This was a piece that I co-authored, originally posted on ValuePunks, a Substack publication focused on global equity research providing independent, institutional-grade research in an easy-to-read format run by two former buy-side analysts who now run their respective independent investment management practices. I highly recommend subscribing. You can check them out here.
Recent months have been quite exciting for the gaming industry. Take Two Interactive announced they were acquiring Zynga, and not too long after Microsoft announces a deal with Activision Blizzard. And just when we thought things were settled, Sony comes out and announces its deal with Bungie in the same month! By now, most investors are aware of the growth of the video game industry (if it wasn’t clear already!)
We decided to publish this deep-dive on Roblox as we believe it is one of the most unique and valuable assets in the gaming industry. Yet, we think the company is not yet well understood. In this report, we go under the hood to deconstruct the Roblox platform, and also detail the transformative changes that are currently taking place. The vast improvements seen in the gaming engine, and the platform’s expanding international presence (~80% of Roblox’s users now comes from outside of the United States) are just some of the things highly worth noting.
To do so, we had the privilege of co-authoring this piece with our friend @DMTCapital, who has experience as both a developer and player on the Roblox platform since 2017 (you can check out his Substack here). We hope this will provide an authentic look at the business from the perspective of someone with a deep first-hand experience of the platform.
Content
Platform Breakdown
Growth opportunities
Business economics
The “Metaverse”?
Management
Platform Risks
Valuation
Platform Breakdown
Roblox isn’t a game. It isn’t a game developer either. Yes. That’s right. Everyone comparing Roblox to Activision, Take Two, Electronic Arts, Ubisoft etc. for the purposes of “Oh look how it’s being valued compared to ATVI!” are barking down the wrong tree.
So what is Roblox? To put it very simply, Roblox is a platform which allows for anyone to experience user generated content in the form of immersive games (which the company calls ‘experiences’), all created using its proprietary game engine known as Roblox Studio. All transactions between parties on the platform are conducted in Roblox’s own currency, known as Robux. In a way, Roblox is a mixture of a gaming infrastructure provider, video game aggregator/publisher, and social platform.
We’ll be looking at the platform from the perspective of three key stakeholders on this platform: Players, Developers, and Roblox Corp.
Players
Roblox acts as an aggregator for all the games created on the platform. From first-person shooters to open-world driving simulators and generic roleplay games, the choice of games is endless. Anyone can create games on Roblox, and there is a long tail of user-generated content on the platform (much like YouTube but for games). Players engage in about 20 of these games on average each month, and a lot of it is congregated around some of the most popular ones. Because the types of games vary considerably, Roblox also offers personalized discovery and search which allows players to find the games that are most interesting and suitable to them.
Most games on Roblox are entirely free to play, which is really good for growing a user base. These free to play games almost always have in-game items which can be bought to enhance user experiences, such as game passes (an example would be a “Police Gamepass” on an open-world driving game like Ultimate Driving). The important detail here is that all these items aren’t priced in USD, GBP, EUR etc. They’re priced in Robux. Robux is sold to players either on an “a-la-carte” basis (1,700 Robux for US$19.99) or through a monthly subscription called Roblox Premium which provides players with a monthly stipend of Robux. We’ll return to Robux later as this is such a key part of the game economy and monetization.
We previously mentioned that Roblox is a social platform too, and that’s something really key to understanding what drives the user base. From a player’s perspective Roblox has much more of a social interaction element to it than any other games.
Expanding on this social element, a key design feature of Roblox that’s important to know is that users have their own single identity, called an avatar. Avatars are a representation of “you” on Roblox that travels wherever you go. Many players change the appearance of their avatars daily, like changing clothes in real life, and spend Robux to purchase clothing and accessories from the Roblox marketplace to personalize their avatars. You can also make friends, message other players and create group chats (subject to privacy setting and/or parental controls), which cements the platform’s status as a social gaming platform for the younger generation.
