The video game industry has seen slower growth over the past few years, but this only makes Roblox's (RBLX -9.12%) performance stand out. The company's user-generated content strategy and social interactions between users have created a vibrant gaming platform. After blowing the lid off second-quarter expectations, management now expects full-year revenue to grow between 22% and 25% year over year.
The stock is up about 10% after earnings, but is it still a buy at around $137? Factoring in the total shares outstanding, that equates to a market cap of $93 billion at the end of July. Roblox is a richly valued platform right now.
Whether it can deliver satisfactory returns from here will depend on how much of the $180 billion spent annually on video games it can capture over time, in addition to capitalizing on other opportunities like advertising.
Image source: Getty Images.
Growing in the right ways
Roblox's social-driven platform is clearly resonating with its user base. The biggest surprise in recent years is how the content is starting to attract users 13 years and older.
For years, Roblox was a popular gaming platform for children, but as of the second quarter, there are now 71.4 million daily active users age 13 and up, compared to 61 million in the previous quarter. Its total player base surged to more than 111 million in Q2, up 41% year over year and marking back-to-back quarters of accelerating user growth.
As the base ages up, these older players seem to be spending more time on the platform than the younger group. Total hours engaged on the platform have been steadily trending higher over the last two years. This reached 27 billion hours in Q2, up 58% year over year.
As with any video game business these days, the strategy is to get players spending more time, and as they do that, they naturally spend more money. Players can buy virtual currency, or Robux, to buy digital items for their avatar, among other things. Given the growth in users and engagement, Roblox's revenue is soaring, up 21% year over year to $1.1 billion in Q2.
These impressive numbers in the second quarter showcase why Roblox could be the future social media platform for young people. They get to hang out with others and express themselves through their digital avatars, while having fun in virtual worlds and gaming experiences. Over the long term, management believes it can capture 10% of annual game spending, which would translate to about $18 billion in annual revenue.
But that's not all.
Advertising is a huge opportunity
Roblox's revenue opportunity could stretch into the fast-growing digital ad market. It has a partnership with Google Ads to scale immersive ad formats, including offering rewards to users in exchange for watching a video ad while playing games.
The company's large and highly engaged user base will be valuable in tackling this opportunity. Morgan Stanley analyst Matthew Cost estimated that Roblox could generate $1.2 billion in ad revenue by 2026, and of course, that would be expected to grow over the long term and contribute to higher margins and free cash flow.
Roblox is already a very profitable business, with management guiding for full-year free cash flow to reach $1 billion. The high margins from ads would only increase margins and free cash flow over the long term.
Can Roblox justify its valuation?
Roblox is benefiting from significant leverage on its operating costs, indicating that it's not done expanding margins. A company that is tapping into a large opportunity and delivering this much growth in free cash flow is going to command a rich valuation. Using 2025 guidance, the stock is trading at nearly 20 times forward sales and 94 times forward free cash flow.
This is how I think about its valuation. If the stock suddenly fell 50% in the near term and traded at 50 times expected free cash flow, that would be a bargain for a company guiding for 60% year-over-year free-cash-flow growth for 2025. From that perspective, the stock looks appropriately valued.
One risk that could hurt the stock is that Roblox does depend on a young demographic, and it's nearly impossible to know what teenagers are going to be into in 10 years. However, Roblox's growth will allow it to keep investing in other gaming genres and new features that appeal to an expanding demographic. And it's already proving it can expand its appeal beyond kids under 13.
To answer the headline question, yes, if management delivers on its growth target, the stock can hit more new highs over the next five years. I don't see it as overvalued when it just crossed 100 million users and is growing over 40% year over year.
