The metaverse has been getting a lot of attention recently as a few large corporations announce their intention to join the industry. It is essentially a place on the Internet where individuals can interact with each other in a virtual environment.
Roblox (RBLX 5.86%) is one of the field's pioneers, having been in the business for 16 years. On Nov. 8, the company reported fiscal third-quarter earnings that hugely impressed investors. Its stock has since soared, and that could leave you asking whether it's too late to buy. Let's see.
Roblox is gaining users and increasing cash flows
Note that Roblox is free to join, and most of the experiences on the platform are accessible to players. However, some particular items and experiences cannot be accessed for free. For these, users need to buy Robux, an in-game currency required for exclusive items and activities. And that is how Roblox makes money. It takes a percentage of the money spent on these exclusive engagements.
Interestingly, Roblox does not create these specialty experiences themselves. Instead, it asks outside developers to spend their time and resources building these and promises them a percentage of their creations' revenue. If a design fails to draw interest, the developer is out of luck, and the time spent on the product is for naught.
This business model has been lucrative for Roblox and enticing for gamers. As of the end of its third quarter, Roblox boasted 47.3 million daily active users on its platform. That's up from 36.2 million in the same quarter last year and 18.4 million two years ago.
Additionally, Roblox generated $171 million of free cash flow in Q3, up from $159 million last year. The asset-light business model allows for cash flows to build rapidly and increase customer engagement.
That's in contrast to a business model like Netflix's, which has to keep pumping billions of more dollars into creating content as its user base grows. Roblox does not have that issue. Instead, developers have a more significant opportunity to make money as Roblox expands its user base, thus encouraging them to create more products and experiences for the platform.
Is it too risky to buy Roblox at these prices?
Of course, there are risks with its business as well. Roblox has no guarantee that developers will continue making content for its platform. With a lack of new experiences, users could get bored with the old ones and stop signing on to Roblox, starting a downward spiral that would decrease revenue and cash flow.
Further, by outsourcing development, Roblox agrees to pay a percentage of revenue, which decreases its profit-making potential. Netflix pays to produce a movie one time and typically does not have to pay the creators regardless of how popular it is or how many years its members watch the film. The Roblox model comes with lower risk and lower maximum profit margins.
The market certainly likes how Roblox is doing things. Since its third-quarter report on Nov. 8, the stock is up more than 50% and its price-to-free-cash-flow ratio is over 100. While the company is more expensive than it used to be just a few days ago, it's built on an excellent foundation and is rapidly growing users. Long-term investors cannot be faulted for buying Roblox even at this price.