As we mentioned before, games on Roblox are not created by Roblox. The players are the developers, and the developers are the players. But here, the word developers is used liberally in the sense that anyone can create games on Roblox. No need for a degree in computer science or game design - everything is designed so that one can start from zero. Teenagers are creating games for other teenagers to play, and they know best what’s fun for each other. This gives Roblox a unique ability to adapt as a platform. Roblox is essentially a bet on the creativity and imagination of kids and teenagers to create amazing games for their communities. There is no game development risk taken by Roblox, the company.
Moving on, let’s look at the developer platform in depth, which is one of the most interesting and unique aspects of Roblox.
Developers
Roblox has eight million active developers. The vast majority are just teenagers and younger kids who are just learning to code. They create experiences for others, and do so purely out of their own enjoyment. There are also more sophisticated developers and studios that do it to make real money (older teens and young adults). The typical developer journey is that players start out developing experiences casually when they are young. But as they get older some of the extremely successful developers choose to move on professionally, hiring others and even setting up studios that employs 10-20 or even up to 40-50 people. In terms of how sophisticated the developers are on the platform, it truly runs a gamut.
Roblox Studio, based on the Lua programming language, is where the development takes place. It’s a beginner friendly, yet full-stack development environment that is designed to grow with the sophistication of its users. So even kids can start on it and build simple things like a basic obstacle course with 3D design tool that requires no coding knowledge. Once they become more familiar they then add more complex elements and interactions that require coding. Commonly used game engines like Unity and Unreal take quite a bit of training to use proficiently, and even an avid gamer can’t just pick these up and start creating games on them right away. Roblox Studio lowers the hurdle such that it truly enables people to be both players and developers.
You can think of Roblox as having two simultaneous platforms – in the form of a demand aggregator for players as we discussed in the earlier section, and also a developer platform which we discuss here. Roblox provides the development engine (Roblox Studio) for free to developers, which forms the core of the developer ecosystem. Other key features of the developer ecosystem include:
Community: The annual Roblox Developer Conference (RDC) is a big deal and an important part of Roblox’s developer culture. Lots of hiring and deal making happens between studios and developers here. Roblox also offers an in-house ‘talent hub’ (with currently 2,300 job listings) where developers can find work and recruit others.
Developer Marketplace: Developers can find, purchase, and sell building blocks for their creations including plug-ins, meshes, 3D models, decals, audio and videos. These allows developers to build more efficiently and deliver richer experiences.
Documentation and monetization tools: The developer hub contains API documentation, tutorials, and educational material. Roblox’s analytics tool provides developers information about the performance of their creations (user counts, retention rates, monetization). Developers can also purchase advertisements displayed on players’ discovery and search pages, helping to increase the traffic for their creations.
Earlier, we talked about Robux, and how players use it to buy a variety of things to enhance their in-game experience, such as avatar clothing and game passes. Robux is used by the developers as well. Items in the developer marketplace are quoted in Robux and advertising on the platform is also paid in Robux. In fact, a lot of the times developers actually pay each other not in USD but in Robux! Many developers save up in Robux so that they can have reserves for advertising their future games and to pay other developers. We hope by now it is clear how highly sought after Robux is in the virtual economy, by both the players and the developers.
Developers can earn Robux through various ways: selling their own in-game items and game passes, clothing and accessories on the Roblox Marketplace, and selling things to other developers in the Developer Marketplace. In recent years Roblox also introduced something called Premium Payouts, which rewards Robux to developers based on the time spent in-game by Premium players (players with a Roblox Premium subscription) in their experiences. This allows developers to monetize through their in-game engagement, in addition to selling items to players.
Robux can be cashed out into USD under Roblox’s Developer Exchange Program (DevEx). But most casual developers typically don’t get to do this. First, there is a minimum cash out threshold, and few casual developers actually reach this point (Roblox recently dropped this to 50k Robux from 100k, but it’s still not easy). Second, the conversion spread for cash outs is unfavorable (this is a key way Roblox makes money!). When buying Robux, players pay $0.01176 per Robux ($19.99 for 1,700 Robux), but when cashing out the company only pays at a rate of $0.0035 per Robux. These barriers effectively act as nudges for most developers to just keep Robux within the Roblox walled garden, as opposed to cashing out for real money.
