Roblox (RBLX 2.90%) is a unique video game platform that enables users to build their own games in a virtual "sandbox" world. The company went public in March via direct listing, an increasingly popular alternative to the traditional IPO process. After gaining an impressive user base of both gamers and game developers throughout the pandemic, the company has earned a spot on most analysts' and investors' radars.
Whereas Roblox's user base and revenue increased significantly as of its first-quarter 2021 earnings report, the company faces unique challenges ahead in expanding and maturing its young, unprofitable user base. If it can overcome these hurdles, the stock could potentially be unstoppable.
A massive user base -- but there's a catch
Roblox's first-quarter numbers were impressive on the top line, with revenue increasing 140% over the prior-year period to $387 million, and daily active users (DAUs) increasing 79% to 42.1 million. Bookings -- i.e., purchases of virtual currency ("Robux") for in-game use -- increased 161% to $652.3 million.
This promising surge in popularity can be attributed in part to the company's unique virtual sandbox characteristics, allowing both developers and gamers to escape into an engaging, customizable world of community-built games during the pandemic. No other company is quite like it, so Roblox stands alone in a highly specific niche that was poised to win in a pandemic economy.
Roblox exceeds other gaming platforms like Epic Games (the developer of Fortnite) in DAUs, but there are some key challenges for Roblox's monetization of its user base. The majority of Roblox users are under the age of 13, limiting the strength of network effects that are critical to the success of social and gaming platforms.
For example, 13-year-olds on Fortnite may influence an extensive network -- friends, older siblings, neighbors, extended family -- to game with them on Epic's relatively age-agnostic platform. Alternatively, 13-year-olds on Roblox would likely only be able to influence friends or family members in their immediate age range to join them on Roblox.
This appeal to young gamers is partially thanks to the company's structure -- Roblox's users, not the company itself, develop games for the platform. Young developers create games suited for young gamers, which attracts more young gamers to the platform. This cycle has made it more difficult for Roblox to appeal to a wide age range and expand its potential network effects.
Reaching into parents' pockets
Monetization is another reason Roblox needs a wider age range on its platform. Users under 13 almost definitely reach into their parents' wallets, not their own, for in-game purchases on Roblox. As of March, average bookings per DAU were $15.48 (increasing 46% over the prior-year period). In other words, the average daily user of Roblox spent about $15 on Robux in a year. Importantly, selling this virtual currency is the company's primary source of revenue.
Compare this figure with Epic Games' $100+ average bookings per active user on Fortnite (according to a 2020 survey of 1,000 Fortnite gamers). Although Fortnite does have some younger users, the game is rated "Teen" by the Entertainment Software Rating Board and is not intended for gamers under 13. The majority of the game's users are over 13 and have deeper pockets of their own than Roblox users, leading to much higher bookings per active user.
Roblox leadership realizes that it needs to expand into an older user base, and the company reported 111% growth in DAUs over the age of 13 in its first-quarter earnings report. While growth in DAUs over 13 outpaced overall growth in DAUs, the company's long-term strategy for attracting and retaining a user base over 13 is not clearly defined.
Considering that the company missed expectations for earnings per share in the first quarter with a larger loss per share than the prior-year period, expanding and monetizing this user segment should be a primary focus.
What could go right
Don't get me wrong -- Roblox is on a strong growth trajectory and has exciting potential in applications like virtual education and online events. The company has been free cash flow positive since 2018 and has promising international partnerships with impressive companies like Tencent, the largest gaming company in the world by revenue.
However, both of those future opportunities come with major barriers of their own. Roblox only has loose plans for expanding its platform beyond gaming in the future (the company only mentioned the word "education" twice in its 200-page S-4 in late 2020). It could easily be beat to the punch by a number of big tech competitors.
Furthermore, its partnership with Tencent will face many regulatory hurdles considering the companies are developing a platform specific to China -- Roblox's Chinese server will very likely be isolated from the rest of the world, diminishing potential international network effects.
Overall, there are several key performance indicators that I'd need to see grow sustainably before investing, especially considering the company's premium valuation is priced for the best-case growth scenario for several years to come. Namely, watch for continued high-double-digit growth in DAUs, with the over-13 age segment's growth outpacing overall growth.
Also look for a significant increase in bookings per DAU as Roblox's user base matures and the company retains and monetizes the over-13 age segment effectively. And look for headlines about the company using its free cash to invest in its future plans outside of gaming.
As CDC guidance regarding masks and social distancing loosens drastically, gamers of all ages will be returning to the new "normal," which could drastically derail the user growth and monetization of immersive gaming platforms like Roblox. During this historic shift, watch the indicators I outlined above to gauge whether Roblox can retain and mature its user base to succeed in the long run.