Roblox - King of the Micro-transaction
Growing up, I loved video games. I ate, slept and breathed video games. I'm a part of the "Halo" generation; one where you come home from school, fire up the Xbox and immediately hear nine other people call your mom "gay." But it was also a way of fostering closer friendships over Xbox Live with people you actually knew. It was the millennial version of hanging out with friends, without having to deal with going outside and being eaten alive by mosquitoes in the August Georgia heat.
Back then, video games were fun because they were, well, fun to play. No ulterior motive from the game company other than get people to pay $60 up front, and then you play until they shut the servers off. Then we had the introduction of World of Warcraft.
World of Warcraft discovered the monthly subscription model, or what my dad used to call "the razor blade." You drop $40 for the CD to install the game, then $15 a month until you can't afford it anymore and Blizzard comes by to repossess your house.
Well unfortunately, the game made more money each year than the GDP of Belgium and every other developer took notice. Now, everything runs on a model of micro-transactions or subscription services, with many video game developers even skipping the whole "please pay us $40 up front" step just to get to the point where you enter your parents' American Express number, like some pushy club owner firing the bouncer to get you to bottle service as quickly as possible.
Today, we have three current micro-transactional kings of the video game industry: Call of Duty Warzone, Fortnite and the feature of today's piece, Roblox.
Roblox has taken Gen-Z (and their parents' bank accounts) by storm, so I wanted to dig a little deeper into what this company actually is, why I keep hearing the term "Robux" thrown around with the same frequency as "financially induced ulcer," and why Roblox could be a major player in the Metaverse. Let's go!
This article is for educational purposes only, and should not be taken as investment advice. For individual situations, please contact an investment professional. The author does not have a financial stake in Roblox Corporation (NASDAQ: RBLX) and does not plan on opening one in the next 72 hours.
Roblox Top-Line Numbers
FY 2020 Revenue: $923.89 million (+81.73% YoY)
FY 2020 Net Income: -$253.25 million (-256.86% YoY)
Q3 2021 Revenue: $509.43 million (+102.19% YoY)
Q3 2021 Net Income: -$74 million (-52.23% YoY)
Market Capitalization: $48.70 billion
What Is Roblox's Business?
Roblox Corporation is an online video game developer whose main product is the game "Roblox," that allows users within the world to build their own games. I just said the word "game" too many times, so let me clarify.
The product "Roblox" is essentially a platform for users to be able to develop their own video game experiences within it using an object-based development system. Basically, the user doesn't have to do any actual coding; they use objects and in-platform rules to develop their own gaming experience which can then be played by other users in the platform.
Other users are able to access different gaming experiences via one-time in-app purchases (referred to as "game passes") as well as various micro-transactions, from purchasing game development elements to avatar clothing to full other user experiences, all through the use of the in-game currency system "Robux." This is a clever way to convert real money to fake money in order to purchase the most popular games on your Roblox account.
As for their users, well they have over 200 million daily active users, which is a lot of potential walking, talking micro-transactions!
The commissions of all Robux-based sales are then split between Roblox and the user, with 70% going to Roblox as revenue for the work of someone else. While that 30% might not seem a lot due to the user being the one that put the actual work in, some creators have reported making over $100,000 per year just in Roblox transactions. As for the Roblox side of the revenue, I'll chat about that in a few minutes. First, let's get into the history of the company, which is actually much further back than I thought...
How Did Roblox Get Started?
Despite really only rising to prominence in early 2018, Roblox was started all the way back in 2004 by current CEO David Baszucki and co-founder Erik Cassel. The two co-founders were serial entrepreneurs, having founded an educational software startup in the late 1980's that produced two key programs that caught corporate America's eye: a 2D physics simulator and something similar for mechanical devices. The company was acquired in 1998 by MSC Software for $20 million. This also gave Baszucki and Cassel seats at the table at MSC, until they departed in 2002 to found "Baszucki and Associates," an angel investing firm. That's right: these guys were VC's before it was cool and everyone on Twitter can lie about doing it.
