The market is turning sour on Roblox (RBLX 2.43%) stock. A darling of the pandemic, Roblox shares are down 47% year to date in 2022. Indeed, the company faces headwinds as economies reopen, but the market value has been cut in half while the negative impacts from reopening are nowhere near that magnitude.
Perhaps the market perceives Roblox was overvalued to begin with, and the headwinds were the catalyst to correct the valuation. Let's look closer to determine if the crash is a buying opportunity.
A cash-generating business model
It's no surprise that Roblox thrived at the pandemic's onset. The company's platform is geared toward kids. Many of them were sent home for remote learning, and parents were hesitant to allow them outside of the immediate family. Revenue growth accelerated from 46% in the first quarter of 2020 to 140% in Q1 2021. It started decelerating in each consecutive quarter after that.
Roblox is free to join and to play for basic-level gameplay. To experience the good stuff, players must deposit real money and buy an in-game currency called Robux. The company earns revenue when players spend that Robux over time. Interestingly, Roblox does not create the items or games that generate revenue. Instead, it outsources this activity to third-party developers who spend their time and resources creating experiences they hope players will enjoy. For their efforts, developers earn a percentage of their creations' revenue.
This outsourcing business model generates healthy cash flow for Roblox. Money comes in from consumers, and Roblox does not pay developers until players spend the money on their creations. Even then, Roblox only pays a percentage of the cash it attracts. Indeed, Roblox's cash flow from operations was 43% of revenue for the trailing 12 months.
Economic reopening headwinds
As economies reopen, kids return to school, and outdoor activities gain popularity, Roblox's engagement is falling. The fall is most apparent in the U.S. and Canadian regions, where daily active users fell by one million from the previous quarter to 11.2 million. Further, engagement in the quarter ended Dec. 31 is down by 11% from the prior-year period and 17% from the preceding quarter. This is now the third consecutive quarter of falling engagement. The decreases from one of its most lucrative regions foretell drops in revenue and free cash flow (FCF) in the near term.
Is it time to buy Roblox now?
Interestingly, headwinds from reopening are apparent in some of Roblox's key metrics but are not in the range of magnitude of the 47% sell-off in the stock price. Before the stock crashed, it was selling at a price-to-FCF ratio over 100 and a price-to-sales (P/S) ratio over 40, expensive to be sure. After the sell-off, Roblox is trading for a price-to-FCF ratio of 46 and a P/S ratio of 16.
If investors could expect anywhere near the growth rates Roblox achieved during the initial stages of the pandemic, it would be an excellent value. However, with the headwinds accelerating and getting worse, it would be prudent for investors to wait for a further pullback in the share price or a demonstrated stop in decreasing engagement before acquiring shares of Roblox.