This might all sound somewhat “discouraging” for a developer, but this isn’t a huge problem because keep in mind developers on Roblox tend to be players themselves. For them, the Robux earned in their accounts is Robux which they otherwise would have likely paid real money for anyways. They can use the currency to splurge on any of the constantly growing amount of games on Roblox as a player, any avatar clothing, or even “Limiteds” (as a sort of digital flex on the platform). If they’re savvy entrepreneurs, they’ll “reinvest” the Robux to hire developers or spend on advertisement to potentially boost their sales even further.
What about developers who are doing it to make real money? While there are always some developers that complain, the reality is that the platform remains very attractive. Roblox provides them a large captive base of audience, and very cheap and wide-reaching advertisement slots to reach players. What’s also attractive is the zero startup cost – you get to use Roblox Studio for free, and there is also no storage, hosting, and infrastructure expenses. Compared to more sophisticated development options like Unity or Unreal engines, Roblox is easier and cheaper to build on. The fact that the whole platform is a one-stop solution for developers, and allows them to start with no upfront cost makes it super attractive. Also, Roblox is only taking a cut if the developers are making money, which keeps their incentives aligned.
In 2020, there were 1.3 million earning developers who earned a total of $329m. 1,250 of these developers earned more than $10,000, and 300 earned $300,000 or more. The distribution is similar to other creator platforms - as in most creators make little or nothing, but the rare ones that do have the potential to make big bucks (and at a young age).
Now, let’s wrap up by seeing where Roblox - the company - fits into this whole picture and how the company makes money:
Roblox Corp
Roblox’s role in this entire setup is providing the infrastructure for these games to run on, whether it be the Roblox Studio or game servers. In return for the privilege of allowing developers to create games for free, Roblox sets up a walled garden and makes sure that all transactions on the platform must be done in Robux. Roblox’s bread and butter is selling Robux for much, much higher than they redeem it for. As the sole issuer of Robux on the platform, they have full control over how Roblox is bought and sold on the markets. Roblox also provides content moderation and monitors gameplays to identify and filter abuse, toxicity, and ban malicious players.
Roblox’s role here is actually quite similar to what the government does: provide the infrastructure, basic services, and manage monetary policy. And what do governments get in return for providing all these? Taxes! Roblox taxes all transactions in the virtual economy at 30%. This effectively destroys Robux and takes it out of circulation, meaning that users will eventually have to keep buying Robux to participate in the economy. Note that to get the best outcome, Roblox has to figure out the optimal rate of taxation. Similar to a government you end up with the problem of the Laffer Curve - tax too high and you reduce the underlying activity in the Roblox economy as developers have less incentive to create games; tax too little and you get a very small cut of very large underlying activity and end up with a possible situation where lots of players can/want to cash out. So far 30% is working fine.
What Roblox has managed to set up over the many years is truly phenomenal. They don’t have to worry about coming up with game ideas or keep up with the latest trends in the game market - that is entirely down to the community. All they have to do is sit back, run the underlying infrastructure, and then rake in cash by selling Robux for USD, then tax every transaction on the platform denominated in Robux at a rate of 30%, pay their operating expenses and whatever little redemptions (at a rate at which they decide as the monopoly issuer of the currency), and enjoy!
[It is also worth noting that although certain developers can cash in Robux, Robux is not a right to cash. It is not a liability on Roblox’s balance sheet. The company retains all rights to Robux and makes no guarantees on its financial value, as it is clearly laid out in the T&Cs.]
Effectively, what Roblox has done is that it has set up a walled garden with massive network effects. People wanting to play these hot games built by Roblox’s community have to pass through Roblox, and they take their cut. Young people keep creating more and more engaging games, and users keep spending money on experiences across a growing variety of games. The whole platform has a virtuous cycle embedded within it. The business is almost self-running. It’s very similar to Apple’s model of creating a strong mobile phone user base and then taking a cut of all sales from developers on IOS - it’s an amazing model.
