Stock Idea: Roblox is coming of age
It was about a month into the pandemic when Roblox became my five-year old son's obsession, and my saving grace as a parent. Stuck in lockdown I was scrambling to find ways to keep my son engaged. Since I first joined my son on Roblox in 2020 to becoming an investor in the company when it went public in 2021, my eyes have been opened to what Roblox is today and what it's poised to become.
From working together at a pizza restaurant, to going on an expedition to Antarctica, building a boat or visiting each other's elaborate theme parks we created, after spending hours in all sorts of different world's with my son I've discovered that Roblox is not to be dismissed simply as a video game for kids.
Roblox is a place where you can create an infinitely customizable avatar to be yourself, or to be who you feel like being. You can create and experience nearly anything you or the millions of Roblox creators can imagine. Roblox is a third place (beyond home, school or work) to find others with shared interests, or connect with your "offline" friends, and then share experiences together from the millions available on the platform. You can even make a living in Roblox by creating and selling virtual items, or by developing experiences. You can try new things not achievable or attainable in the real world. All while remaining safe in a civil, virtual society. This is not a utopian vision Roblox is aspiring for. All of this is achievable today, inside Roblox.
Often categorized as a gaming company, Roblox is on a trajectory to be much more. Roblox defines their mission as:
To build a human co-experience platform that enables billions of users to come together to play, learn, communicate, explore and expand their friendships
Roblox is one of those rare founder led technology companies with an awe inspiring mission; innovation and transactional platform capabilities; and the most advanced ecosystem in a massive thematic that will change the nature of the economy, business and society. They check a lot of the "potential generational company" boxes.
Before you roll your eyes about yet another metaverse hype article, this is not one of this. Yes, the term metaverse is being hijacked as a quick way to bring clicks, spending and investment to media coverage, products and companies. While buzz words in tech come and go, many stick around. Whatever it ends up getting called, the trend is clear. People crave more immersion in their digital experiences and creators want more engagement with and monetization from what they create. In these areas, Roblox excels.
Roblox would likely do fine as a stock with continued excellence in its native gaming market. However, the multibagger potential of Roblox lies in its ability to become a dominant platform in what is likely to be, but certainly not guaranteed, the next era of computing for decades - the metaverse.
So, what is the metaverse?
In the simplest terms, the metaverse is a digital parallel universe that places people inside a 3D version of the Internet. A sort of 'embodied' internet, the metaverse offers persistent and synchronous experiences that make it feel like you are in the internet and not just accessing it in a 2D manner, like we do today on our PCs and phones.
The metaverse has long been thought of as the next evolution of the Internet. In fact, the concept of the metaverse is decades old. It traces its heritage to a book published in 1992 called Snow Crash, written by Neal Stephenson, that coined the term metaverse. Stephenson described the metaverse as a three-dimensional space where people can socialize, access information and entertainment through their own personalized avatar. The metaverse has been portrayed in popular culture many times, in films such as the Matrix and Ready Player One, as a dystopian world. While this portrayal makes for a good science fiction film, they fail to capture the breadth of experiences and potential use cases.
The best description of the metaverse I've seen comes from venture capitalist Matthew Ball who defines the characteristics of the metaverse as:
Persistent - the metaverse continues indefinitely
Synchronous and live - the metaverse is a living experience that exists consistently for everyone at the same time
Concurrency with agency - everyone can participate in a metaverse related event/place/activity together at the same time (without limits to concurrent users), with individual agency.
Fully functioning economy - people and businesses will be able to create, own, invest, sell, and be compensated for valued work they do in the metaverse.
Expansive - metaverse experiences will span both the digital and physical worlds, private and public network, and open and closed platforms.
Interoperable - People will be able to bring their data, digital assets and content to the different experiences and worlds that are part of the metaverse (e.g., Roblox, Fortnite, Meta's Horizon, etc.).
Populated with user generated content - the content and experiences found in the metaverse will not be created by platform owners like Roblox. It will be millions of contributors ranging from individuals to businesses that create metaverse content.
Of all the companies vying to be the dominant platform in the metaverse world, Roblox has the most of Ball's metaverse characteristics checked off.
While Roblox has the metaverse platform lead today, they are not alone. They face intense competition, not the least of which is Facebook, who changed their name to Meta in October 2021 and pledged to spend $10 billion in 2022 and more over the next several years to build out the metaverse.
Despite the new threat of such a formidable competitor, Roblox investors can take solace in the fact that it's unlikely that the metaverse will be winner take all. One of the key features of a true metaverse is interoperability. For the full vision of the metaverse to be realized it needs to be a world of world's that allows people to move seamlessly across with their avatar(s) and personal digital assets in tow. Facebook knows this. For the betterment of the community and mostly for selfish reasons to not attract more regulatory scrutiny, they have pledged to work with other companies to build the metaverse. While I'm not inclined to take Facebook's word for it, the external factors should be strong enough to keep Facebook honest.
So, if you are intrigued about the potential of the metaverse and don't want to wait the predicted ten years some say it will to take for its full realization, Roblox offers a good opportunity to invest in a platform that already exhibits many of the metaverse characteristics. In this article I use my framework for evaluating technology related stocks to review Roblox in the context of the six characteristics below to see if it's worthy of consideration by growth investors:
I will conclude with my bottom line take on the bull case for Roblox and why I'm a happy shareholder that is in it for the long run.
In the case of the metaverse, the most important factors to assess if it has truly arrived are i) Have we reached a tipping point for the metaverse to move into mainstream adoption?; and ii) Will the metaverse drive structural change to the economy, business and society in order to sustain its existence beyond a passing fad?