The two men went on to found the Roblox Corporation in 2004, eventually releasing their first full game in 2006: "Roblox." Then...nothing happened. No mass adoption, no fanfare and no press coverage thanks to Baszucki's noted distaste for doing press appearances. It wasn't until Cassel tragically passed away from cancer in 2013 that the snowball started to gain momentum.
The company went on a capital raising tear through the Valley from 2013-2020, eventually capturing a $4 billion private market valuation following its Series G funding round of $150 million. By that point, the company had made several key executive hires that allowed the game to move to a proprietary cloud-based architecture, as well as gain permission to launch in China through Tencent's already mighty user base.
October 2020 saw the company begin preparations to go public on the Nasdaq under the ticker symbol "RBLX," but it also saw the final private market funding Series H round which valued the company at a staggering $29.5 billion. In March of 2021, Roblox officially became a public company, which saw the company's market capitalization skyrocket to over $41 billion on the date of their direct listing.
The Roblox Bull Case
Roblox PRINTS Money
I mentioned in a previous section about how the company actually makes money via a lopsided commission structure using the native "Robux" token for user generated content. Well, Roblox has proven incredibly adept at making so much money they don't know what to do with it.
The revenue numbers for this company are pretty impressive, and like many companies that are remote in nature, the pandemic was the match that lit the fuse. Revenue numbers during the pandemic skyrocketed, showing a 140% year-over-year increase from Q1 2020 to Q1 2021 ($162 million to $387 million). As families were forced inside to slow the spread of COVID, desperate parents stuck their noisy children in front of Roblox and threw whatever credit card or bank account onto the Roblox website they could at them to get them to shut up.
Well, it seems as though those children have developed somewhat of an addition to the platform, and it's spreading to the parents. According to Roblox's earnings report from Q3 2021, the company saw users over the age of 13 years old outnumber those under 13 years old for the first time in the company's history. That also led to some outrageous engagement numbers, with the company reporting that 11.1 billion hours of the game had been played throughout that quarter alone (up from 9.3 billion hours in Q2 2021).
But now that the pandemic is "over" and the shelter-in-place requirements have been lifted, those numbers are set to drop, right? Nope! Q2 2021 revenue reported in at $454 million, and Q3 revenue continued to grow at $509 million, though this is considered a "slow down" by their lofty standards.
They Are a Potential Metaverse Play
We had to get here eventually. Look, Metaverse is a term you're going to hear everywhere, all the time now, so just get used to it. And no, the Metaverse does not have to be Mark Zuckerberg's idea of a virtual world where everyone wears a goofy headset and we're eventually confined to our chairs like the people in Wall-E.
The Metaverse is already here every time you load up a Zoom meeting from your pandemic home office, and I hate to say it, but thanks to Roblox, your kid is better at the Metaverse than you are.
Roblox has become the de facto version of the Metaverse for most of the late stage Gen-Z'ers. It's also one hell of a lesson in cryptocurrency and digital real estate, as well as getting used to attending "in-person, live" events in the virtual world. Here's what I mean:
In October of 2021, past-and-now-somehow-current celebrity Paris Hilton announced a partnership with Roblox to bring you "Paris World." It's a unique plot of land in the virtual world that contains digital recreations of real world items from Paris's life, including her Beverly Hills mansion, private yachts, jets and cars.
All of this is available to view virtually, and it even contained a live New Year's Eve party in which Paris herself DJ'd the event. The stunt was met with universal contempt, but it did serve as a proof point for the company: that it can now be a leader in virtual real estate and events.
If you go back to my article I did earlier this week about my cryptocurrency investing strategy for 2022, you'll see that I spent quite a bit of time on the Metaverse and how it could serve as a potentially viable investment, specifically in terms of the native currency used to purchase digital real estate like that one asshole who spent $400,000 on the virtual house next to Snoop Dogg. While I'm not planning on running to my Coinbase account to purchase Robux, this virtual land grab (referred to as "unreal estate"), could be an interesting catalyst to drive more users to the platform.
