Roblox the disruptor

While Roblox (US:RBLX) may have flown under investors’ radars until its recent market debut, anyone with children under the age of 16 is probably well aware of the wildly popular gaming platform. For the uninitiated, Roblox is not a video game; it is a platform that allows people to create and publish their own video games using its suite of tools. In effect, the company outsources game development to its users, and by the end of last year there were more than 20m games available to play.

Following in the footsteps of workplace messaging platform Slack (US:WORK) and data analytics company Palantir (US:PLTR), Roblox opted to go public via a direct listing in the US rather than an initial public offering (IPO), allowing insiders and early investors to immediately cash in some of their shares. Roblox’s shares closed at $69.50 on their opening day, more than 50 per cent higher than the $45 ‘reference price’ set by New York Stock Exchange.

Currently trading at just over $72, a market capitalisation of $38.4bn means that Roblox is worth more than some of the biggest names in gaming, including FIFA maker Electronics Arts (US:EA) and Grand Theft Auto developer Take-Two Interactive (US:TTWO). It is also a considerable leap from Roblox’s $4bn valuation in a funding round in February last year.

Disrupting the gaming landscape

In relying on user-generated content, Roblox employs a very different business model to traditional video games developers such as Activision Blizzard (US:ATVI) which depends on a steady stream of expensive blockbuster releases – so-called ‘AAA games’. Scott Galloway, professor of marketing at the NYU Stern School of Business, says that Roblox is a “gaming gamechanger” that “leapfrogs the traditional video game industrial complex” by disrupting conventional forms of distribution.

Similar to how YouTube democratised video broadcasting, Roblox has brought game publishing to the masses.

There is no typical Roblox game. The platform offers everything from puzzles to first-person shooters – and they are available to play across PCs, games consoles and smartphones. In its most popular title, Adopt Me! – which has been visited more than 20bn times – players look after virtual pets.

Founded in 2004 by David Baszucki and Erik Cassel, the company struggled to find traction early on and its popularity has only really taken off in recent years. Momentum has been supercharged by the pandemic-driven video games boom with daily active users (DAUs) swelling by 85 per cent in 2020 to 32.6m. Users spent a total of 30.6bn hours on Roblox last year, at an average of more than two-and-a-half hours per day.

Roblox has proved a particular hit with younger audiences, becoming the de facto playground during the pandemic. Some 54 per cent of its DAUs are under the age of 13 – in the US alone over half of children under the age of 16 are on its platform.

Roblox’s games are free to play, but users can enhance their experience through in-games purchases which are paid for using Roblox’s fictional currency, known as ‘Robux’. Game developers get to keep 70 per cent of the Robux spent within their games – which can be converted back into real-world currency – and the rest goes to Roblox. It has proved a lucrative business for some – in 2020, out of 8m developers, more than 1,250 earned at least $10,000 in Robux, while more than 300 developers earned at least $100,000.

Galloway says Roblox gets in return “a deep collection of content and a powerful marketing engine”, creating “a flywheel for its own future growth”. Its asset-light business model resembles a virtuous circle whereby additional content attracts more users, which drives more revenue and encourages more developers to create games, and so on. As users encourage their friends to join the platform, this free word-of-mouth advertising keeps sales and marketing costs low.

As more players spent more money on Robux last year, Roblox’s revenue grew by over 80 per cent to $924m, of which $329m was paid out to developers. The company has yet to turn a profit, and as it invests in growth its operating loss widened from $76m in 2019 to $266m in 2020. Bernstein is projecting that Roblox will swing to a $112m operating profit in 2024.

The company is adept at generating free cash flow, which came in at $411m in 2020, up from just $14.5m in 2019. Free cash flow is driven by ‘bookings’, which reflect the amount of Robux that users purchase in advance and spend at a later date. This differs from revenue, which is the amount of Robux that users have already spent. Effectively, bookings are pre-paid revenue.

Is Roblox on a collision course with social media? 