Have we reached a tipping point?
According to Business Insider, 158 CEOs of public companies mentioned metaverse on their earnings calls in 2021. It's tempting to use this stat as an indicator of reaching a tipping point for mainstream adoption of the metaverse. Many a trend have reached similar levels in the hype cycle, only to recede into the background. How do we know whether we are at metaverse peak hype cycle ready to burst, or at the beginning of a more sustained mainstream adoption?
Breaking a new technology into the mainstream, beyond its early adopter roots, is hard. The chasm between early adopters and the mainstream market is littered with technologies or companies that tried to make the transition but failed. For us to know if the metaverse is breaking into the mainstream beyond its gaming roots, we need to see evidence of it expanding beyond its origin niche market of gamers.
The interesting thing about gamers is they are not who they used to be. Often thought of as the weird, "geeky" teenagers who hide in their basements playing video games all day, the stereotype is no longer valid. We are all becoming gamers. There are more than 2 billion people worldwide who play some form of video games today. It is projected that this number will grow to 3 billion gamers by 2023 (Source: Business Casual). Off a total population base of 8 billion and the current trajectory, it's safe to say gamers are quickly becoming the majority. It's not that we've all discovered how awesome the Legend of Zelda, Halo or World of Warcrafts are. It's that the nature of gaming has evolved. Gaming has really become a merging of play, social experiences and entertainment. Roblox is a perfect example, where it is much more of a platform to have experiences with others than it is to play traditional, objective based video games.
It also helped mainstream adoption that the Covid pandemic demonstrated that an online world for socializing, playing, working, learning, and entertainment can be a suitable compliment to their physical world equivalents. In lieu of physical get togethers, people gathered on Roblox to celebrate their birthdays, go to concerts, attend graduation ceremonies and even get married when the pandemic induced global lockdown took hold.
Another common form of skepticism I hear about the metaverse becoming mainstream is people pointing to the failure of the online world Second Life, which was launched back in 2003. While it's true that the proto-metaverse Second Life has never scaled beyond one million users, it is not uncommon for breakthrough technologies to have several failed starts before the technology or societal norms catch up to the idea. Remember MySpace and Friendster, the precursor social networks that came before Facebook? Advances in Artificial Intelligence (AI), 3D technology, Virtual and Augmented reality, 5G and edge computing, digital currencies, and computing capacity capable of supporting physics calculations, synchronization, motion capture and other advanced workloads; have coalesced to now make the metaverse more technically possible. Undoubtedly, there are additional advances necessary, such as concurrent infrastructure, industry adopted standards and protocols for interoperability, in order to achieve the more advanced versions of the metaverse.
While the above is not conclusive, in my opinion there are enough brush fires to indicate a wild fire is upon us. I could be wrong. You have to decide for yourself. More than any other stock idea i have written about, much of the long term thesis for Roblox rests on the hypothesis that the metaverse megatrend is real and will be the new computing and social platform for the next few decades.
Will the metaverse drive structural change to the economy, business or society over the long term?
The full vision of the metaverse is creating another place where people can socialize, play, work, conduct commerce, and learn. The kicker is that the metaverse enables people to do things they cannot, or easily, do in the real world. The impact to the economy, business and society will be immense. The metaverse will have its own, independent, economy; in fact Roblox already has its own widely used currency - Robux. New jobs in the metaverse have already been created, with many more expected to be added over the years. With the much more immersive experiences the metaverse can offer, commerce will be done differently.
The impacts to society are much more difficult to predict, but likely no less profound. What does it mean that the metaverse will bring about a degradation of the boundaries between the real world and the virtual world? With the level of abundance in the metaverse that is possible (duplicating virtual goods like a digital house is trivial), what will this do to today's wealth gap? With the lure of abundance and a better life in the metaverse, will some people spend most of their time in the virtual world at the expense of time spent in the real world?
Interesting questions to contemplate and real dangers that will need to be addressed. For example, news of sexual harassment happening in the metaverse are emerging. The key is to create a safe and civil metaverse, an area where Roblox excels.
With all of the recent hype around the metaverse there have been a variety of bullish estimates of its total addressable market (TAM). Grayscale forecasts the metaverse market will grow to generate $1 trillion in annual revenue. Not far off, Bloomberg estimates that by 2024 the metaverse market will grow to $800 billion a year in revenue.
Making up the market opportunity for a platform company like Roblox are a growing set of metaverse verticals beyond gaming, and demographic and geographic expansion.
Entertainment and music
Likely the first early mainstream market to adopt the metaverse, entertainment and music is an easy transition for gamers and early majority users to make. In the past few years, major entertainment companies such as the Cartoon Network, NFL, FIFA, Marvel, Nascar, Netflix, Warner Brother's, Sony, and Hasbro have all produced experiences on either Fortnite or Roblox.
New forms of entertainment we probably can't imagine today will emerge. Perhaps an early glimpse of this was the success of RivalPeak on Facebook Watch, which falls into a new entertainment category called MILE (Massively Interactive Live Event). Viewers were able to affect the outcomes by solving puzzles, deciding what characters could do and influencing who got booted out of the event.
Not to be outdone, the music industry has an opportunity to revolutionize how artists can connect with and perform for their fans. This includes virtual concerts, launch parties, virtual merchandise ("verch"), music festivals, persistent experiences and listening parties. Some estimates have forecasted concerts in the metaverse could be a $30 billion busines in a few years.
