had believed him, Jesus said - If you hold to my teaching, you are really my disciples. Then you will know the truth, and the truth will set you free."
I often find that the truth can cut multiple ways. Sometimes the truth can be a harsh reality that I am not eager to accept. Other times, it can really be liberating, even during difficult circumstances. The one thing I know in my life is that when I keep to the truths of the Bible, I am often free from many things that could otherwise ensnare me.
When it comes to investing, the most important truths that I can find are the exact pieces of information to help prepare me for a near-term event. The timing for an illustration of this is perfect as the Roblox Corporation (RBLX) initial public offering, IPO, is on the horizon.
An average of 36.2 million people from around the world come to Roblox every day to connect with friends. Together they play, learn, communicate, explore, and expand their friendships, all in 3D digital worlds that are entirely user-generated, built by a community of nearly 7 million active developers. Roblox calls this emerging category “human co-experience,” which the company considers to be the new form of social interaction. The platform is powered by user-generated content and draws inspiration from gaming, entertainment, social media, and even toys.
Roblox is powered by user-generated content from the company's community of developers and creators who build immersive and engaging experiences found only on Roblox, as well as the vast majority of the items for customizing avatars. Upon signing up for Roblox, users personalize their avatars by selecting body types, clothes, and gear. Users are then free to immerse themselves in the millions of developer-built experiences. Developers and creators can earn virtual currency, Robux, through microtransactions in their experiences, through engagement-based rewards, and by selling virtual items. Robux can be exchanged for real-world currency through the Developer Exchange Program.
In the nine months ended September 30, 2020, 31.1 million average DAUs across over 180 countries enjoyed experiences on Roblox across mobile, desktop and console platforms. Our users are diversified across multiple dimensions, including age, geography, platform, and gender. Each day users can express themselves through their avatars, explore different worlds, and engage with others in the Roblox community.
Roblox offers users the ability to build engaging, immersive experiences that they can easily share with the Roblox community. Experiences refer to the various titles that can be enjoyed by users in the platform. Users who create experiences are called developers and those who create avatar items are called creators. Developers can also build and sell custom tools and 3D models to help other developers create experiences. Collectively, developers and creators contribute to the platform in three ways: by building experiences for users to enjoy, by building avatar items for users to acquire and express themselves with, and by building tools and 3D models for other developers and creators to utilize. In this way, developers and creators enable Roblox to offer a wide variety of experiences and cost-effectively crowd-source these experiences, marketplace content, and development environment.
Roblox invests in the developer and creator community by providing a comprehensive set of tools and services through Roblox Studio that enable them to easily build, publish, and monetize experiences. In addition, the company's developer relations function focuses on providing appropriate support for all developers and creators to ensure engagement and growth in the developer and creator community. This includes creating self-guided tutorials, managing and moderating online developer and creator forums, and operating special programs for aspiring and top developers and creators such as the incubator program and annual Roblox Developers Conference.
The key investment thesis for a stake in Roblox is driven by the company's four growth strategies:
Age demographic expansion
Roblox continually invests in the Roblox Platform, including significant investments in high fidelity avatars, more realistic experiences, 3D spatial audio technology, and other social features. These investments should enable Roblox to support human co-experience in the entertainment, learning and business markets. For example, developers will be able to build and host virtual concerts, classrooms, meetings and conferences on Roblox.
As a result of platform extension, developers, and creators are now able to build higher quality experiences and content that appeals to an older age demographic. The company believes there is significant potential to increase penetration and engagement across all age demographics. Roblox ultimately aim to be a brand that serves all ages. An early sign of what is possible: Roblox's 17 to 24-year-old user age group grew faster than its core under 13 age group in the nine months ended September 30, 2020.
Roblox is looking to grow the global reach of the platform. The company believes some of that will occur by the same organic, word of mouth user and developer growth that has been seen in markets like the U.S., Canada, and the United Kingdom. In addition, Roblox is investing in technology that will also enhance growth around the world. For example, the company feels that features such as automated translation and built-in regional compliance will enable them to scale usage in global markets, allowing developers to publish in multiple languages and allowing users to communicate with each other even when they speak different languages. Further, Roblox is addressing the opportunity in China through Luobu, a wholly-owned subsidiary of the joint venture with Songhua, an affiliate of Tencent Holdings Ltd.
The company feels that there is significant potential to increase monetization on the platform. First, Roblox is actively working with the developer and creator community to help them improve their monetization. Second, Roblox recently introduced a subscription service, Roblox Premium, which is poised to increase conversion of free users to paying users as well as the retention of paying users. Finally, the company expects to work with leading brands to build unique marketing opportunities on the Roblox Platform. To date, though meaningful monetization has not been generated from marketing partnerships, each of Warner Bros Pictures, Netflix, NFL, WWE, Marvel, and FC Barcelona have introduced branded content on the platform.
Direct Listing Clarity
I need to pause at this point and provide the narrative for Roblox's transition from a private to public company. Roblox was slated to go public last December in 2020. However, all throughout 2020, we have witnessed substantial gains for new IPOs going through the traditional process. This has led many critical comments of the pricing mechanisms to bring companies public being flawed. The worst case was the Snowflake, Inc. (SNOW) IPO.
As such, both Airbnb, Inc. (ABNB) and DoorDash, Inc. (DASH) went public just before Roblox was supposed to, and after the results, Roblox put their IPO on pause to figure out the most efficient method. I believe that Unity Software (U), being a peer, and its extreme Stock Price, SP, appreciation after its IPO was another key driver in Roblox's concerns.