Growth opportunities
While some investors and analysts have expressed concerns about Roblox’s growth runway, we think there is still plenty of growth that can be unlocked.
As a cross-platform, free-to-play service that is growing internationally and aging up its player base, we think Roblox’s user count is still far from being saturated. We also think there is room to grow bookings per user which is currently at ~$60/year, as more sophisticated experiences are created on the platform over time and as cohort spend improves. Keep in mind this is less than the price of a single title on a PS4/Switch console. For this price, users can experience multiple top games with their friends and stay engaged for an entire year.
Here, we’ll take a closer look at the two most important growth initiatives at Roblox – aging up and international expansion.
Aging up
While still in early stages, so far the progress on aging up has been encouraging. The proportion of users aged 13+ has been growing, now accounting for more than half of all users on the platform. According to management, 17 to 24-year olds now account for 20% of all users and this was up 51% in the fourth quarter compared to last year.
Here’s what a gaming veteran with 25 years of industry experience says about what the potential of aging-up means for Roblox’s growth potential:
“It doesn’t have a roof on how big it can get. I’m pretty sure that Overwatch won’t be 10x as big in 10 years. I’m not so sure about Roblox. It could be 10x as big in 10 years because I don’t see the limit on the structure. I know right now Roblox is very much kids’ games, but that’s not a rule in the universe that should be.”- Development Director, CREY Games (January 2022) - Stream transcript
What does it take to age-up the platform? Roblox has been making progress across a number of areas:
Enabling Roblox Studio to develop more high-fidelity games. For example, first-person shooters with better graphics and a higher skill cap which draws in more competitive players (more on this later)
Financially incentivizing more professional developers and studios to develop on Roblox. While Roblox doesn’t make games itself, this is effectively the content cost.
Expanding platform features that older players value. For example, Roblox is working on making its avatars fully customizable and user generated. Right now, users can accessorize their avatars but the form factors are predetermined. In the future, entire avatar including its shape and size becomes customizable. In addition, Roblox has enabled voice communications, something which the platform hasn’t done until recently for moderation reasons.
The investor/analyst community seems to be intensely focused on the “aging up” story. But often overlooked is the fact that there should still be room for spend to grow even among the existing/younger age brackets as they are immersed to an ever-expanding catalogue of quality content. Like how Amazon is able to capture increasing share of wallet by adding more and better items to its marketplace. Taking a step back, the core engine remains the same - whether for older or younger players - it’s really about Roblox’s growing catalogue of immersive content, which can entice more aggregate spending on the platform.
International expansion
Outside North America, Roblox has a fairly big presence in Europe and South America. The current strategic priority is APAC - the world’s largest gaming region. APAC user growth has been very strong, and in fact there are now as many Roblox players in APAC as US + Canada. Roblox has established a Korean subsidiary in July 2021, and has gained a lot of players there. In the fourth quarter, it was disclosed that Japan and India grew by more than 100% over last year (albeit from a small base).
Roblox Studios is available in multiple languages, allowing developers to push out content not just across devices (PC, mobile, Xbox) but across multiple languages as well. Once a sizable player base is established in a given region, the next step is to foster a vibrant local developer community, which can introduce more localized experiences. This is yet another advantage of Roblox as a UGC platform – localization can be left to the community which knows how best to execute.
Google search trends for Roblox has been steadily growing for the last 12 months, and continue to remain high in the major Asian markets, as shown below.
The only exception to the APAC growth story is China. Roblox entered China through partnering with local giant Tencent (Roblox 51% and Tencent 49%), but in December 2021 Roblox voluntarily closed down its service, just five months after it launched. It looks like China’s gaming crackdown has factored into the decision. Minors are now subject to severely restricted play time, in addition to stricter censorship on gaming contents which spells especially challenging landscape for a platform like Roblox that rely on content generated by others. This opens up the platform to more content risk. It’s uncertain what the future holds for Roblox in China.