A few pioneering artists in the metaverse include:
Lil NasX had 37 million visits to his virtual concert. It would traditionally take a decade to reach the millions of fan Lil NasX reached in a weekend. He has also sold close to $10M in virtual merchandise.
Travis Scott’s virtual concert had nearly 30 million people spend nine minutes fully immersed in his music.
I believe the genie is out of the bottle in terms of the music industry moving into the metaverse. More and more artists are engaging with their fans in a way that is not possible in the real world. Roblox recently inked a deal with Sony Music to bring more artists in the metaverse.
The entertainment and music industries have massive opportunities ahead thru immersive storytelling (i.e., the merging of movies and gaming), world building, and fan interaction in the metaverse.
The pandemic lockdown drove us all to find a new place to socialize and interact with family and friends, and to meet new friends. For many, this meant taking to Zoom, Skype or Facebook portal to scratch our socializing itch. For others, the 2D, Hollywood Squares like online meeting experiences were not enough and they discovered the metaverse is a great place for socializing. It's not a stretch to imagine that the metaverse would be a natural place for socializing. Existing metaverse experiences such as Roblox and Fortnite have been blurring the lines between gaming and social for years. A Morgan Stanley survey found nearly a third (30%) of surveyed gamers say games are first and foremost a means to social connection.
The metaverse is already starting to revolutionize social interactions to a world where we meet online more spontaneously and discover things to do together in the metaverse. The appeal of social in the metaverse is the ability to do things together that we just can't do in the real world, such as going to the moon together, escaping natural disasters or destroying a city together, just because.
There are a number of metaverse like experiences, such as Replica and VRChat, that point to the growing demand for socializing in the metaverse. With a growing loneliness epidemic where 36% of Americans, including 61% of young adults, feel serious loneliness; it's no wonder that people are searching for new places to connect with people or even machines. One example is Replika, an intelligent AI bot that millions of people use today as a friend or romantic companion.
The learning opportunities that the metaverse unlocks for educators will be revolutionary. The metaverse can bring to life concepts, phenomena and events in a way that no other medium can. Imagine students being able to explore ancient Rome rather than reading about it in a textbook, dissecting a virtual frog in high fidelity rather than in real life, or taking a mission to Mars rather than just watching a video.
Education in the metaverse is very intuitive. Over the last two years Zoom class became the norm and student performance and motivation suffered. Zoom classes just can't offer active engagement with learning content. The metaverse on the other hand makes learning fun and engaging.
While the potential of education in the metaverse is clear, we are still in the experimentation stage. No one has yet figured out a successful model that works for in classroom hours.
Roblox is the furthest along, already demonstrating how the metaverse can be used in education:
There are over 240 organizations teaching with Roblux Studio, albeit the majority are for after class hours
74 countries have education programs that include Roblox studio
7M+ monthly active users participate in educational experiences on Roblox
Roblox also has big plans to cross over into in classroom hours, with an ambitious target of 100 million daily active students by 2030.
Wherever there is a large, engaged audience, commerce is soon to follow. It's no different with the metaverse, as a new form of commerce, called immersive commerce (or iCommerce), has emerged. iCommerce is any activity related to buying products and engaging with the brands behind those products in online, immersive experiences. This includes buying both real world and virtual products.
The last couple of years has seen a spike in brands entering the metaverse. From Tommy Hilfiger launching a digital fashion business for Roblox avatars, to Chipotle opening a virtual restaurant, to Gucci selling several rare Gucci items on Roblox. Some of the more impressive initiatives include persistent worlds that brands such as Nike, Ralph Lauren and Vans have created in Roblox for their fans. I have personally tested all three of these experiences and I was impressed with the quality level and engagement. Much more enjoyable than going to their physical stores.
While it's not something that necessarily feels native to me, buying and selling virtual goods is a massive and growing market. The virtual goods being purchased include avatars, clothing, accessories, electronics, equipment, furniture, cars, houses and most recently in the news, virtual land. The global virtual goods market is projected to reach $190 billion by 2025 (Source: Adroit Market Research).
While I see huge potential and signs of the metaverse becoming the new office, I believe further advancement in the area of Augmented Reality (A/R) and Virtual Reality (V/R) is necessary. Until slipping on an A/R or V/R device to go to your office in the metaverse is as easy as turning on your PC and joining a Zoom meeting, it will be hard to expand beyond early adopters. Without the full immersion of A/R or V/R I don't see enough benefit for information workers to join a Roblox like 3D office or boardroom environment from their PC or phone.
Today's limitations with A/R and V/R is reflected in moderate shipment forecasts. IDC projects 14.9 million A/R and V/R devices will be shipped globally in 2022, growing to 55.2 million units by 2026. Impressive growth, but still a drop in the bucket in terms of the overall market opportunity. If your colleagues and network are not in the metaverse, it will be a lonely place to work.
Despite these limitations there are bleeding edge organizations that are taking steps to move employees into the metaverse. Consulting firm Accenture purchased 60,000 Oculus headsets to train new employees. Visa Inc. also is exploring the workplace potential of the metaverse, piloting the technology as a way to reflect the physical office in the virtual world. Smaller and more technically inclined organizations, such as Neustreet - a media and data startup; are going all in and buying land in metaverse platforms such as Decentraland and building a virtual headquarters where employees can meet and hold virtual events.
