Chit Chat Stocks - Roblox | Deep Dive

Episode Date: November 26, 2020

Roblox is an interactive gaming platform and game creation system. Users can play games created by other players or create their very own games and allow others to play. As the world of gaming continues to grow it will be interesting to watch and find out which companies can rise to the top. Even more important which companies will grow sustainably so that they may last for a long time to come. Subscribe to 7 Investing with the code "CCM": https://7investing.com/subscribe/ Follow Ian and check out his work on Twitter: https://twitter.com/IanGrayLive Follow Chit Chat Money on Twitter: https://twitter.com/chitchatmoney Subscribe to Chit Chat Money on Youtube: https://www.youtube.com/channel/UCG5Ni-SI-jyrEsoNUhqftNQ Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investment. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are not financial advisors. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guest is not formal advice or a recommendation. Now, please enjoy this episode. all right guys welcome in this is the deep dive episode the thursday episode on the chit chat money feed we're talking roblox today a pre-ipo company we're going to deep dive into the s1 but before we do that ryan do you want to talk about our friends over at seven investing they are our

friends that is right they are our partners uh and we have our code ccm for seven invest So if you don't know what 7invest is, I imagine you do. But if you don't, they provide seven recommendations each month, and they have these detailed analyses with those recommendations, and they're really good. And we've had them on the show a million times, so we obviously think highly of their analysis, and we think you will too, and we think it's worth the money.

You get $10 off if you use the code CCF. And you're not locking into a long-term deal. These are personable analysts. You can communicate with them. they're open you're not locked into just whatever the newsletter says they're for you know they want a continuous dialogue with people we could go on and on forever it's like a netflix but you get a return on your investment perfect perfect yes exactly and we have ian here today as well so uh ian how are you doing i'm doing pretty well excited to talk roblox yeah i'm as well uh we're

all getting ready for the weird thanksgiving break uh but it's gonna be a weird one but i guess hopefully this i think will come out on thanksgiving so this could be a good thing to have you know you're walking trying to get away from the family maybe a little bit take a little break for a half hour this could be perfect for us okay and i'll just dive into what roblox does this is it first of all it's a company that brett and i are very excited about um and we have been obviously it's not in the public markets yet i imagine in this as well but they're about as close to an actual metaverse as we've seen um so their platform consists of three different services there's uh roblox client roblox studio and roblox cloud so roblox roblox client is where

the users can explore the 3d digital worlds this is basically uh where the bulk of their customers or users are and then the roblox studio is allowing users to create games or create digital worlds within the game and then the roblox cloud is their internal internal data infrastructure so unlike most software companies they're not using aws and their cloud they're not basically having to use another cloud computing software or cloud computing company in order to do it they have their own but they have 36.2 million people that come to roblox every day on average to connect with friends and the users in case i wasn't clear the users are the ones creating these digital worlds and these games and so it's sort of like the users are creating the platform for you and you've just

equipped them with the tools to do that yeah and the the developers i think there's seven million of them they get paid a revenue cut of what the other users pay for their products um so it's not they're just making it for free um there's businesses built on this platform and you can pay right there's i think there's three developers that made more than 10 million in revenue yep um and there's nine there's like 900 000 that makes some sort of money whether it's like 100 bucks so there's 900 000 people out there that have products for people to pay for and this is all through the money that they are their internal roblox currency is called robux uh it's tough to it's tough to say roblox robux but uh basically you're exchanging real money for robux and you're

using the robux currency in these digital worlds but a little bit about the history roblox was actually started all the way back in 1989 when the two founders david bazuki and am i saying that right that's correct and eric cassell uh programmed a 2d simulated physics lab called interactive physics this was initially designed for students to show how cars would crash or they could build destructible houses but then they officially started roblox in 2004 with the same goal of inspiring creation and imagination like they had with this uh interactive physics but instead this time through the gaming space uh which is what the business is today and obviously a lot of people had free time during covid and a lot of people were home and so they had an incredible year

