Roblox: Lavish SBC And High Valuation Make The Stock Unattractive (NYSE:RBLX) (2024)

Roblox Corporation (NYSE:RBLX) has continued to grow in recent quarters since my previous article on the stock, with daily active users, bookings, and revenues seeing good and consistent increases. Yet, profitability has continued at an incredibly weak level, and the valuation appears to be excessive even with the great continued growth.

I previously wrote an article on the stock, published on the 10^th of August in 2023 with the title “Roblox: Investors Need Faith In The Metaverse.” In the article, I initiated Roblox at Sell due to the company’s incredibly high valuation combined with bleak earnings. Since, the stock has now returned 17%, nearly the same as the S&P 500’s (SP500) 23% return in the same period.

Roblox’s Impressive Growth Has Continued, Some Slowdown in Rest of 2024 Expected

At the time of my previous article on the stock, Roblox had recently reported the company’s Q2/2023 results. The company has now reported more recent growth, showing continued impressive growth – bookings in 2023 ended up growing by 22.6% to $3.52 billion, and continued with a 19.4% growth in Q1.

Underneath, KPIs also continue to show a good performance. In the first quarter, daily active users increased by 17% year-over-year, average monthly unique payers by 13% with increasing average bookings, and hours engaged by 15%. The continuously scaling KPIs show good momentum for Roblox to build future momentum on. Percentage wise, the growth is slowing down, but still showing a similar performance in absolute terms with 11.6 million new daily users added in Q1 from the previous year.

Roblox’s upcoming years’ target is also now clearer, as in the Q4 shareholder letter the company pointed at a 20% annual top-line growth expectation through at least 2027, with margin expansion of 1-3 percentage points expected each year with cost management.

For 2024, Roblox currently guides for bookings of $4.0-4.1 billion, expecting a middle point bookings growth of 15.0%. Revenues are expected to grow even more aggressively, with a 24.6% middle point growth, as deferrals are expected to slow down.

Notably, though, Roblox had to lower the guidance with the Q1 report from the previous guidance of $4.14-4.28 billion. The newer guidance isn’t very much below the previous one, but shows signs of slowing down, especially with the given Q2 guidance – for the quarter, only 13.4% in bookings growth is expected as the middle point of the guidance, down very notably from 19.4% in Q1.

Roblox has seen growth in bookings pick back up above 20% in the United States and Canada in late April to early May as told in the Q1 earnings call, but, guides for weaker growth in the quarter. If the trends have continued to improve, the guidance’s middle point could well be beat. The full-year guidance seems to expect quite similar growth in the back half of 2024 as in H1.

Profitability Continues to Be Weak

The most discouraging part in Roblox is, in my opinion, the company’s continued incredibly weak – trailing GAAP operating income stands at -$1.26 billion, a -42.9% margin with Roblox’s revenues. The income continues to be largely weakened by trailing $923.6 million in stock-based compensation ("SBC"), causing dilution and eating away shareholders’ equity while not affecting cash flows. Notably, the SBC is only guided to scale, with $1.08 billion expected in 2024.

Deferrals also push down earnings as revenues still trail bookings by quite a wide margin – operative cash flows stand at $523.3 million in the past twelve months despite the weak earnings.

The covenant adjusted EBITDA is guided to grow by 30.9% in 2024 into a middle point guidance of $565 million, representing a 1.7 percentage point margin expansion year-over-year. While Roblox is swaying away from using the metric, it shows the clearest indication of operative cash flows in my opinion, and is a useful metric. The metric still excludes SBC, being a major cost to shareholders.

Roblox has quite a large amount of fixed costs – I believe that margin expansion is challenging but doable, and the scale of the expansion shouldn’t be exaggerated in estimates. Two major cost categories continue to scale with revenues, as cost of revenue accounted for 22.3% of revenues in Q1 and developer exchange fees accounted for 25.3%.

Infrastructure and Trust & Safety costs seem to be plateauing, giving space for margin expansion, with 15.5% of revenues in Q1 related to costs in the category. Personnel costs have scaled so far, but could be a source for future margin expansion if costs are managed in a more disciplined manner – I believe that better margins could be achieved if targeted for, but at the cost of growth. With GAAP figures showing apparent negative margins, achieving future leverage is crucial in my opinion. Roblox has pointed at a target of achieving 1-3 percentage points in annual margin expansion, and I believe that the range is a fair baseline expectation going forward.