Leading technology companies such as Microsoft, Cisco, Meta (Facebook), Nvidia and others are investing to build metaverse platforms where people will work together. For example, Microsoft recently launched a new product call Mesh for Microsoft Teams, bringing mixed-reality to Microsoft Teams where people in different physical locations can join collaborative spaces and share holographic experiences. It's no surprise these large tech companies are investing to bring work into the metaverse. There are significant benefits. Research from Lenovo reveals that close to half of employees (44%) are willing to work in the metaverse and believe that it can deliver benefits such as productivity to the workplace.
A related market is the industrial metaverse, which has the capacity to represent each part of an organization's real-world system (equipment, machinery, factories, supply chain, etc.) in a virtual environment. Companies such as Nvidia and Unity are helping build this industrial metaverse through technologies such as 3D design tools, photorealism, digital twins, APIs, AI, and computer vision. The goal is to help organizations run simulations, enhance manufacturing and logistics, reduce waste and accelerate time to market.
Because identity is so important to how people express themselves in the metaverse, it's no surprise that fashion is emerging as an important metaverse vertical. On Roblox today, one in five Roblox gamers update their avatars daily. Fashion brands and influencers have taken note and are flocking to the metaverse to connect with their fans, run virtual runway events and collaborate on the design of their products directly with fans. Luxury fashion brands like Gucci and Louis Vuitton have begun selling virtual handbags and accessories, including limited edition items, for digital avatars. Fashion retailer Forever 21, has partnered with Roblox to build a Forever 21 Shop City, wherein users and fashion influencers own and manage stores to become the “top shop”.
To bring more immersion and entice more brands to sell their virtual wares in the metaverse, Roblox recently launched layered clothing. Layered Clothing mimics the way clothing drapes and forms on a body. Individual items like shirts, hats, outerwear, and shoes can be layered in any order, and when fully launched platform-wide, future avatars will be able to wear up to seven layers of clothing in addition to accessories. With a more realistic canvas available on Roblox, I expect the floodgates for fashion brands wanting a piece of the metaverse to really open up.
One of the biggest knocks against, and misperception of, Roblox as an investment is that their platform is age bound, specifically the belief that it will only ever appeal to kids under 13. While Roblox built it's original audience mainly with a younger demographic, it has made great strides aging up. In recent months Roblox revealed that for the first time, more than half of its users were older than 13. In fact, the growth rate of users over 17 is the fastest growing of all Roblox user cohorts.
The biggest factors in the aging up of Roblux users is that the experiences on Roblux have become more engaging, higher fidelity and more complex, appealing to users of all ages. Roblox has invested significantly in recent years to improve the fidelity of the experiences on the platform and have incented developers to build more engaging and deeper games. These improvements in graphical fidelity and more complex experiences has led to older teens and adults in their twenties and thirties flocking to Roblox. As of September 30, 2021, 28% of the top 1,000 experiences qualified as “aged up,” a significant increase from 10% of the top 1,000 experiences last year.
The company has a slew of new tools coming designed to help attract older users to the platform, such as more-life like avatars; the ability for developers to restrict some games to older audiences; and a voice chatting feature available to those who are at least 13.
The aging up of Roblox is also happening organically, by way of viral cultural phenomena like Netflix’s Squid Game coming to the platform. The Squid Game series spawned countless user-made games and items on Roblox’s platform (with tenuous blessing from Netflix). Roblox believes that the show’s breakout moment and the creator community’s quick moves to capitalize on the trend brought older users to the platform.
The other vector to Roblox's growing market opportunity is geographic expansion. Early Roblox growth was driven out of the US and Canada. More recently, Roblox has made inroads into Europe and Asia, with lots of greenfield to go after.
Roblox has a proven playbook for geographic expansion that relies on its two network effects, beginning with its content network effect. Roblox localizes its widely appealing content into the language of high potential markets that have some organic growth, to help draw in more users from local markets. That then kicks of the social network effect. Local content attracts a local audience who want to play on Roblox with their local friends.
The lynchpin to this global expansion playbook is Roblox's ability to localize at scale. With 27 million plus experiences on Roblox, its automated translation engine is critical. Machine translation is done as soon as new experiences are published and as experiences get updated. Roblox also uses matchmaking algorithms to place people from the same region into experiences together. This not only improves in game communication, but also fosters the social network effect. The company observes immediate usage and engagement impact when they release machine translation and matchmaking technology into a new market. The playbook works. This reminds me of an important investing lesson about timing (but not about market timing).
Legendary investor Peter Lynch was famous for analogizing the right time to buy a stock to the early innings of a baseball game:
“Enter early — but not too early. I often think of investing in growth companies in terms of baseball. Try to join the game in the third inning, because a company has proved itself by then. If you buy before the lineup is announced, you’re taking an unnecessary risk. There’s plenty of time (10 to 15 years in some cases) between the third and the seventh innings, which is where the 10- to 50-baggers are made. If you buy in the late innings, you may be too late.”
- Peter Lynch
Roblox is currently translated into 10 non-English languages. With India and Vietnam likely targeted next, we are still in the early innings of a major geographic expansion underway.
With a $1.6 billion trailing twelve month revenue run rate, Roblox is still just getting started. As they turn on and ramp new monetization efforts beyond gaming and go after new verticals, demographics and regions; average revenue per user (ARPU) will ramp significantly. Strategically, Roblox has been obsessing over the user experience. This was the right move. Watch out as they now scale into these large and primed market opportunities.
Roblox is competing in the metaverse platform business. What makes Roblox stand out in the ecosystem of platform companies is its position as a hybrid platform company. Roblox has built and integrated two types of platforms - an innovation platform and a transaction platform.