usage definitely yeah it's bumped up and we'll get into the specific numbers before i get into industry uh ian anything on the intro here anything to add or i think you covered it pretty well it's a it's an exciting platform that i'm looking forward to diving into okay i'm gonna hit the industry quick uh this is another gaming company it's been a theme for us this fall uh you probably know the gaming industry is large at about 150 billion dollars a year and growing 10 percent a year roblox is kind of unique but the main competitors could say it could be fortnite could be minecraft um and then less directly all the big games like cod fifa things that people can spend time on and i guess also the mobile games uh but roblox is unique as ryan described

there is a social aspect for it for kids so they kind of have a hybrid social network and maybe they're competing a bit with discord you know snapchat tiktok in a sense uh especially for these younger kids where a lot of parents may not want them onto these adult platforms but think of it really as an immersive creative experience right now that is focused on being for kids i think the majority of their users are under 13 and lastly they compete with the game engines as well so this is for the developer side uh so think of that like unity and epic games yeah this is really the digital playground yeah i mean this is where a lot of kids are coming to connect i think the average hours played is like 2.6 hours a day that's a ton of time on this platform yep all

right uh next up is management ian you want to hit that yeah and just like you were saying there i think it's all about the time spent on the platform and so they talk a lot about and david bazuki the ceo the founder and ceo talks a lot about this too just how much they're focusing on how do we raise the amount of time people are actually spending on the platform um and they've done that in a variety of ways. But as you mentioned, it's kind of interesting because it's really focused on kids. And so I think over half their active users are under the age of 12, which is just mind boggling. There's a public company that's going to be, we're going to get an evaluation later, but that's going to be valued very highly. And half the users are under 12 years

old. But to dive more into David Buzuki, he says that Roblox is really fulfilling the vision of connecting everyone around the world they care very much about um participating in this human co-experience category and not just games but deep simulations and they're really inspired by what people are creating um you know i was even watching a video this morning of people talking about how they go on roblox to like go to high school like and just as a simulation they just walk around and everyone pretends like they're in high school and it's this game that's like it's not even a game but it's just a simulation that people really enjoy and they're having like conversations like you might have in high school so it's kind of you know in my mind it's a little

bit bizarre but it's also um pretty crazy that they're able to create these immersive worlds um david bouzouki owns about 12 of the company prior to the ipo and has 70 of the voting power um it'll be interesting to see exactly how this breaks up once the ipo is priced and they put it out to the market and start seeing what the pro forma ownership and cap table look like after the IPO. But we don't really have that information yet. An early investor, Altos, owns about 21% of the company prior to IPO. Like I said, some of these positions are likely to be diluted and these percentages will rework themselves after IPO. So it's something you'll want to keep an eye on. But some healthy ownership by David Bazzucchi for sure at this point.

One other quick note I'll make is he does have fairly high compensation. He made $500,000 last year, plus $4 million in stock options, which does seem pretty high for a company that's about to IPO. But given where their valuation is probably going to come in at, it's not unheard of. And oftentimes, these stock options do get front loaded before an IPO so that founders and employees can kind of cash in on the IPO process. Okay. Okay. And then is that it for management? I'm going to get to the valuation, but we're not

going to do that first this time. We're going to play the valuation prediction game after we go through the earnings. So Ryan, I'll kick it back over to you and then Ian will do balance sheet and then we'll finish up, do a little prediction of what will come out when they go public. Yeah. The earnings were fun to look at. If you're looking at this S1, you're probably getting insanely bullish. You're not alone. For the last nine months, revenue was $589 million, dollars up 68 percent year over year they had 74 gross margins most of their cost of revenue comes from payment processing fees they obviously aren't paying a ton for cloud computing because that's typically what most people's cost of revenue is but they have their own cloud so they don't have