But even excluding China, APAC’s video game market is roughly the same size as US+Canada by total revenue, and by gamer population it is roughly three times the size. Not to mention some of the emerging markets, like India and South East Asia, are growing at much faster rates. Even taking out China from the equation, Roblox is still far from being constrained by the market size of APAC.
Game Engine
Many former Roblox employees believe the company is on the right track in its aging up initiatives. Specifically, they spoke highly of the capability of the Roblox game engine to build more sophisticated experiences:
“The dirty little secret of Roblox that no one knows or really talks about is just how advanced its game engine really is”– Former Senior Manager, Developer Content Strategy (February 2022) - Stream transcript
“You can also make really complex ones where you can almost make an entire AAA game in the Roblox suite if you really wanted to…I would say that they have most of their ducks in a row to be able to pull it off…It’s going to be a matter of time”– Former Moderation Manager (December 2021)
“Even the time I spent there, there was a lot of focus and investment, and still is, in building the gaming engine for more sophisticated experiences. You referred to the blockiness. There’s a lot of focus on reducing the dependence on that blocky aesthetic. There’s a lot of investment in that area. It’s clearly paying off”
– Former Senior Director of Engineering (August 2021)
Roblox’s generic “blocky-ness” has been a meme for quite some time. However, there’s been marked improvement in graphics and gameplay compared to previous versions, and the games no longer feel anywhere near as tacky. The engine has drastically improved to a stage where games can run extremely smoothly and in very high fidelity, and the limitations on the quality of a game are shifting towards developer capability, rather than the engine itself.
The top image is from Frontlines, a FPS game on Roblox. The other is from FLIGHTLINE, a very niche flight simulator game on Roblox. Both are currently in beta, but these games, we must emphasize, are miles ahead of prominent games in terms of the fidelity of their experiences. And the beautiful thing about it is that all these experiences are being built and edited via the Roblox Studio. In 2022, developers have so much freedom to do what they want that it really is breath-taking. The limits of the engine have constantly been pushed every year, and this is clear to see from the perspective of the co-author who has been toying around with development since 2017 (we wonder to what extent the investor/analyst community is aware).
Another underrated point about the Roblox game engine is that all games can be run via the Roblox application (“Roblox Player” on PC). This means that players don’t have to wait and install every game they want to play, taking up loads of storage on their devices as well as their time. All they have to do is install Roblox once, and they can press “Play” on a game on the website and it automatically opens up the game and connects them to an online server very quickly compared to something like Valorant (a very popular FPS game made by Riot Games).
You also don’t need a heavy gaming rig or anything expensive to play these games. These games are playable on average/low-end laptops, which means that Roblox’s catalogue is far more accessible than conventional AAA games made by Ubisoft, Activision Blizzard and Riot Games, and this helps them address a much wider market. What Roblox is moving towards is allowing for higher and higher fidelity experiences which can be run without higher and higher quality hardware - again a really incredible point.
Business economics
At Roblox, there are two measures of ‘topline’ - bookings and GAAP revenue. Bookings is recorded when players purchase Robux (with USD, EUR,..) and GAAP revenue is recorded when players spend those purchased Robux in-game. The difference between the two comes from accrual accounting related to virtual currency, and isn’t exactly interesting. But you should keep in mind that Robux purchases are non-refundable (must be spent/cannot be cashed out by the purchaser), and players spend them within 3 days of purchase on average. While GAAP revenue is what appears on the income statement, investors/analysts would look at bookings instead to get a better reflection of the “true” topline. Bookings also corresponds to the cash inflow of the business.
On the expenses side:
Cost of revenue consists of app store fees paid to Apple, Alphabet, and Microsoft for Robux purchases on mobile devices and on the Xbox/PC. It’s a blended percentage take rate which should remain roughly stable over time.