Similar to Microsoft Windows, Google Android and Apple iOS, the Roblox innovation platform offers tools, services, and a growing user base for outside developers and creators to be compelled to build games and experiences on it. This includes a Roblox client that enables play across virtually any popular device (phone, video game console, PC, or VR headset), the Roblox studio which anyone can use to get started building their first experience or for coders to build more complex games, and the Roblox cloud which hosts millions of virtual experiences and provides key infrastructure services.
The Roblox transaction platform makes it easy for users to buy avatars, virtual goods and enhance their experiences. It also allows the millions of developers and creators to easily monetize their creations. The transaction platform Roblox has built includes a thriving economy and currency called Robux, which the company controls the exchange rate for (as compared to the USD). Users can purchase Robux and spend the currency inside Roblox on experiences and on virtual goods. Developers and creators earn Robux by building engaging experiences and virtual items that users want to buy. Roblox helps developers and creators cash out by converting their Robux into real-world currency.
As a hybrid platform company, Roblox joins an exclusive group of mostly mega cap peers. Whenever possible, it's always better to bake two pies so you can take more slices.
In a platform business it is the best platform that wins, not the best product. With this in mind, let's evaluate the strength of Roblox's platform attributes - it's network effects, ecosystem of developers and creators, barriers to entry and commitment to safety and civility.
Roblox boasts two powerful network effects, creating a powerful positive feedback loop that grows stronger as more content gets added to Roblox, compelling more users to join, who bring more of their friends onto the platform.
The content network effect, attracts more users onto Roblox as more (and better) experiences get added to the platform. An expanding user base attracts more developers and creators to build on the platform. YouTube operates a similar, though much simpler, model of user generated content. As more videos get uploaded to YouTube, more users come to the video platform to browse and find what's appealing to them. Roblox is investing to make it as easy as possible for anyone to develop and create on Roblox. If you think about the range of content creators in our society, such as artists, fashion designers, writers and storytellers, whose creativity will be unblocked as Roblox continues to hide the technical complexity; this content feedback loop will become even stronger.
The Roblox social network effect works much like any social network, whether it's Facebook, Snapchat or LinkedIn. The more of your friends, family and colleagues are on a particular social networks, the more likely you are to join that social network. People want to play and hangout with their friends on Roblox, as well as meet new friends. To achieve its goal of connecting one billion people, Roblox is investing to make its social experience better, across connections, communication and co-experiences. Recent investment in these areas include real time personalization, the ability to quickly find and join friends instantly in any experience, and spatial voice chat. One area I see huge promise in is Roblox's investment to bring more emotion to your avatars and communications with live expressions, a new technology that tracks people faces and voices in real time to represent their dynamic facial expressions as part of their avatars.
The area where Roblox has the biggest head start in building a metaverse platform is the community of creators that build on Roblox. None of the 27 million+ experiences available on Roblox are built by Roblox. Instead, it's all user generated, with over 10.5 million creators building on the platform. The profile of a Roblox creator is quite diverse, from kids interested in learning how to build their own game, to adult hobbyists and creative individuals who express themselves by making virtual goods, and entrepreneurs and game studios that have grown alongside Roblox.
Roblox is an increasingly appealing platform for creators to build on with its exploding user growth (as of November 2021, Daily active users were 49.4 million, up 35% year over year) and focus on flowing as much in game revenue to its creator community. In October 2021, at the Roblox Developer Conference, CEO David Baszucki shared that Roblux was on pace to pay out $500M to its developers community in 2021. There are over one million people earning Robux, and 1,000 people make a living on Roblox (min of $30K).
Now that they have a long tail of creators, and the technology has advanced, they are focused on up-leveling the tools and services for their builders to create world class experiences, without asking the creators to necessarily learn more coding. A good example is how Roblox now provides creators a library of physically-based materials (e.g., sand, ice, ocean water, etc.) that they can easily bring into the experiences they are building. This allows creators who otherwise wouldn't be able to master the advanced physics necessary to physically recreate reality inside Roblox, to do just that and create more immersive experiences that delight and retain users. Achieving the goal of anyone being able to create Roblox experiences with zero code is one of three current R&D priorities. The other two are hyper scaling so tens of thousands of people can simultaneously interact in one experience, and better communications on the platform.
Roblox has always had a maniacal focus on making it easy for a non-programmer with little or no funding to build a creative game. It's the reason Roblox experiences have traditionally had lower graphic fidelity than games on other platforms.
More simple primitives have allowed Roblox to build a thriving ecosystem of builders that will be difficult for other metaverse platforms to duplicate. Epic, Roblox's biggest competitor today, relies on its own internal developers to create the most popular content on its platform Fortnite. Independent developers and creators are not able to monetize on Fornite as much and as easily as they do on Roblox.
Roblox is developer friendly, a characteristic I love to see in platform companies that I invest in. One of the big innovations that has not only helped drive user engagement on the platform, but also put more money into the pockets of emerging developers, is engagement based payouts. A couple years ago Roblox introduced engagement based payouts as a way to help developers focus first on building high engagement experiences, rather than monetizing right away. Developers get compensated when certain user engagement levels inside their experience are reached.
Barriers to entry
With the tech megacaps circling the metaverse opportunity, most recently Meta (formally Facebook) and Microsoft sharing their strategies, the significant capital spending required to build the metaverse will not be a deterrent for these massive companies. Instead, the barriers to entry Roblox has in its favor are the growing switching costs for both users and creators.
