The metaverse, widely considered to be the next frontier of internet technology, has become a hot topic in the world of investing. More and more people are getting impressed by the idea of an immersive, seamless, and persistent 3D virtual-reality or mixed-reality world. Users will be able to interact in this online world using a range of devices, and perform economic, social, educational, and entertainment activities within it.
Although it's still mostly unchartered territory, the metaverse has the potential to change the way people study, work, play, and live their lives. So investing in companies that could be central to those changes could produce impressive returns.
Here's why I view Cloudflare (NET -3.01%) and Roblox (RBLX -0.59%) as potentially unstoppable metaverse stocks that investors should pick up in 2022.
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The case for Cloudflare
Edge computing -- in which data and applications are stored and processed at locations nearer to the end-users rather than at centralized server farms -- improves data reliability, efficiency, security, and speed. Those network characteristics will be vital for metaverse platforms and applications. Consequently, we can expect that edge-based content delivery network operator Cloudflare will play a major role in supporting the metaverse.
Cloudflare's broad network already extends to 250 cities in more than 100 countries. Approximately 95% of the world's population can connect to that network within 50 milliseconds. It uses a software-defined networking (SDN) model -- replacing networking hardware such as routers, switches, and load balancers with far cheaper and more scalable software. Its broad network reach coupled with its SDN design makes Cloudflare's infrastructure well-suited to supply the metaverse's dynamic networking and computational needs.
Additionally, Cloudflare also offers Zero Trust security solutions: Every user inside or outside the network is validated multiple times before being given access to resources. Such protocols will be essential for protecting the metaverse and those who use it from unscrupulous agents and hackers.
The company is already enjoying impressive success as an enterprise-focused cloud-based network and security player. From 2016 to 2020, Cloudflare's top line grew at a compound average rate of 50% annually. In 2021's third quarter, its revenues rose 51% year over year to $172 million. And with a 100% subscription-based revenue model, it has impressive visibility into its future financial situation.
Currently, 1,260 of Cloudflare's customers are large organizations that spend $100,000 or more on its services annually. Since these large customers account for more than half of its top line, its business model is relatively resilient in the face of changing macroeconomic conditions.
Cloudflare is technically not a metaverse stock. However, it will have a significant role to play in providing the underlying networking and data services required to make the metaverse a reality. This, coupled with its formidable position in the enterprise market, makes it an attractive pick for retail investors.
The case for Roblox
Paris Hilton held a 2021 New Year's Eve party on the virtual island of Paris World, where guests could partake in virtual activities such as flying on her private jet, shopping, or enjoying the beach. It was hosted on the Roblox platform, with Hilton's avatar acting as the virtual DJ.
The event illustrates how Roblox's software tools can be used to create 3D experiences that go beyond just gaming.
Since its initial public offering in March 2021, Roblox has made its presence felt mainly as an innovative platform for online games. Developers and creators have for some time used its technology platform to create games and experiences mainly catering to children. However, on its third-quarter earnings call, the company highlighted a notable shift in its user demographic. More of its users are now 13 and older than are 12 and under -- the first time in Roblox's history that this has been the case. The company also reported a 31% year-over-year increase in daily active users to 47.3 million and a 28% rise in hours engaged to 11.2 billion in that quarter.
The rising age of its clientele bodes well for Roblox's metaverse ambitions, considering that an older population is more likely to engage in experiences involving money -- shopping, banking, etc. And if Roblox can retain its users for more years, this will also help the platform benefit from network effects. Even without the metaverse, a demographic shift toward a somewhat more mature user base will boost Roblox financially, as older players are more likely to have control over their own funds, and have more discretion to purchase in-game objects and experiences.
Roblox was a major beneficiary of the pandemic-necessitated lockdowns and social-distancing measures. Its revenue and user growth moderated somewhat in the third quarter. However, Roblox still has much scope to grow with older demographics, in international markets, and in new areas such as social networking, education, media, and business. The company is not yet profitable, but it is cash flow positive, with trailing-12-month free cash flow of $629 million.
Roblox shares are currently down by more than 37% from the high of $141.60 they touched on Nov. 22. This decline presents an attractive entry point for patient long-term investors who want to add metaverse exposure to their portfolios.