Developer Exchange fees is the amount which developers have cashed out of the Roblox economy (recall the company pays out at a rate of USD 0.0035 per Robux). This is Roblox’s cash expense paid to developers. We expect this to rise as a percent of topline over time to incentivize developers.
R&D expenses, meaning Roblox’s own development headcount, has grown significantly as the company invests in its development engine. A lot of this is share-based compensation. The company is currently investing aggressively in R&D headcount, although this might be a source of operating leverage in the future.
We see that Infrastructure and SG&A expenses have benefitted from operating leverage. This is expected, as these are just mostly servers/hardware and headquarter personnel.
Below, you can see that free cash flow has surged (despite the negative GAAP earnings). The pandemic has led to an abnormally strong period for bookings growth since 2Q20, which has resulted in a period of high cash flow conversion in the upcycle due to lagging costs/working capital benefit. As bookings growth slows down however cash flow will come down, which is what we’ve seen in the fourth quarter. Also, share-based compensation (which is reflected in P&L but not in cash flows) has grown significantly in recent quarters as the company ramped up its R&D hiring.
In order to value the company, investors need to forecast a normalized level of free cash flow out into the future, which presently is very difficult to do. One can toy around and make assumptions with cost trends discussed above, as well as make rough comparisons with other video game peers in the industry. We will come back to this later in the Valuations section.
The “Metaverse”?
To be frank, this is literally our biggest pet peeve right now. It’s clear Roblox’s management has been trying to promote this narrative – they started referring to the metaverse a lot more at presentations. Things are no longer referred to as “games” but as “experiences”. In-game items are now called “metaverse items”. Many developers are extremely confused by this narrative, given that this “metaverse” thing that every tech executive keeps talking about already exists!
Many are hyped about the potential of Roblox beyond gaming – from doing live concerts to partnering with brands on ‘branded experiences’ such as the Nikeland, Vans World, NFL Tycoon, and others. However, we warn that these narratives can get taken too far, and investors and analysts should approach this with a healthy dose of skepticism, recognizing that a lot of this stuff is narrative over substance at this point.
For example, consider the branded experiences. We sort of chuckle when these are brought up to support the “metaverse” thesis. Each of Nikeland, Vans World, and NFL Tycoon has only a couple hundred active players as of the time of this writing. There is very little engagement. To give you a sense of how lacklustre this is, there are low development effort 3D train simulators with more active players than this. The most popular games on Roblox, like Adopt Me, Murder Mystery, Jailbreak, and Brookhaven RP each have tens and up to hundreds of thousands of active concurrent players. It’s still super early days to call this anything. Roblox will surely try to iterate on this over time, but if the end goal is brand engagement, then it’s clearly been a failure so far.
We will concede on one thing however: for many years there’s been the issue of IP theft on the platform with developers creating Nike, Gucci, etc. clothing for players to purchase for their avatars. Now, if you search up Nike, the results get censored on the avatar store. Fashion companies’ ventures onto Roblox mean that they can actually sell avatar clothing and make money off it, but as of now, Nike hasn’t created any items in its group store. Maybe this can change in the future.
Here, we implore the reader to take a step back, and recognize that all the leading things on the platform which brings in engagement and money for Roblox are games, not relatively boring corporatized “metaverse experiences”. Rather than looking at a bunch of games created by brands with only a few hundred active players as the future of the Roblox “metaverse”, the best place to look at to figure out the future of Roblox is its user base. The future of Roblox is entirely powered by the imagination of its users, who know the market they are creating their games for inside out since they are part of the target market themselves. It cannot be emphasized how important this point is.
While we are all for innovation and not trying to bash management’s efforts in this new space, we are just frankly confused and struggling to make sense of it (as are lots of established developers that we have spoken to). What we tend to observe is that investors tend to hype up new narratives, while not giving enough credit to the strength and uniqueness of Roblox’s core engine. The core is what truly makes Roblox such an interesting platform, and what will continue to drive its future growth.