to like pay variable expenses so that's that's capitalized yeah right and then operating income was negative 206 million with a net loss of 203 million, but they had 293 million in free cash flow or a free cash flow margin of 50%. The sort of difference there was all because of deferred revenue really, but they had 1.25 billion in bookings for the first nine months, which is a ton that was up 170% year over year. And so, like I said, the difference between gap earnings and cash flow was really due to $1.3 billion in deferred revenue. And so to kind of explain the deferred revenue, it's basically the purchase of Robux, but the Robux hasn't been spent yet or realized yet. It's basically this accounting anomaly, but there's a direct

quote from their S1 that says, substantially all of our bookings are generated from sales of our virtual currency, which we record as deferred revenue and then recognize that revenue over the estimated average lifetime of a paying user. So bookings is the number to pay attention to because it's really giving you the true revenue. And so that's why you're seeing this giant difference in cashflow and gap earnings. Their daily active users grew 81% year over year to 31 million. From 2018 to 2019, DAU growth daily active users was only 42%. So it doubled its growth rate yeah um which is really impressive but basically they're showing you that at scale they can be very profitable um and then should we do our balance balance sheet first yeah

yeah i'll dive into the balance sheet so pretty pretty healthy looking balance sheet 100 or 801 million dollars in cash um so plenty of plenty of cash their cash flow positive as ryan was mentioning no debt on the balance sheet but i will and ryan touched on this but i'll take a moment just to talk about some of the other items on their balance sheet, because it's kind of interesting. And sometimes, I think helpful to understand the specific items that a company has on their balance sheet. So as he mentioned, there's a lot of deferred revenue on the balance sheet, about $1.3 billion, which might be which is a liability, and it might be concerning to you. But as Ryan mentioned, this is from cash that they've already taken in, and that they're not

going to have to be paying anything out on that liabilities. They're just letting people use the robux that they bought so that's what that piece of it is from there's another item that's called developer exchange liability which is about 46 million dollars and that comes from the they actually pay out their developers in robux to give them a portion of the robux that they earn from their games that they've made and then developers can have have the choice to use those robux within the roblox digital economy or to cash them out for a specified transaction rate exchange rate that roblox sets and so based on that transaction rate basically what it's saying is that roblox could be paying out up to 46 million dollars in cash to developers um but

that's just again not a real concerning number it's a very small portion um of the balance sheet but just something to kind of keep in mind about this company and something if you're wondering what that is that's what those two items are okay yeah and then i guess that's that's interesting because looking at the developer exchange liability will be something to track um if you're you're trying to look for you know holes in any investment thesis that is something if that's inflating a ton that could be inadvertently increasing their operating cash flow and when in reality it's not the free cash going to the business um but before we hit the ad break we're going to do the valuation prediction game uh this is going to be a two-part thing uh we do this for companies that

we are just going over the s1 i'll kick it off to ian first what valuation do you think roblox will come out at and what valuation do you think it deserves i'm gonna say i think it's gonna come out at i'm gonna go bold and i i think it's gonna come out at 45 to 50 billion dollars wow it's unfortunate but it could be true it could be true yeah all right and what do you think what what do you think some a company like this kind of deserves i'm again going to be a little bold here and say i think that's what it deserves um looking at some of the numbers based on uh some of the other comps and the sales ratios you know like unity or um some other companies it's there's a lot i think it's in line with those and i think it's going to get a premium to some of

those companies because of all the bookings it's not just going to be based on the sales that are being made but actually may be closer to based on the bookings that they're making and so i I think it does deserve a higher price-to-sales ratio than some of these other companies out there. All right, Ryan? I think Ian might be right on what it comes out at. I don't know if I'd want to buy it at $40 to $50 billion. I mean, if they got a bookings multiple of like 30 times, which doesn't seem crazy for a company growing bookings 170% year over year. With those cash flow margins, yeah.