Roblox has built up strong relational switching costs for its users. Roblox users have spent countless hours building their identity and Avatar, forming new friendships with other Roblox players they meet on the platform, as well as strengthening existing friendships they brought onto the platform. Roblox has emerged as a new social network where you don't just read a 2D feed about what your friends are up to; rather in Roblox you deepen your friendships by doing things with your friends in 3D worlds. Just like Facebook has the classic social graph lock-in, users on Roblox will be hesitant to move to a new metaverse platform without their network of friends.
With over 24 million experiences available on Roblox, users will have a very hard time getting bored on the platform. It will be very difficult for new entrants to build a competing ecosystem of games, content and experiences that will draw users away from Roblox and onto their platforms. As the history of platform wars has taught us, a lead in the battle for ecosystem compliments such as games, apps and content, is critical to tipping the market to your platform.
Whether it was Windows, YouTube, Airbnb or Uber, the platform with the largest ecosystem of high quality complements or supply side participants tends to win.
By the second half of the 2000s, the war for smartphone dominance was pretty well decided, with Apple's iOS and Google's Android sharing the spoils. By the time Microsoft entered the market in 2010 with a true smartphone OS, Apple and Google had won over developers with their dominant market share leads. Despite very positive reviews for Windows Phone 7, the smartphone platform war had already been won because developers were not interested in developing on a new platform with just 2 percent of the smartphone OS market. Microsoft was never able to convince enough developers to build on its nascent platform, leaving it with a dearth of low quality apps and a peak 3.2% share.
Much like Apple, Roblox has traditionally operated a closed system, where all elements of the solution are provided by the platform owner. In the case of Apple, they own all parts of its system, from the hardware, to the app store, the O/S and to services offered on their platform. Their ownership of all key components of the solution allow them to erect a walled garden, keep competitors out on a whim, and essentially charge a tax (i.e., 30% take rate on apps sold in their app store) to any 3rd party that wants to sell to the 1 billion+ Apple users. Similarly, Roblox controls all of the disparate parts of their platform; instead of one app for social interactions, another app for in game purchasing or advertising, and a different app for each game, everything is all in the same place and controlled by Roblox.
While Roblox's closed system roots put it into a very favorable economic position to tax complementors who want to help round out the Roblox ecosystem, I'm pleased to see the company opening its platform up more and more in recent years. This includes their acquisition of Guilded to connect gaming communities and the Roblox Open Cloud. The Roblox Open Cloud opens Roblox APIs to the world, enabling developers to create experiences, games and content in third-party tools of their choosing and then plugging that into Roblox, rather than being restricted to Roblox Studio.
In the metaverse platform wars, I believe Roblox wins thru differentiation and scale, not by limiting the total economic opportunity with a walled garden.
Safety and civility
The internet has become a very divisive and toxic place. A bright light inside the hellscape that parts of the Internet have become stands Roblox. From day one Roblox has embedded safety and civility into the platform.
Roblox takes a layered approach to safety and civility inclusive of thousands of full time Roblox moderators, machine learning and AI scanning experiences to ensure interactions and communications remain age appropriate and civil, and a framework for civility that if broken offers users easy ways to mute, report or block bad actors and report unsafe behavior.
With plans to grow 10X and continue geographic expansion, Roblox recognizes the importance of scaling its safety and civility systems. At its investor day the company shared its plans for dynamic civility, where unique policies for different places, regions, people and experiences will be applied appropriately.
Roblox is very well regarded amongst tough childhood safety advocates. Titania Jordan, chief parent officer at Bark, a company that uses AI to monitor children’s devices, said that although bad behavior can sometimes slip through the cracks at Roblox, the company is still “commendable” in its approach to child safety, especially compared with sites like Facebook, Instagram and TikTok.
Competitively speaking Roblox's legacy with safety and civility puts it in a very enviable position. From day one, Roblox over indexed on safety and civility, making it very popular with children and their parents. Now, as the company ages up to go mainstream, they are adding the freedoms of expression that older users will demand for Roblox to be relevant to them. In contrast, much maligned for its poor safety and civility track record, Facebook is entering the metaverse wars from a completely open environment where anyone of any age can freely use and see hateful, racist and unsafe language. It will be a very heavy lift for Facebook to try and put the genie back in the bottle and create a more safe and civil place for users of all ages.
With its progress towards building an entire economy on its platform, the opportunities for Roblox to purse are limitless. Truly, the potential total addressable market for Roblox is bringing all elements of our real economy into the metaverse. Work, health, finance, play, commerce, industrial, education, entertainment, and real estate. With a lack of scarcity concerns in the metaverse, like those we face in traditional economies, the size of the metaverse economy may end up dwarfing our real life economy. But, let's come back to earth and discuss the optionality for Roblox that is achievable over the next 10 years.
At its first investor day held in 2021, management outlined its four levers of growth.
We have already discussed at length the playbook Roblox is effectively executing to expand into new geographic markets and age demographics. We have also reviewed the progress Roblox is making extending its platform into new verticals, most notably music, education, and fashion.
Today, the only meaningful way Roblox monetizes is thru users purchasing its in-game currency, Robux. Things are about about to change, likely resulting in a major ramp of Average Revenue per User (ARPU). Where I see the most near term monetization promise is advertising, real world commerce, and events. Looking ahead longer term, I see potential opportunity in a new category I'm calling Metaverse-as-a-Service.
Brands have been on Roblox for many years. They started out by integrating into existing experiences on the platform with virtual items, branded missions and scavenger hunts. Roblox has reached an inflection point with consumer brands. With close to 50M daily active users and 250M monthly active users, brands are able to achieve significant scale and engagement today with their advertising budgets on Roblox:
Gucci created a garden inside Roblox and in one month had 40 million visitors
Warner Bros promoted a movie, In the Heights, attracting 900,000 viewers in one day
Cartoon Network launched its Ben 10 experience and saw 160 million visits
Nascar had 24 million visits in 10 days
Brands are very happy with the results they are seeing on Roblox.
