Roblox Developer Conference 2019

Ian Tuttle/Getty Images Entertainment

Roblox (NYSE:RBLX) is a pioneer in the Metaversum gaming space. Users and developers can create and play immersive games with the platform. The company makes most of its money from the sale of the in-game currency called “Robux”, as well as from advertising, licenses and royalties.

The company’s popularity catapulted during the pandemic with many people stuck indoors and a lack of other entertainment options.

Roblox Stock History

Roblox was briefly a Wall Street darling as a so-called “pandemic stock.” This identification alone suggests that this was a short-term trade and not a long-term investment.

Capitalizing on its pandemic surge, the company went public through a direct listing in March 2021. The stock opened with a high valuation and peaked in late 2021 along with much of the tech stock market before plunging back to earth as shown below.

RBLX stock price
Data from YCharts

The stock is now 75% below its 52-week high and almost 50% below its closing price on the day of its direct listing.

This doesn’t mean it can’t go much deeper.

prevailing mood

Wall Street is currently bullish on Roblox stock, with an average price target of $47.55. This implies an upside potential of 37%.

Roblox Stock Wall Street Ratings

Alpha wanted

Roblox price target

Alpha wanted

Similarly, three of the last four articles by Seeking Alpha contributors have buy ratings for the stock. The recent writer with a sell rating also states that they “remain bullish over the long term.” These authors have provided quality comments and I encourage everyone to read these articles.

I don’t share their optimism.

There are red flags regarding several Key Performance Indicators (KPIs). I expect Roblox stock to underperform the market over the medium to long term. If the market continues to panic sell in the short-term, I expect Roblox stock to fall more than the broader market.

RBLX rated as a growth stock

Roblox is currently losing money – lots of money. The company lost more operating profits last quarter than ever before and has never posted a single quarter of positive operating results. On an annual basis, the company reports growing operating losses of $76 million, $266 million, and $495 million in 2019, 2020, and 2021, respectively. But profitability isn’t the issue — growth is.

As it moves further from profitability, Roblox is a pure growth stock, and the valuation reflects that.

Roblox is trading at a price-to-sales (P/S) ratio of over 9 despite its 75% drop. This is well above its Metaverse brethren, Unity Software (U), as shown below.

Roblox vs. Unity Software PS Ratio
Data from YCharts

Wall Street will give premium valuations to growth stocks with long histories. But here’s the rub: you’d better keep growing. If not, the stock will be trampled on as it re-rates on slowing growth. And that’s a massive risk.

I will focus on three KPI topics investors should be concerned with:

  1. Slowing revenue growth and user decline
  2. The bookings are falling
  3. Where has all the cash flow gone? I’ll explain.

sales growth

Since Roblox is in a growth phase and is trading like a growth stock, let’s start with the obvious; sales growth. Revenue has exploded during the pandemic and nobody reasonably expects this to continue. However, the rate of declining growth rates is alarming.

Roblox revenue growth

Roblox. Chart by Author.

You might be thinking, “Of course they growth rate slows down; This is how percentages work when the numbers get bigger. Why, surely absolute growth still climbing.” Right? Well… absolutely not.

The chart below shows the amount of revenue added each quarter year-on-year. As we can see, it’s not just a trick of percentages showing a declining growth rate. Dollar-to-dollar growth is also slowing significantly.

Roblox Earnings

Roblox. Chart by Author.

It’s a metric I look to when I write about growth stocks. Take CrowdStrike (CRWD) for example. Its growth rate slows somewhat as the numbers get bigger, but its absolute growth (total sales added in the previous period) is accelerating quickly. Not so for Roblox.

After slowing for some time, the number of daily active users (DAUs) eventually fell from $54.1 million to $52.2 million in the second quarter for the first time in the company’s short history. Without user growth, this company is gone.

Some might attribute this to the spring weather; However, DAUs increased in the second quarter of 2021, and the decline follows a pattern of slowing growth.

The bookings are falling

The vast majority of Roblox’s sales come from Robux, and it makes information about those sales available to investors as “bookings”. What is the difference between bookings and earnings? Due to accounting policies related to revenue recognition, some sales are recognized as revenue over time rather than all at once.

In plain language, and in general, bookings are an excellent barometer of future revenue growth or decline. As bookings increase, sales are likely to increase in future periods. Likewise, a drop in bookings is a bad sign for future sales.

As seen below, not only has booking growth slowed; it has declined for two straight quarters.

Roblox Bookings

Roblox. Chart by Author.

That makes it unlikely that revenue growth will suddenly take off in the coming quarters. Some believe advertising will save the day; However, this is highly speculative.

where’s the cash

While Roblox didn’t turn a profit in 2021 and 2020, it produced tons of free cash flow. This is powerfully supported by stock-based compensation, but also by something else: deferred income. Simply put, cash is collected in advance for revenue recognized in future periods.

Below is the company’s cash flow statement.

Roblox Cash Flow Statement

Roblox 10-K

Deferred revenue is exceptionally healthy in 2021 and 2020.

Rising latent income is a great sign of future growth, as is rising bookings.

Unfortunately, for two quarters of 2022, deferred revenue fell from $485 million last year to just $149 million this year. That’s a 70% drop. As we can see below, barring a holiday boost in the fourth quarter, deferred revenue has been and is steadily decelerating.

Roblox Deferred Revenue

Data from Roblox SEC filings. Chart by Author.

That has resulted in a sharp drop in cash from operations, even though stock-based compensation has nearly doubled so far this year.

Cash flow from operations fell to its lowest level since the third quarter of 2019 at just $26.5 million. Keep in mind that Q3 2019 predates the pandemic and Roblox’s popularity explosion.

What’s that supposed to mean?

Roblox is a pure growth stock with no near-term opportunities for actual gains. No problem here, absolutely. Some of the strongest companies in the world started this way. The problem is that growth is drying up like a puddle in the desert — and that’s extremely risky for shareholders.

If the company continues to report declining metrics, the stock will continue to suffer. The KPIs that point to future growth, like bookings and revenue accrual, are all pointing in the wrong direction. And the declines are staggering.

The quantitative readings flash red.

Qualitatively, Roblox struggles with a volatile market in the long term. Many people have tried the platform during the pandemic and the hardcore fans will stick with it. Others get busy, play less, and eventually quit altogether and move on to something else.

This happens all the time in the pop culture and entertainment world. Examples that come to mind are the online poker craze of the early to mid 2000s, fantasy sports, Pokémon, and sports betting. All of this will be around for a long time, but ultimately only the enthusiasts will remain.

So far, the looming recession and the rapidly rising interest rates have not been mentioned. None of these will have a positive impact on Roblox’s sales or profit numbers.

Roblox stock has plummeted from its highs, and many investors might see it as a bargain at these prices. Several contributors on Seeking Alpha and Wall Street agree. I take the opposite position.

This is only my third downright pessimistic article on Seeking Alpha. It’s not that I don’t have negative opinions on many popular stocks; I do. But in general, I focus my writing on those I’m optimistic about. Of my two previous strong bearish calls, the first is down 94% and the other is down 50% in just over four months.

Roblox needs to prove it’s not just a flash in the pan. Key indicators are alarms. Just because a stock has fallen a lot doesn’t mean it can’t go much further down. Investors should be wary of Roblox stocks.

Editor’s Note: This article was submitted to Seeking Alpha’s Best Contrarian Investing Contest, which runs through October 10th. With cash prizes and the chance to chat with the CEO, don’t miss this competition – open to all contributors. Click here to learn more and submit your article today!

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