It doesn't end with real estate, however. Paris World seemed to spark further interest in branded areas of Roblox for users to spend their hard earned Robux in, which prompted both Vans and Nike to set up their own instances to sell things like virtual avatar apparel. Now that's hot.
Surprisingly Decent PR (Sometimes...)
Normally on this site, when I talk about a company's public relations persona, it's usually negative. From Disney's unintended, indirect endorsement of Chinese concentration camps to Shopify's bizarre issue with substandard hiring practices, companies are really good at putting both feet in their mouths. While Roblox has plenty of that that I'll get to, they actually have a fair amount of good PR as well that I thought it would only be fair to touch on.
Roblox (the company) has been recognized by Fast Company as the ninth most innovative company in the world in 2020. They've also been recognized as a great place to work, winding up on several lists for what they provide to their employees in terms of general benefits and culture. They also have a 4.4/5 score on Glassdoor from employees, which is genuinely impressive in the video game developer realm since most development companies suffer from a culture of "crunch" which burns employees out faster than having to stay home with a screaming child.
Nancy Pelosi?
I'm going to get my fucking head chewed off for this, but it's actually something we need to talk about in this era. I've spoken many times about how the typical investor usually will not beat investing in a simple index fund. About 90% of investors lose to the index over a three year period. Well it turns out that members of Congress probably belong in that upper 10%.
The issue first reared its head in this cycle in early 2020, as Georgia Senator Kelly Loeffler disclosed the sale of stocks and call options, as well as the purchasing of pandemic-related companies and "stay at home" stocks, based on information she learned during a confidential Congressional meeting about the spread of COVID and possible lock-downs. Her and her husband turned a massive profit, and questions were asked about the legality of this trade and how it might conflict with insider trading laws.
Loeffler and her husband were cleared of any wrongdoing, but now Congressional stock trading is back in the spotlight thanks to Speaker of the House Nancy Pelosi.
Thanks to the Stop Trading On Congressional Knowledge (STOCK) Act of 2012, members of Congress are forced to disclose any public securities trading by their families within 45 days of a purchase or sale. Pelosi and her husband have proven particularly adept at trading stocks, raking in nearly $17 million in 2020. Tik Tokers in the finance space are now tracking her every move, and entire websites are set up to track what Pelosi is buying and selling, which is where Roblox comes in.
According to official Congressional documents, the Pelosi's purchased "between $100,000 and $250,000" of call options on Roblox between December 16 and December 21 of 2021, with the options expiring "sometime in late 2022 or early 2023." If Pelosi does it, it might not be a bad call.
The Bear Case
Frequent Copyright Issues
So I talked about the positive side of Roblox's PR strategy, but you knew the other shoe had to drop at some point. Their list of rough public relations moments is actually pretty substantial.
Most of the disputes Roblox is involved in centers around copyright. As the platform is nearly entirely reliant on user generated content created by children, you're going to start seeing some familiar intellectual property begin to crop up. Both Cinemark Theaters and the National Music Publisher's Association have engaged in copyright-centric lawsuits with Roblox over the use of their IP without consent, though both were settled.
Roblox has also had some really strange run-ins with YouTubers, including issues around cyber-bullying and fraud. Most notably, YouTuber Keisyo accused the company of withholding $150,000 from her when she was unable to convert the 42 million Robux in her account. Why? Because Roblox accused her of fraud. Keisyo subsequently quit the game and has rededicated her YouTube account to other ventures. And I'd like to leave it there, but there's an elephant in the room that I need to discuss: child labor.
Accusations of Child Labor
In August of 2021, investigative YouTube channel "People Make Games" released an expose on their findings on the Roblox Corporation. Specifically, they were focused on the disproportionate revenue share the company has, paying out less than 30% of revenue to the creators, who, in most cases, are children under the age of 13.