Venture capital firm Altos Ventures is Roblox’s largest shareholder. Ho Nam, the MD/co-founder of Altos Ventures, has been involved with Roblox for over 15 years. Note what he has to say on the matter:
Management
Founder/CEO David Baszucki owns ~11% of total shares and has controlling interest via his 100% ownership of class B shares (which grants a 20-to-1 voting power). Altos Venture owns ~15% of shares, and one of its senior executives (Anthony P. Lee) sits on Roblox’s board.
While we’ve refrained from hyping the whole “metaverse” narrative earlier, that doesn’t change the fact that we do like Roblox’s management a lot. Culture is quite important for a gaming company, where people are the main productive asset (look no further than ATVI for how culture can hamper a gaming company). Former employees of Roblox have spoken favorably regarding David Basczuki and the management team.
“When it came to me working in the Roblox company culture, lots of friendly people, very cool and down-to-earth people do. In fact, they have a great level of communication with each other as far as different teams synergizing with each other. That level of communication is great.”
- Former Moderation Manager (December 2021) - Stream transcript
“I think the team is led really well by Dave. Just the fact that this company has existed for 15 years is incredible. A lot of that has to do with Dave’s vision”
- Former Senior Engineering Director (August 2021)
Regarding this statement on vision, see the below picture, which was taken from one of Baszucki’s first business pitches in the early days of Roblox in 2006. At that time, they have already envisioned an avatar-based world incorporating UGC and social elements. It must take an absolute level of obsessiveness to keep at this and execute for 15 years. Some critics today refer to Roblox as an overnight ‘pandemic success’. The platform has indeed grown tremendously during the pandemic. But this doesn’t do proper justice to the vision, execution, and the underlying ingenuity of the business and the people behind it. All it took was 15 years for Roblox to become an ‘overnight success’!
You can find in Roblox the type of management who are long-term thinking and genuinely obsessed and passionate about what they’re building. Again, here is what Ho Nam has to say (by now, you should know that the first thing you need do if you’re interested in Roblox is to go follow @honam on Twitter!)
Platform risks
Trust & safety is big deal at Roblox. This is a hangout spot for young children, and nobody talks more about platform safety than David Baszucki. We believe investors are in good hands when it comes to this. Before starting Roblox, Baszucki actually spent a decade selling educational software to schools. This is a management team that truly understands the responsibility they have in operating a minor’s platform.
Roblox has hired 2,500 contractors working in content moderation 24/7. Roblox’s censorship regime is the strictest of any game. In fact, Roblox’s censorship regime is routinely mocked and people have complained about it for years because it even censors benign words. That’s how far they’ve gone to try and appease the helicopter parents who want to hide their 11-year old kids from the reality of the world around us. Letting children play games where they pretend to drive cars on a heavily censored platform is way safer than letting them play in a park in the real world. That’s the thing that we believe critics of the platform need to understand.
Over the years, there have been online articles accusing Roblox for being inappropriate for children. For example, Problems at Roblox (The Bear Cove) makes the claim that Roblox is “the leading platform for paedophiles” among other accusations. Jumping on this bandwagon, BBC released a piece too: “Roblox: The Children’s game with a sex problem”
If you are interested in a rebuttal of these, we have written a Twitter thread on it in the past which you can read here:
To our surprise, this thread actually went quite viral within the Roblox developer community. Here is one person who agreed with us:
If you are not familiar, Asimo is a legend within Roblox’s developer community, and owner of Jailbreak, one of the most popular Roblox games of all time with 5.6 billion cumulative visits.
People have also written about all sorts of things over the years, from the trading/speculative economy of in-game items to Roblox ‘exploiting’ child labor. To be honest, it’s all quite rubbish. In fact, Roblox specifically don’t allow you to cash out Robux from trading gains into real world money (Robux that can be cashed out must be “earned” properly through standard developer activities). The speculative flipping is just a by-product of allowing users to acquire and sell Limited items, which actually have utility in a real gaming environment. We are not going to do a line-by-line rebuttal of all of these, but you get the point.