The Roblox story is about more than just gaming as it increasingly overlaps with social media. Baszucki is ultimately aiming for his company to become part of the so-called ‘metaverse’, which is a series of interconnected digital worlds where people gather to learn, work and socialise. Right now, users can host private parties and Roblox has also pushed into virtual concerts – four shows by rapper Lil Nas X in November attracted more than 30m viewers.

Community building is at the heart of any successful social media venture and playing video games is one of the easiest ways to connect with others. As user-generated content takes centre stage, Roblox, along with next-generation multiplayer gaming peers such as Fortnite, could pose a challenge for traditional social media giants such as Facebook (US:FB) and Twitter (US:TWTR). Indeed, Professor Galloway believes that "Roblox could be to Facebook what Shopify is to Amazon, the non-social media social media firm”.

It is not an easy market to operate in, especially as regulators pay closer attention to anti-competitive practices by incumbents and the proliferation of fake news and other harmful third-party material. But Roblox looks like a different beast. 

Given that its user base is much younger, the nature of the content shared on Roblox is mostly apolitical, but it does carry the burden of maintaining a safe environment for children, protecting them from exploitation, predators and abuse. The company does seem to be taking the task seriously. As Professor Galloway pointed out in a recent blog post, the word ‘safety’ appears 121 times in Roblox’s IPO filing document, eight times more than in Facebook’s.

Baszucki says that “safety is not a retrofit; it’s been in our DNA since day one”. Indeed, the company’s second-biggest expense after paying developers’ fees is investing in its infrastructure and safety measures. These costs rose by more than two-thirds in 2020 to $264m.

From a brand engagement perspective, Roblox looks as though it could be more attractive than Facebook and Twitter in the long run as advertisers can create their own games and experiences on the platform. For example, AT&T’s (US:T) Warner Bros and DC Comics created a Wonder Woman game, offering access to special avatar accessories in exchange for Robux. This is more engaging than an ad that most users would scroll straight past, and although the spending power of Roblox’s young user base is still relatively weak, the platform is starting to draw in older audiences.

All of this should keep the tech giants on their toes, but it’s worth noting that the increasingly blurred line between social media and video games is not new. Facebook has introduced free-to-play games to its own app, although they are often quick and simple, rather than big, exclusive games. Meanwhile, Amazon (US:AMZN) is making better headway in the social media gaming territory. Its video streaming service Twitch – where users tune in to watch others play games – logged 5.44bn hours of viewed content in the final quarter of 2020, according to a report from StreamLabs and Stream Hatchet.

Video games have always been social, but it was the arrival of the online, live multiplayer experience that nudged the industry towards the realm of social media. Now, a focus on user-generated content and the community building that will naturally follow may push the likes of Roblox into much closer competition with the old guard. 

Will Roblox prove a winner?

Roblox’s growth is set to slow in 2021 as children go back to school. The company anticipates that hours spent on the platform could fall by up to 3 per cent, although revenue is still expected to rise by up to 64 per cent to $1.52bn.

In the long term, Roblox faces the challenge of how to keep children within the Roblox ecosystem as they get older. The company is aiming to appeal to an older demographic, although, as analysts at Bernstein point out: “It is difficult to be simultaneously cool for 8-year-olds, and 18-year-olds.” Competitors such as Microsoft’s (US:MSFT) Minecraft are also unlikely to remain idle.

International expansion is also key to Roblox’s growth plans. More than two-thirds of DAUs are already outside of North America, but the company is looking to tap into China, the biggest gaming market in the world. Foreign gaming companies must partner with a domestic publisher in order to enter the Chinese market and Roblox’s joint venture with Tencent (HK:0700) received a publishing licence in December.

With a forward price-to-sales ratio of 19, Roblox is more expensive than its video games peers, although its unique business model could justify the premium valuation. Venture capital firm Greylock Partners – which invested in Roblox back in 2018 – believes the company “has the potential to grow and sustain more like a content marketplace ([such as] YouTube) or social network ([such as] Facebook) with the monetization engine of a game publisher”.

Still, as with most new listings, it is wise to wait for the initial exuberance to settle before considering making an entry. Analysts at Bernstein believe that “high volatility seems likely for some period of time… In our discussions, most professional investors believe there will be heavy retail interest in this name, without much price constraint”.