Other brands are taking note, they see the level of scale and engagement they can reach on Roblox. The Roblox ad business is on the precipice of massive growth over the next few years.
Wootton put it succinctly at Roblox's investor day in 2021:
“In the next three to five years, every brand will have a Roblox strategy.”
But wait, the ad story on Roblox gets better. They have rebuilt their entire ad platform,
adding targeting criteria, outcome optimization and the holy grail for marketers of attribution reporting. They are committed to building a world class ad serving platform. Expect more improvements to come.
Brands have long been searching for ways to engage more deeply with customers to create real connection and build loyalty. Consumers are continuously bombarded with ads and notifications from brands, wherever they go. Consumers have grown skeptical, seeing through vapid, traditional marketing and are demanding something more personal and engaging from brands. In a 2D world, engagement marketing is really hard. At their investor day last November Roblox debuted what the future of advertising and engagement marketing looks like with their new offering, immersive ads.
Immersive ads are purpose built for the metaverse and available for brands, developers and musicians to drive traffic to their experiences and products. Immersive ads on Roblox are native, 3D, social and connected to multiple experiences in the metaverse.
The potential Roblox has with their immersive ads reminds me of another early pioneering tech company now called Alphabet. Back in 2000, Google launched a revolutionary new ad format they called AdWords. This simple set of sponsored blue links returned on the right side of Google's search results page finally brought the elusive outcome of relevance to the world of advertising. Twenty two years later Google's search advertising business is a $150B+ juggernaut that is one of the best businesses in history. What made Google AdWords work is how they are native to the Google Search experience. Not only do AdWords blend so well into Google's interface, but they make the product better given their level of relevancy to what the user is searching for.
I see similar potential with Roblox's immersive ad format. Immersive ads are more of a feature of Roblox than a distracting ad. They are designed to take advantage of the same dynamics at play in a popular Roblox experience; immersion, expansiveness, portals to new worlds, and social. They deliver on another outcome that has long been elusive for marketers with their advertising spend, engagement. The potential to connect friends in a relevant and immersive ad on Roblox, and have them engage together with the brand has the potential to help marketers build legions of loyal fans.
With the sort of immersive experiences brands such as Gucci, Nike and Vans are building inside Roblox, I believe older users will be brought onto the platform. A few weeks ago I went to the mall and there was a long line to get into the Nike experience store. While some of this was driven by Covid restrictions, it demonstrated to me how customers crave deep engagement with brands. Why drive to a store to wait in line? In Nikeland I can dream, compete, imagine, create my own mini-games and discover Nike wear that I can use to outfit my Avatar with endless options.
Roblox appears to have all of the ingredients necessary for an emerging ad network juggernaut:
Levels of engagement marketers have not seen on other ad platforms
Two powerful network effects, creating a powerful positive feedback loop of new experiences, more users and more creators pushing Roblox past 250M monthly active users (MAU) and on its way to 1B+ MAU
An ad serving network reaching world class status
A self-contained walled garden with first-party data
Ad prices that are currently 100x cheaper than alternative, making it cost effective to experiment and learn what works, and easy to achieve a high ROI
A new, native ad format that has the potential to revolutionize the advertising industry like Google AdWords did
Advertising is a huge opportunity for Roblox to finally tap into. Roblox has generated just north of $0 per DAU in ad revenue. Compare this with the over $55 per global DAU in ad revenue generated on Facebook globally.
Real World Commerce
With tens of millions of virtual items being bought and sold in Roblox's marketplace every day and hundreds of millions of monthly virtual transactions, commerce is alive and well on Roblox. The next big commerce opportunity for Roblox is to enable real world commerce in the metaverse.
Imagine visiting the Gucci Garden in Roblox, discovering some new handbags, trying it out on your avatar, and buying it "two for one" style where your purchase of the virtual handbag kicks off a back end e-commerce process that has the physical version of the handbag show up on your doorstep the next day.
At their investor day Roblox shared their vision of real world brands using Roblox to sell physical versions of their products and services. They believe Roblox will become a major commerce channel for brands. I tend to agree.
Today, Roblox 49M daily active users are spending an average of 2.6 hours per day on the platform. With that much time already being spent on the platform socializing, playing, discovering new worlds and buying virtual items, it seems only natural that users will spend some of that time shopping, especially if real world commerce is integrated into the experiences people are already spending so much time in. We see it happening with social, as commerce becomes integrated into social media, people are buying directly from within Facebook, Instagram or Pinterest.
People prefer trying out new products before they buy them. The metaverse offers a unique experience for consumers to interact with 3D virtual versions of products before buying. VR and AR adoption should provide a catalyst for this new category of real world commerce on Roblox. Being able to “touch” and interact with a product increases sales conversion rates and reduces returns. In a recent Digital Deloitte and Snap study, it was shown interacting with products that have AR experiences leads to a 94% higher conversion rate.
Next level commerce that Roblox may enable in the future involves customizing products to suit consumers specific tastes. Most users spend a lot of time creating inside Roblox. It's not a stretch to imagine working side by side with your favorite brand (probably thru an AI run designer avatar) to design and/or customize their product to suit your needs, before having it sent to your house.