I'd be surprised if this came out anything below $30 billion. Yeah. It sucks. I would love to buy it cheap, but so would everyone. And that's the problem. So you're going to get a valuation that's pretty steep. Yeah. It looks like they're on pace to push. They're definitely going to hit over 1.5 billion in bookings this year. So they're probably going, I'd say they're going to get in between 45 and 50 billion as well. I think they deserve closer to 30. That seems reasonable. The 1.2 billion in bookings? Nine months. Is only nine months.

yeah so i mean 30 seems fair it's not something where i'd be like oh we gotta put every all their chips in at 30 billion dollars 45 billion dollars is probably what well it depends on what market environment they're in but say it came out tomorrow yeah i think it would be upwards of 50 billion dollars yeah i'm afraid this is gonna go more the way of snowflake and get sales multiple well above 100 yeah which is unfortunate but yeah all right we're gonna hit the ad break, and then we're going to come back and talk about other things with Roblox.

Cox Panoramic Wi-Fi includes advanced security to help protect all your connected devices. You'll get real-time alerts. Oh, like this one, so you don't have to worry about malware. Or when your kid downloads a song from a shady link.

And now all your computer can play is... Red color, red color, where are you? all blocked thanks to advanced security included with cox panoramic wi-fi advanced security must be enabled in the panoramic wi-fi app restrictions apply all right welcome back in next up is competitive advantages ian let's go first with you yeah so i want to talk a little bit about competitive advantage i mentioned with

skills a few weeks ago in our deep dive um at the end of the day roblox is just fun it's a big thing and in theory it's going to become more addicting as developers create better and better experiences that are more and more immersive um this has led to a leading position in the co-experience world and even the little nods x concert that they had a couple of weeks ago where um if you're unfamiliar with him he's the guy who wrote old town road that became a sensation and he actually held a concert within this virtual world that people attended um it's kind of crazy but it seems to be Like I said, it's fun, it's addicting, and should become even more addicting if time goes on. That's interesting.

All right, Ryan, what do you have? Yeah, so mine's the cloud infrastructure. Pretty much every other business, any software business at least, a large portion of their cost of revenue comes from cloud hosting fees. So they pay those out to AWS, Azure, something like that. Roblox doesn't have to do that because they have their own cloud infrastructure. And so it was obviously a lot of costs up front to build this and install it. Um, but now it provides tremendous operating leverage and they're going to scale well and margins should expand at scale because of it.

Yeah. I mean, those gross margins should be a lot better. They're going to have to invest more capital upfront, uh, but hopefully that can benefit them in the long run. I'll hit mine for competitive advantages. I think it's very similar to YouTube. So Roblox focuses on building the best tools for creators of games and these immersive experiences.

Like we said, this attracts, you know, both the users and the developers. This keeps developers around because Roblox is the best way for them to make money, and it's the easiest way to build these experiences. And then users stick around because it has thousands of different activities they can do. I think a network effect actually applies here. Similar to YouTube, it's going to be a winner-take-all scenario, but in a larger addressable market and more than just video. All right.

Next up is future growth opportunities. Ian, what do you have? Yeah. Yeah. So I think their main future growth opportunity is going to be continuing to create tools that push the extremes of co-experience. This might be a bit out there, but I think Roblox can begin being used in the classroom going forward through really immersive case studies, deep simulations that could have students trying out what it means to be an accountant or what it means to be a construction worker, and just really have immersive experiences

that have some educational benefits. And I think there's all sorts of other experiences too. if you thought that last thing was a little crazy what i'm about to say might even be even crazier but i think roblox in some ways could become a sort of virtual office someday um with people having interactions digitally and it's hard to even talk about but i think you know like those videos from 20 years ago when people were trying to understand the internet um i think there's some things about this digital co-experience space that we just don't even really understand how it can be used and it's if roblox can capitalize on this become one of the major players and digital co-experience for years to come it's going to be a big deal right okay that

makes sense um that is a little bit out there but i think i can agree there there is a lot of room to run outside of gaming for these you know more replicating normal life if you're just everyone's distributed at different places around the globe uh ryan what's your future growth opportunity Yeah, mine's less out there. It's really just expanding monetization. So they went right out and said this in their S1, if you're looking at it, and they had basically, I think it was four growth opportunities and one of them was higher monetization. And so they have their subscription and they can juice more monetization out of their developers. but they also said, and this was the interesting part for me, was partnering with brands. So they said, finally, we expect to work with leading brands to build unique marketing opportunities on the Roblox platform. To date, though, we have not created meaningful monetization for marketing partnerships. Each of Warner Bros. Pictures, Netflix, NFL, WWE, Marvel, and FC Barcelona have introduced branded content on our platform.

