Roblox (RBLX 6.59%) stock is down more than 20% from its highs in early June after the video game platform company announced seemingly solid operating results for May. Whenever a stock price moves inversely to good news, it's time to dig deeper.
That's especially true given that the stock's price decline is leading many investors to think of significantly boosting their stake in the video game developer. After all, Roblox has a highly scalable business model, is rapidly growing its revenue and earnings, and is reinvesting its cash flow back into its business in the form of more research and development. Just what could go wrong?
Image source: Getty Images.
What are the odds?
In May, Roblox grew its daily active users (DAUs) by 28% over last year, to 43 million. At the same time, the company's revenue increased by 125% year over year to $150 million. Those numbers are awe-inspiring, but not nearly as high as the 138% per year revenue growth and 37% DAU growth the company witnessed in April. In addition, DAUs fell by 300,000 from April to May.
The stock is very expensive right now at 19 times forward sales and 99 times forward earnings. Those metrics are justifiable as long as the company can sustain its impressive growth trajectory -- which I don't think is possible, at least not at those levels.
Roblox attained much of its success by filling a niche market at the right time, providing a platform of games primarily for children when coronavirus lockdowns shut down schools. Roblox added 5 million content creators and 50 million monthly active users in 2020 alone. Its gaming platform hosts the most popular games among kids ages 5 to 12, who account for nearly 40% of its DAUs.
That momentum will soon reverse as the pandemic subsides and kids head back to school in the U.S. and Canada, the sources of most of Roblox's revenue. Roblox is only the 66th most popular video game and the 55th most well-known title in the U.S. outside of this age group. Forty-six percent of people of all ages in the country have never heard of Roblox.
An unexpected drawback
On June 10, the National Music Publishers' Association, representing multiple music publishers, announced it would be suing Roblox for $200 million for alleged copyright infringement. The company currently maintains a library of digital offerings -- 3-D models, skins, icons, audio, etc. -- uploaded by users and developers alike for community use. The audio part includes many popular copyrighted but unlicensed songs to enhance the gaming experience.
Until April 2021, users could purchase an in-game item called the "Golden Superfly Boombox" for 500 Robux ($6.25) that could play thousands of (copyrighted, non-licensed) hit songs encoded in developer files after the user joined an in-game server. It was one of the most popular in-game purchases with over 500,000 lifetime downloads before the company shut it down.
Roblox responded to ongoing piracy on its platform by vastly expanding its moderation team with tactics including blocking users, muting audio, and removing search results. This action, which many users saw as "overmoderation," could be a cause behind its recent user decline.
The verdict
Roblox's stock is richly valued, with its growth on the verge of falling off a cliff. School reopenings will significantly drive a decline in its core user base of 5- to 12-year-olds. And in response to the piracy lawsuit, the company will have to increase content moderation, which just doesn't sit well with older players.
The platform is also not that highly ranked in popularity, in general. I would suggest that investors check out some of the more fairly valued video game stocks instead. It's definitely not a good time to double down or go all-in on the sell-off.