In early January 2021, Roblox announced that it would go public through a Direct Listing, DL, offering. The key difference here is that a DL offering allows existing shareholders to sell on the first trading day of the IPO. It also gives secondary market investors information on the most recent SP transactions prior to the trading day.
DL offerings don't typically see a 100% gain like traditional IPOs do on the first day (let alone one month or more out). This is because the balance between buyers and sellers is more efficient on the first trading day. This is tremendously helpful for secondary market investors, as they can know the latest SP and assume perhaps a 30% pop or lower depending on actual trading.
Valuation & Forecast
When it comes to a company's valuation and forecast, I like to deconstruct things by the key financial metrics that investors should consider. I do this on a Trailing Twelve-Month, TTM, basis. For Roblox, these include:
Net Cash Position: $1.3 billion (includes most recent funding round)
Revenues: $730 million
OCF / Percent: $382 million / 52.5%
FCF / Percent: $311 million / 42.8%
Shares Outstanding 545 million
Bookings: $1.5 billion
Daily Active Users (DAUs): 31 million
Hours Engaged: 25.9 billion
Average Bookings per DAU (ABPDAU): $40
Roblox is experiencing substantial growth. Revenue growth is up nearly 70% from the previous year through September 2020 - Gross Profit, GP, is up over 60%. Cash Flows, CFs, are up enormously with Operating Cash Flow, OCF, up nearly 450% through September 2020 - Free Cash Flow, FCF, is up an astounding nearly 3,500%.
From a valuation perspective, we have the news reported in early January 2021 that Roblox just completed a new funding round raising $520 million with a valuation at $29.5 billon. From the company's most recently filed S-1 amendment, the highest valuation based on average SP and Shares Outstanding, SO, has divulged a $3.5 billion valuation, assuming Market Capitalization, MC. I feel that Enterprise Value, EV is more appropriate.
So taking the most recent funding round, assumed SO dilution, and SP paid based on the valuation, and I can equate to the published valuation, but believe an EV closer to $28.6 billion will suffice. The current SP for Roblox is likely somewhere between $54-56 per share.
The valuation multiples I rely on are OCF/FCF per share as the primary, and EV/Revenues as secondary. EV/Revenues is only used when OCF/FCF metrics are not available. For many investors, OCF/FCF metrics are foreign as these are not widely published as are P/E and EBITDA ratios. However, by using relative peer industry analysis, and historical valuation performance, one is able to have a clear idea of how to consider valuation. Discounted Cash Flow, DCF, analysis is futile as it uses unrealistic assumptions, no matter how well they are perceived to be (especially for 5-10 year projections).
Today at around $55 per share, Roblox is trading nearly 30 times TTM Revenues and 80 times OCF per share. Unity Software is currently trading nearly 55 times TTM Revenues and 7,400 times OCF per share. Unity Software is project to do $760 million in Revenues for 2020 and $1 billion in 2021. If I had to model Unity Software's Revenues for 2022, I would place a $1.25 billion estimate. Despite Roblox's seemingly high valuation, it is much stronger position versus Unity Software as it closest peer, but this assumes the most recent pre-IPO SP. Roblox is on track for $830 million in Revenues for 2020, ahead of Unity Software.
I always model out two years to look at growth trajectories and investment opportunities. As we are already in 2021, it is prudent to look towards the 2022 calendar year. For Roblox's key metrics the following is assumed:
Net Cash Position: $2.5 billion
Revenues: $1.56 billion
OCF / Percent: $700 million / 45%
FCF / Percent: $515 million / 33%
Shares Outstanding 605 million
Bookings: $2.5 billion
Daily Active Users (DAUs): 58 million
Hours Engaged: 61.4 billion
Average Bookings per DAU (ABPDAU): $37.5
I am modeling Roblox to average approximately 37% Revenue growth over the next two years. At the same time, I am expecting their Gross Profit, GP, OCF/FCF margins to decline from the strong pull-forward driven by the pandemic in 2020.
At a SP around $55 per share, Roblox is trading around 18 times 2022 Revenues, and just over 50 times OCF per share. Assuming that the SP could increase by 30% or so, we could be looking at a day one SP of $70-75 per share. At the midpoint, this would generate a EV of $38.2 billion, or 24.5 times 2022 Revenues and 70 times OCF per share. Looking back to TTM information as of September 2020, EV/Revenues would be at nearly 52 times, with OCF per share being at 105 times.
Modeling a fair valuation moving forward I would consider a 35 times Revenues and 80 times OCF per share being justifiable for Roblox's growth into these multiples. This would afford an 18-month Price Target, PT at around $95 per share, or around a 30% premium from the $72.50 midpoint.
As more information, notably the amended S-1 becomes available, I will update my models accordingly. However, based on the information available today, this is a pretty good review and valuation assessment of Roblox.
Since postponing their offering and using a DL instead, Roblox has immediately accomplished two things. First, the company has brought its valuation pre-IPO to a much better level as we have seen Unity Software's valuation jump above $40 billion. Second, existing shareholders and potential secondary market shareholders will have better transparency on first-day trading strategies.
It is to the second point that I will continue to consider to what level of weighting I will initiate a new position in Roblox. Companies like Slack Technologies (WORK) and Spotify Technology (SPOT) saw their first day DL SP jump around 30% or so. Palantir Technologies (PLTR) saw the opposite where the SP actually dipped below the most recent pre-IPO purchases. Market dynamics will suggest how much I initiate, and how I manage the position thereafter.