That makes a lot of sense. If this is where people are spending 2.6 hours a day and they are 30-some million users on here, advertisers go where the eyeballs are, and this is going to be a great place for brands to market. Yeah, I'd agree. All right. Mine is going to be the joint venture with Tencent to bring Roblox to China. You may have heard us talk before about how we're iffy on China businesses, but I want to make clear that that's for companies that are ADRs from China. that our business is over there that we don't understand we can understand roblox so if they have this partnership with tencent i know we don't you know we don't technically like you and

whatever yeah you guys know i mean i mean it would be dumb or almost irresponsible not to do business where there's that many yeah visible consumers or users potential users um so we like when uh businesses that we already like diversify and start to do business in china it's just sometimes we have we're worried about we have lack of understanding or some worry or concern when it's incorporated in china right okay and then they haven't officially launched this co-venture but they've invested a lot of money into it up front they've hired dozens of employees for it um it's going to be called luo uh lubu or something like that luobu uh it's spelled l-u-o-b-u if you want to research it and they mentioned it 24 times in the s1 so i think they're pretty excited for it

All right. Last part of the show is going to be highlights and lowlights. Ian, kick things off for us. Yep. So one highlight I'd like to touch on is they seem to have pretty smart management. About seven years ago, they shifted from advertising being their main source of revenue to this digital economy and the Robux model. And that's really paid off. And so I just trust them to continue to make good moves like that moving forward. I'll say even today, I've never really heard of roblox much before today i'd seen it around on finn twit and like was like oh people are interested in this as an investment but i never really interacted with it but i set it up set up an account on roblox and was playing a game in less than five minutes um and ended up like i

was horrible at the game but i was like huh like i could keep playing this for a little while um and that just was you know i'm not i'm not really a gamer but i just found myself kind of getting immersed into the experience and was enjoying it so anyways i just think it's a an interesting business and something that was really easy to pick up and i can see why they've had this huge growth in users um one of my low lights is that it does seem like this is the perfect time for them to go public which is a highlight for them it's a low light for us in terms of public market investors because it it will mean that they're likely coming out um with the best numbers that we'll see for a while um and the the growth rates will probably significantly slow in the coming

quarters which we'll just have to keep an eye on um and then the last thing i'll mention is i don't know i can't decide if this is a low light or a highlight but over half their users like i mentioned are 12 and under and that the fact that they're already making as much money as they are when half over half their users are 12 and under and don't really have that much purchasing power on their own is pretty impressive to me so um like i said not really sure if it's a low light or highlight but if they can continue to grow those users and as they and build new experiences as they become older i think it could be a pretty big deal yeah i mean if they yeah if they can move up the age brackets i know right now it's probably tougher to build games that are complex enough

uh you know they're kind of leaning towards that minecraft model simpler which is what children like but as you know computing gets better as their technology gets better they're hopefully going to move into older older age brackets um all right ryan what are your highlights and lowlights my low light is similar to ian's which is they they put as one of their growth opportunities moving up market with age demographics that's probably pretty tough to do and having a consumer demographic that has the attention span literally of a 12 year old or younger um you know they they can move in and out of games they don't have any loyalties to it and it's not like they get stuck in these habits they like to move around uh with different games and i mean i would counter though

this is not a game though this is a there's thousands of the same thing about fortnite and minecraft well no those are specific games i mean there's it's a platform a lot of people say that fortnite is a platform and you can do different stuff within it uh it's one game though so roblox has myriad of different games for all different types so i would i would disagree on that but sorry every time there is a game like this where it goes viral really quick everyone says it's different and especially the last few years they have something that goes you know viral like a fortnight you're like oh no this there's huge staying power but it's probably one of the most competitive industries on earth and a lot of people are flocking to it especially