While Roblox does provide some kind of payment, ethical questions have to be raised about a business model that is built entirely on the backs of what looks a lot like child labor, according to People Make Games. It's not like these kids are working in a factory or a machine shop, but they are still spending time and effort on building a product that this company then in-turn sells to others and pockets 70%. Thanks to Roblox's payout structure, you also don't see a dime of that cash unless you hit the payout threshold of $1,000, meaning many children will never see any actual rewards from their work. However, it is important to note that Roblox has rolled out a "Premium Payouts" feature in order to attempt to alleviate some of this concern.
Here is the video from People Make Games in full:
To put a bow on this part, Roblox Chief Product Officer, Manuel Bronstein, responded to the video in an interview with Axios, stating that they are looking to pay more money to creators in the future, hence the new Premium Payout model. However, People Make Games issued their own statement that they had received pressure from Roblox to remove the initial video. How did they respond? They released a follow-up video.
Wall Street Is...Mixed on Roblox's Future
Shares of Roblox are currently in a precarious position. Having fallen from their all-time high of $134 to their current level of $89 (at time of writing), the company should theoretically be in a better position valuation-wise in order to jump in. Not everyone sees it quite that way.
While the consensus analyst price target is around $116, implying a pretty decent upside to the stock over the next 12 months, institutions and insiders have been dumping shares like the Titanic getting rid of all those extra passengers. Despite online sentiment for the company being pretty high, according to TipRanks, hedge funds have shaved a collective 9 million shares from their management, and insiders sold off over $11 million last quarter.
As you can see above, their return on equity is also a disaster in the the trailing 12 months. One analyst also recently hit the company with an "underperform" rating. The company valuations and sentiment are all over the place, indicating that absolutely no one knows where this one is headed in the near-term. Not to mention the recent release of the Federal Reserve's December meeting minutes that indicated three intended rate hikes in 2021 (UPDATE: This number now sits at 9 rate hikes in 2022).
This means typically that investors flee from high-growth tech stocks like Roblox, indicating that 2022 could be rocky year not just for them, but for the whole sector.
Should You Invest In Roblox?
Roblox is a genuinely fascinating company because it takes the idea of a video game and breaks it over its knee like Bo Jackson after a strikeout. Essentially the developers built a cloud-based container, and then set hoards of children onto the platform to do all the work for them, and Roblox is there to vacuum up the profits. Honestly, it's really smart and I'm kind of annoyed I didn't think of it myself.
The company's financials are a shining light here. They have beaten analyst estimates quarter-over-quarter and turn in pretty terrific numbers. They have also set themselves up extremely well in the Metaverse sector of investing, something everyone is going to have to get a lot more familiar with very quickly.
What scares me here is that the video game market is cyclical. Halo was the king, then it wasn't. World of Warcraft looked unstoppable, then it was stopped. Even Fortnite has come down from its recent renaissance. Video games are in a unique space where nothing lasts forever, so the question has to be asked: was the pandemic the perfect environment for the company? Did they peak in 2020 and 2021 with people locked in their homes with nothing but time and money to spend? It's for those reasons that, like apparently every Wall Street analyst, I'm having a hard time coming up with a definitive conclusion on this company. I think Metaverse could be absolutely massive for this company, but talks of increased community compensation and potential slowing user growth leads me to a pretty neutral-leaning-bullish stance on the company in the long term. In the near-term, I'm pretty bearish simply because of the impending Fed rate hikes. These have historically shown to batter a company like Roblox, and I think they're in for a rocky 18 months, assuming Powell has his way.
Short-term: Bearish
Long-term: Bullish(?)
But what do you think about Roblox Corporation? Do you own it? Why or why not? Let me know in the comments below and don't forget to subscribe to my mailing list to get these in your inbox as soon as they post!
