Roblox (RBLX 3.15%) has been on my watch list for over a year. The metaverse pioneer, which caters to young children and teenagers, exploded onto the scene during the pandemic when kids were sent home for remote learning, and extracurricular activities were canceled. Parents felt better with their kids spending time playing with their friends virtually rather than in person.
The rise in popularity did not go unnoticed by the market, and Roblox's stock shot up over $120 per share. The expensive valuation was the primary reason I did not buy Roblox. However, when the price fell below $40 per share, I started a position in the metaverse stock. Here's what attracted me to Roblox in the first place.
A low-risk business model with good cash flow
It starts with the business model. Roblox is free to join and use. The company makes money by selling an in-game currency called Robux required to experience things unavailable to free users. Here is the part I like. Roblox does not create the unique items and experiences that players spend Robux on. Instead, it outsources this task to outside developers who take on the risk and spend their own resources. Roblox promises a percentage of the revenue their creations generate as an incentive to spark interest.
That means Roblox only spends money on creations that players are spending money on. There's no expensive capital spending on games that could turn into flops. There are no large teams of game developers on the payroll who may or may not turn out enough hit games to offset their salary. The model has proven to generate cash flow. Roblox has delivered over $100 million in cash from operations in seven consecutive quarters. The figure is falling as kids are going back to school and extracurricular activities are restarting, but that was expected.
Importantly, Roblox is attracting millions of new daily active users despite economic reopening worldwide. Roblox said it had 55.1 million daily active users in its most recent update. That is up significantly from the 37.1 million it boasted at the end of fourth-quarter 2020, before reopening gained momentum. I was concerned that players would disengage from the platform as entertainment options outside the home became more abundant. That has not been the case thus far.
Finally, Roblox might have untapped potential to generate revenue and cash flow from advertising. As it is, Roblox does not offer advertising on the platform. Undoubtedly, marketers would be interested in gaining the attention of over 50 million daily active gamers. Maybe Roblox could segment free players from those who deposit money and only show ads to free players. Nevertheless, there is a non-zero chance that Roblox will eventually enhance monetization through advertising.
Value matters more than the price
I mentioned earlier that the lower stock price finally got me to buy. That said, it's not the price alone that prompted my decision. Instead, it was Roblox's price to free cash flow. That ratio had fallen to 42 and was even lower when I purchased earlier in the week -- and was down from over 100 at its peak.
There you have it, down 65% from its high; I started a position in Roblox. I may add more depending on the price and performance of the company over the next several quarters.