developers and we're seeing a lot of stuff around gaming right now i'd be surprised that's my low light is there's always a chance that people trend away from this and it's not like there's super valuable ip in my mind it's not like a disney where they can tap back into it or a nintendo where they can seven years later drop another mario kart uh with a different you know it's just yes there's a lot of optionality yes there's a it's more like a metaverse and i i said it in my intro i think it's as much of a metaverse as any game we've seen before but there's always something new that's going to come along in the gaming space uh highlights they if you look at any part of their business it's a diminishing cost structure which is really good the users generate

the company revenue so it's little cost for them customer acquisition is cheaper because there's a huge network effect and there's very little variable expenses as they scale so it's as far as a business model goes it looks perfect and i don't say that about a lot of businesses um but yeah i do like the business overall there's just a concern of the age demographic okay i'm gonna hit mine um unlike professional gaming studios studios you know roblox is not hit driven the people don't really understand their cash flow uh margins are strong they're focused on safety which is very important for the younger demographic uh a lot of people are concerned about youtube and snapchat other things like that for younger children to be on

if roblox you know i think they said safety 88 times in their s1 that's something they're trying to focus on moving up the age brackets could be tough but i think it could be very valuable for them again 2.6 hours are spent per day on the platform i think that is definitely a highlight and i also like how they're not reliant on one game so it's like they're it's not about them creating games it's about developers creating games so they don't need to determine what the hits going to be one of their developers or multiple of them will create the hits and it doesn't matter if one of those falls out of favor another one can come out i think that's great for them not to be relying on hits um well it's the same as you guys though covet bump might be

temporary um might not be the same as the business in the steady state tough to find low lights though but yeah that was mine all right last question are we more or less interested here Ian, what do you think? I'm definitely more interested. Like I said, I didn't really know much about this company, really not anything, until I started researching it. And, you know, all the numbers look amazing. I think it has a good product.

And what you were just talking about there, Ian and Brett, about harnessing the power of some of the most creative developers in the world and that if the most creative developers in the world continue to be creative and use Roblox, Roblox is going to be very successful. And that's the thing that excites me about this company. yeah go ahead ryan yeah and i i do agree i from all the businesses that i've looked at in the last year maybe the last two years this is the most excited i've ever been about one and not spotify no well i'm more excited about this one yeah uh i like spotify as well but the

i guess the whole thing is valuation at this point and we don't get to see that But there's just so much about the business model that benefits from scale, and we're seeing that come to fruition. And 170% growth in bookings when they were already a prominent business. They had 17 million-some users already, and then they went ahead and grew DAUs 82%. That's incredible. um but like i said the the age demographic is still a bit of a concern yeah it is all right i'm definitely more interested uh same reason as you guys i think there's strong competitive advantages and i think in a few years there's probably going to be 100 billion hours spent

on that on the platform in a year i mean there's a lot of ways to make money on that and there's also a lot of ways to make money on that without screwing people and also you know providing a place for developers to make money and you know how build a living um it's it's a win-win it's a win-win-win scenario that's the stuff we like to talk about a lot where their partners are winning the company's winning and the users are they're winning they're having fun it's a lot like a shopify in my opinion yeah and i i'll bet it gets a similar multiple unfortunately because i mean one can hope not i guess yeah we're hoping for a good entry point um but yeah they provide a similar kind of business model where they basically tool the developers to create money for them which

is like perfect in my opinion yeah all right Ian anything else before we wrap up no I think that's it all right well thank you Ian for coming on remember everyone we are not financial advisors even if we sounded very excited about this company we are not your financial advisor nothing on the show is a formal advice or recommendation give us show suggestions on twitter at chitchat money or email us chitchatmoneypodcast at gmail.com. We are actually not going to have any deep dives in December. We have some, don't worry, we're going to have shows up, but they're going to be a special show. So watch out for that. Deep dives will be back in January. Thank you all for listening. We'll see you on our next episode.

Bye.