Major Metaverse Growth Is Now Likely a Far-Fetched Idea

The buzz about Roblox’s and Meta Platforms’ (META) metaverse development has slowed down considerably – while Meta Platform has released its Meta Quest 3 VR headset that Roblox has adapted to, it looks that the hype in the potential has died down. The metaverse was last mentioned in Roblox’s Q1/2023 earnings call in the Q&A, and while development in the area seems to continue with $276.0 million in trailing capex compared to $426.2 million in 2022, it doesn’t seem that the potential is as pronounced as before was hyped. I believe that VR/AR will still likely only show a modest revenue growth pathway for Roblox, and not a way to reach 1 billion active users that Roblox’s high ambition hopes for.

Updated Valuation: RBLX Stock is Still Overvalued

I have updated my discounted cash flow [DCF] model to now include bookings and covenant adjusted EBITDA instead of reported revenues and GAAP EBIT to better visualize the investment case, and have compensated for the high stock-based compensation by attributing a 23.5% total dilution to the current share count, a dilution that represents five years' worth of SBC at the market cap of $23.0 billion and guided 2024 SBC of $1.08 billion.

I now estimate bookings to grow at a CAGR of 10.8% from 2023 to 2033 with a gradual slowdown, representing a similar pace as guided for in 2024 and likely representing around a 20% revenue growth rate as net deferrals should affect revenues with a lag as outstanding unused currency on the platform should increase. For the perpetual growth, I estimate 3%, the same as previously.

Roblox’s increasing scale and cost management should account for good margin expansion, and I estimate total leverage of 13.7 percentage points from 2023 into an eventual 26.0% covenant adjusted EBITDA margin. The cash flow conversion from the metric should be good as net losses should defer Roblox from paying significant taxes and capital expenditures are moderate.

The estimates put Roblox’s fair value estimate at $18.20, 49% below the stock price at the time of writing – the stock continues to be overvalued despite great continued growth. Greater growth or margin expansion, or SBC that causes less dilution than I anticipate, could still make the stock be worth significantly more than I anticipate, but I still expect the investment to carry a weak risk-to-reward. The fair value estimate is up from $17.85 previously.

A weighted average cost of capital of 11.29% is used in the DCF model. The used WACC is derived from a capital asset pricing model:

In Q1, Roblox had $10.4 million in interest expenses, making the company’s interest rate 4.12% with the current amount of interest-bearing debt. I estimate a low debt-to-equity of just 5%, near the current figure with the market’s equity valuation.

To estimate the cost of equity, I use the United States’ 10-year bond yield of 4.23% as the risk-free rate. The equity risk premium of 4.60% is Professor Aswath Damodaran’s latest estimate for the United States, updated on the 5^th of January. Yahoo Finance now estimates Roblox’s beta at 1.58. Finally, I add a liquidity premium of 0.2%, creating a cost of equity of 11.70% and a WACC of 11.29%. The WACC is near the previous 11.63% estimate.

Takeaway

Roblox’s growth has continued well as KPIs continue to show healthy scaling, although a slight slowdown is expected in the rest of 2024 with the Q2 and lowered 2024 guidance. Still, margins are highly worrying, with continuously high stock-based compensation causing dilution and high other costs. Roblox targets for 20% in annual top-line growth in coming years combined with 1-3 percentage points of annual margin expansion, but the current -42.9% operating margin seems to require even more aggressive expansion from growth and cost discipline.

The stock’s valuation continues to be unattractive, as the stock has performed in line with S&P 500 after my prior article. More aggressive cost control or growth could turn the stock more attractive, but the weak risk-to-reward leads me to remain with a Sell rating for Roblox Corporation.

I write mostly about small cap companies in the United States, focusing on a thorough explanation on valuation. My investment philosophy revolves around the DCF model, and analysis that leads into my assumptions used in the model. The approach doesn't limit my investment philosophy into either growth or traditional value investing - rather, I factor in both into my thesis, revolving my theses on a large-scale picture instead of single catalysts.