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Roblox IPO: "A Digital Disney World"

Jan 25, 2021

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The best part of childhood is living in a fantasy land (and not paying taxes).

No better spot than ‘The Most Magical Place on Earth’: Disney World.

I have fond memories of my brother and I flying through the air on E.T. bikes basking in the feeling of total freedom and infinite possibility.

What wasn’t fun, however, was getting lost in the maze of hotel hallways and having my parents call security thinking I was kidnapped.

Oh, the joys of childhood!

If you have your own kids, you’ve probably heard of the new ‘digital playground’ called Roblox.

If you don’t and you haven’t, please get out from under that dinosaur rock and tune in.

“50% of all children aged 9-12 in the USA play Roblox every week.”

Roblox is going public in February and it will likely double.

Partly because every ‘HOT IPO’ has in the last 12 months.

But more importantly, after doing a deep dive, reading their S1 (prospectus), talking to my portfolio management and tech friends, I think Roblox has some serious GAME.

Pun intended ; )

Let’s break it down in <5 minutes:

Fundamentals 👉 Numbers 💰
Competitors 👉 Moat 💪
Growth 👉 Upside 🚀
Risks 👉 Risks (LOL) 🌪
Valuation 👉 Analysis 🎯

And, GRIT’S TAKE: Are we going to make MONEY here?

Let’s find out!

1. Fundamentals

Roblox is like the world’s largest:

🏨 HOTEL COMPANY AirBnB 👉 doesn’t own real estate

🚕 TAXI COMPANY Uber 👉 doesn’t own any cars

🎮 DIGITAL PLAYGROUND COMPANY Roblox 👉 doesn’t create any games

Roblox is an online gaming platform where millions of kids (and some adults) come to play, learn, communicate, explore, and expand their friendships.

All in 3D digital worlds that are entirely user-built.

“We call this emerging category ‘human co-experience,’ which we consider to be the new form of social interaction.”

Like building imaginary forts with your friends in your backyard.

Except it’s digital, pros are building the structures and your parents are spending a lot of money buying gear, digital pets and accessories.

And Roblox is getting very rich!

Highlights:

Founded in 2004
$589MM revenue
+170MM monthly active users (Oct 2020)
Freemium, monthly subscription & one-time payments
US$29.5B Valuation

Revenue

No doubt, COVID caused a revenue bump for Roblox; with kids stuck at home they clocked some serious hours.

Revenue was up +68% year-over-year to +$588MM (9 months ended Sept 2020).

But, even pre-covid, the trend was their friend as new users flocked to the platform!

And spent an ever increasing amount of time playing on it.

Compare Roblox to the other MAJOR platforms that compete for our attention and it’s absolutely jaw dropping!

That’s because they’ve nailed the ‘Holy Grail’ of the platform economy: getting customers addicted!

The Flywheel!

One of the most iconic 'back-of-the-napkin’ tech start-up ideas came from none other than Jeff Bezos in 2001.

“Bezos' drawing illustrated the idea that success starts with a fantastic customer experience. A great customer experience will attract more customers. Customers will attract more 3rd party sellers. Third-party sellers will drive more product selection. And more selection will ultimately lower the cost of products and innovation, creating a positive flywheel effect.”

Every Silicon Valley start-up now dreams of achieving the flywheel. Yet, almost none do.

AND Roblox nails it!

They attract CUSTOMERS ↔️ which attracts DEVELOPERS who create great content ↔️ Attracting More CUSTOMERS

Rinse. Wash. Repeat: an incredibly lucrative virtuous cycle!

To keep the content quality high, their customers coming back and the flywheel spinning, they share a decent amount of their revenue with their developers: +$250MM in 2020, more than double 2019.

And this has attracted an an astonishing +7 million developers!

“Meet the 17-year-old who has already made more than $100,000 creating video games”

But this is really only a 25% payout (of revenue) to developers. If you compare it to other marketplaces its not a lot.

“Take the Apple App Store — they give developers ~70% of revenues. Amazon gives 75% to 85%, similar to Walmart. Etsy gives ~95%.”

Roblox having and seemingly sustaining such a high ‘take-rate’ is insanely impressive.

Especially, because a lot of what they give to developers is never converted to fiat and instead its plowed back into the ecosystem in the form of ROBUX: the grease that keeps the wheel spinning, the ultimate digital dollar!

ROBUX

Robux is the ‘in-game’ currency that powers the ecosystem. It costs real fiat money to buy. It can be bought, sold & earned. Customers use it to BUY:

Games
Virtual Items
Animations to serve avatars
Unique Abilities

If you want to truly understand the magnitude of the love for Robux watch this video.

I promise you will enjoy ; )

Now let’s get bottom-line real. Does Roblox actually make any money?

Net Loss

Technically, on paper, no.

The company is still losing money with a net loss of $203.2MM in the 9 months ended September 30, 2020.

They spend a lot, over 41% of their revenue, on G&A (people), R&D (development) & S&M (sales) (red circle below).

If they can hold part of these costs fixed as their revenue grows, they could become very profitable.

This is called OPERATING LEVERAGE.

Like buying an awesome outfit, over-wearing it to the point that your friends take you aside and tell you to get a new one. The ROI is undeniable!

And it looks like Roblox is on its way there.

If you look at the free cash flow they generate, it’s skyrocketing.

Free Cash Flow (FCF): GRD’s FAV!

In the 9 months ended September 30, 2020, FCF was $292MM (green circle below) up from a mere $5.9MM the year before.

‘CA$HING!"‘

Their FCF is growing because customers are buying a lot more Robux to play games on the platform.

You can see it in their bookings, which grew +170% YoY.

“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”

Translation, the money is in the door but they recognize it “over 23 months” in case customers cash back out into fiat dollars and don’t actually spend it on the platform.