But one thing we do concede on is that running a children’s online platform entails tremendous responsibility. And under the wrong management team with improper incentives, there can be many possible ways for this to end up badly. For example, underinvestment into content moderation could seriously damage the trust and brand of the platform. Management is therefore crucial. We think Roblox has done a phenomenal job at managing the platform risks, and they have proven that they deserve investor’s trust. Investors should feel good about being invested alongside David Baszucki. There is something to be said about his longevity in the business.
Valuation
Below, we provide three scenarios of what key financials could look like in ten years. In addition to a ‘weak’ and ‘strong’ scenario we also include a ‘Metaverse’ scenario, for the purpose of dreaming big (e.g. what if Roblox can get to Netflix metrics). On the right side of the chart, we have included metrics from Netflix, Spotify, and Snapchat just for reference. These are provided just for interest, and we are not implying in any way that there should be convergence between Roblox and any these platforms. Please always do your own valuation.
One way to think about a long-term FCF margin structure is as follows: Cost of revenue (20% of bookings), developer exchange (25% of bookings), employees and infrastructure (30% of bookings), leaving 25% as the FCF margin. We note that major developers like ATVI and EA have FCF margin in the 25-30% range.
For the purpose of valuation we don’t assume that Roblox will pay any dividend, and assume that all cash flow generated during the period will either be used to repurchase shares to offset dilution, or reinvested into growth (M&A).
If you are to believe in a reality that falls somewhere between our weak and strong cases above, it results in roughly high-single digits IRR (at the current share price of ~$50). If this valuation exercise is anything to go by, then the current stock price seems reasonable enough if your time horizon is long, although patient investors may prefer to accumulate on further dips.
But what’s also interesting is that in February, the board granted a “Founder and CEO Long-Term Performance Award” to Dave Baszucki. Valued at $234 million, it allows him to earn up to 11.5 million shares over seven tranches. To earn each, Roblox’s average share price over a 90-day period from the commencement dates (listed below) must exceed the hurdle rate.
Whether this compensation package was “necessary” in the first place is a separate discussion on governance, which we won’t get into here. However, we were surprised by how high the price hurdles were set (these are more ambitious than the most bullish scenario we presented earlier). These numbers are usually carefully chosen. At the very least, the board/CEO must envision scenarios that they view as realistic enough, even if highly ambitious. These may be relevant when thinking about the potential range of the upside, even if they are not to be interpreted as base cases.
Roblox as a strategic acquisition target
We’ve seen many gaming acquisitions lately, and there is no doubt that Roblox has a ton of strategic value for certain potential acquirers. Given the demographics of Roblox’s young users, the engagement, the global growth, and its evergreen portfolio of games created by the community, this is an asset that companies like Meta and many others would drool over. The only restriction here is antitrust, and also the obvious fact that Roblox is not up for sale.
What more can we say, you’ve heard from the biggest shareholder. There is no reason to think Dave Basczuki would want to sell this business any time soon. M&A should not be part of the current thesis here. Nonetheless, investors could derive comfort in knowing that they own something with a ton of strategic value and probably no shortage of potential bidders if it was to be put up for sale any day.
Concluding thoughts
To conclude, we think Roblox is a really incredible company which has been growing for so many years, and has been executing on the right things (even if we think that they’re hyping up the metaverse narrative a bit – we’ll have to update and refine our thinking on this over time). The hard part for Roblox was solving the basic dilemma of attracting players without any games created by developers, and attracting developers to create games without a player base. But that’s done now. We think there is still a long growth runway that can be unlocked.
Last but not least - investors have a huge user base of young people on this platform who not only game, but are constantly creating new games for their peer group. As we said before, Roblox is a bet on the everlasting creativity of the younger generation - we believe that younger players know what other younger players want the best. By providing an improving sandbox environment for them to unleash their ideas, as well as a vibrant captive social platform, this company will continue to grow into the future.
Disclosure: The co-author and his clients have a long position in Roblox.
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