This cash piles over on their balance sheet:

NO DEBT ($50MM undrawn line)
+$800MM cash (at Sept. 30th 2020)

Plus, on Jan 7th 2021 they raised another US$520MM in a pre-IPO financing.

Including this, Roblox has raised a total of $855.7M to date.

Worth noting, that Altos Ventures is their largest external shareholder with +21%.

They have done a lot in gaming (they back GenG, major eSports franchise in Korea) and I suspect is a strategic ally to support Roblox management in expanding to Asia.

Now let’s talk competitors and their moat.

2. COMPETITORS

While 99% of the public will say Roblox's biggest public "competitor" is Unity Software (U-US, $39B). I argue that is a false narrative beyond investors bucketing them as "gaming" companies.

“Roblox is fun for children ..Unity requires code to work”

Unity is more like Adobe; they are a B2B software company that sells software to game developers of all sizes. They rely on multi-year contracts from big companies to be successful.

Nonetheless it’s a quality company that has done really well. It’s up +300% since its IPO in September.

The two more appropriate competitors, because of the social + gaming aspect, are both private and booth owned by major companies:

Minecraft 130MM active users
Fortnite 350MM active users

Roblox is starting to give them a real run for their money with +170MM active users as of October 2020.

In terms of Roblox “defensible moat” the best way I’ve seen it described is here:

“The core game engines are the most defensible; like the land and physical infrastructure of a park, they are built up over decades and impossible to fully short-cut…most creators are reluctant to use new engines/tools once they become proficient in one.“ - Matt Ball

Now, the trillion dollar question is: what’s the upside on Roblox?

The platform is built, millions of customers and developers are on it, the flywheel is spinning…

How can we get it to spin faster?

3. GROWTH

“The game of investing is one of making better predictions about the future than other people.” -Charles Munger

I see 4 key growth drivers:

Advertising: Monetize large & untapped ‘in-game’ ad inventory. This could literally yield hundreds of millions in new revenue.
Cross-Over JVs: Brands building virtual worlds that also cross-over to their physical worlds. Think Nike building a virtual game that then carries over to their physical stores like ‘Pokémon GO'.’
Subscriptions: Continue to grow recurring revenue subscriptions (like Netflix) leading to higher multiple on the stock.
Tencent JV: Asia expansion in the works. Signed in 2019 but still working through regulatory loopholes. If you look at users, most come from outside North America (left chart below), but if you looking at bookings/revenue (right chart below) most comes from North America. Translation = there is a massively under-monetized user base that is ripe for monetization!

4. RISKS

I see 3 risks. The first two are highlighted in their S1 & the last one has been highlighted in the media and by my Twitter followers.

COVID BUMP: “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.”
Customer Concentration: “We rely on a very small percentage of our total users for a significant majority of our revenue and bookings that we derive from our platform.”
Safety: Children are often exposed to violent shoot and kill game play, horror games, and other inappropriate virtual behaviours. They should invest some of the IPO money into moderation.

5. VALUATION

There is no way to sugar coat it, valuation is expensive!

BEAR CASE: At $29.5B this is 7x higher valuation than the last round in February. On a revenue multiple basis, it’s +35x 2020E versus the NASDAQ at 4.5x and the biggest public gaming company in the world - Tencent - at 14x.

BULL CASE: Roblox is cheaper than its competitor Unity at 55x 2020E revenue.

And hey it’s 2021, throwing a dart at a bankrupt company can make you a millionaire.

How is Grit Playing It?

Compared to the recent IPOs I have covered HERE — Coinbase, Robinhood & Affirm — Roblox takes the cake!

It’s flywheel & FCF make it a standout winner.

Roblox is going public via a direct-listing (i.e no money is being raised). I think it will ‘IPO POP’ with extra POP. This style of listing means not only will retail investors be chasing it but Wall Street institutions too.

We saw this happen with Slack & Spotify which are both up big since their direct-listing: +60% and +160% respectively.

Back in November, I tried to get my hands on some Roblox pre-IPO shares. I told my dealer I didn’t care what price I paid, just to see what he could find. He came back empty-handed.

Anecdotally, this tells me the IPO will do very well.

Will I be buying? No, not yet. I want to see where it settles in first. I don’t believe in chasing FOMO.

Until next time. Always Yours. Incessantly Chasing ROI,

-Genevieve Roch-Decter, CFA

P.S “Bitcoin just crashed to levels not seen since....earlier this month. Everyone relax and zoom out.” -@Apompliano

P.P.S Tonight at 830pm ET join my ‘Crypto Clubhouse’ first of many to come!

P.P.S READ BELOW SOME IMPORTANT GRIT UDATES 👇

GRIT UPDATES:

Mandarin GRIT. 1 billion *NEW* potential Grit Newsletter readers! Ecstatic to announce that through a powerful group of Asian investors we have now launched a Mandarin version. Sign-up here!

US News GRIT. We were featured in a small caps story this week: "They have strong prospects going forward," says Genevieve Roch-Decter, CEO of Toronto-based Grit Capital, and a former portfolio manager of $100 million

YouTube GRIT. Boom! Weekly, I now drop the newsletter in video format. This week as a special edition, since I have so many new subscribers I do a ‘Top 10 Things You Should Know About Me’!

What else we Grittin’ On:

China Booming. GDP grew 6.5% in the final quarter of 2020, making it the only major economy to expand last year. Taking over the world!

Farmer Gates. The Largest Owners of American Farmland Are: Bill and Melinda Gates. Rich people love to own hard assets!

Bubble Warnings. The Markets Can Remain Irrational Longer Than You and I can sit still and not play it ; )’

Sources: Roblox S1, Scott Galloway, Matthew Ball, PitchBook

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