There is something irreplaceable about co-experiencing a concert with thousands of other fans and feeling the presence of the musicians performing. Access has always constrained how many people can experience this. Concert venues have capacity limitations, artists can only tour so long, and increasingly a greater consciousness about the environment and one's carbon footprint all conspire to limit access.
In the metaverse there is unlimited abundance. Capacity limitations do not theoretically exist. This abundance, coupled with the social and immersive aspects of the metaverse, make Roblox an awesome event location. Roblox thinks so as well, which is why they have started to host concerts and hiring (thank you https://twitter.com/aznweng for the data) to build out a proper event platform on Roblox.
Any large scale event is part of the market opportunity for Roblox. Concerts, conferences, comedy shows, and sporting events are just the tip of the iceberg. While Roblox does not monetize events today, I expect premium experiences to be introduced that will compel event organizers and attendees to pay or even subscribe.
When you distill the metaverse down to its core essence, a potential, longer term market opportunity for Roblox becomes a little more clear. The metaverse is not a single application. It’s not a single world, and hopefully by now I've shown you it’s not a game. The Metaverse is the next version of the internet. It brings together real-time experiences, communication, hyperscale computing, AI, motion tracking, 3D design and many other emerging technologies that provide the scaffolding for the metaverse. At the end of the day the metaverse is infrastructure.
Anytime we see a company building out at scale infrastructure it's hard to resist wanting to contrast with Amazon and how they built out their second act and perhaps best business, Amazon Web Services. Roblox might be one of the few exceptions where I don't have to hold my nose while I explore the opportunity for them to "aaS" (as-a-Service) the infrastructure that's core to their main business. Okay, that was pretty cheesy. But, think about the opportunity to turn the metaverse infrastructure they are building into a service that other companies can rent for their metaverse endeavors.
The reason I entertain this notion of Metaverse-as-a-Service for Roblox is they are on the bleeding edge of technologies required to bring the full vision of the metaverse to life. For example, one of their top areas of R&D investment is hyperscale compute to enable tens of thousands or even millions of people to convene in a single place in the metaverse and simultaneously interact with anyone.
This parallelism problem has not been solved for metaverse experiences with thousands of people, let alone tens of thousands of people. None of Fortnite, Facebook, Second Life, or Roblox, is able to do this today. They all sort of mimic it by creating thousands of instances of the same experience across multiple servers, with each instance constrained to 100 people in each copy of the experience.
If Roblox is able to crack that big nut of massive scale parallelism, there will be a lot of interest from other companies wanting to deploy that technology for their own metaverse related projects. Want to run a 200,000 person plus tech conference in the metaverse? Rather than build the infrastructure required organizers are going to want to rent it. Roblox could decide to keep the tech propriety as a competitive advantage, or they may decide to monetize like I'm suggesting.
There are other metaverse related technologies that one day may be turned into a service, such as spatial audio or storage for virtual items.
While less certain than the other areas of optionality, metaverse-as-a-service could emerge as a need in the market and Roblox will be in a very good position to help fill it.
Roblox has a current market capitalization of ~$36.5 billion (as of Feb 7th 2022) and Price/Sales ratio of 21. In context of its short history as a public company, the current share price of Roblox could be viewed as on sale by some. Down from its high of $141 reached in November 2021, Roblox has been kicked in the teeth like most tech companies in this bear market. It is now more than 50% lower than its highs, currently trading at $63.06. Today doesn't matter, it's the next five to ten years for Roblox that do. But, it helps the bull argument to have the stock trading at historically low prices.
Roblox's revenue growth as a public company is stunning. It has grown revenue 100%+ YoY in each of the three quarters it has been a public company. It still has a ton of greenfield in Asia, Europe and Latin America; and with an older demographic. With the optionality in front of it and great unit economics of the business, there is a lot of upside for Roblox and its long term investors.
Roblox has gross margins of 75% (as of CY21 Q3) after payments to Google and Apple for their take rates, and other, less significant operating charges. With two thirds to three quarters of Roblox usage happening on mobile even they can't escape mobile platform fees. It will be interesting to monitor how Roblox's gross margin may change over time as more of its usage shifts from mobile to VR /AR.
These great unit economics flow through to cash. Since Q4 FY19 Roblox has been cash flow positive and scaling from there. At the same time the company has been investing in building its own cloud infrastructure to accommodate its accelerating user growth, it has also been growing its cashflow. Pretty impressive. Their decision to build their own infrastructure, rather than use the margin incinerating AWS or Azure, is paying off.
The other major investment area eating into cashflow is developer exchange fees. As more developers build for Roblox these fees will grow. Growing developer fees are a net positive. Developers getting paid more by Roblox means more users are being attracted to the platform, are spending more money on it and reaching new levels of engagement.
While the company is not yet profitable, suffering a $74M loss in Q3 of 2021, I take comfort in the sound investments they are making to grow their network effects and scale their infrastructure. Roblox is a platform company in the very early innings of a massive thematic. Just like Amazon and Facebook in the early days of their platform wars, Roblox's focus needs to be on capturing share. With strong unit economics, profitability will follow at the right time.
Roblox was founded in 2003 by current CEO David Baszucki and Erik Cassel, who passed away in 2013 after a three year battle with cancer. Baszucki, known by his username Builderman on Roblox, is lauded by early investors and employees as a visionary, systems thinker and empowering leader.
Baszucki's vision for Roblox began with his first start up, Knowledge Revolution, which built educational software to help people learn about physics. The software allowed people to build anything they could think of, as long as it was consistent with the laws of physics. In his observations of how people were using the software he noticed users not only enjoyed "building stuff and creating stuff" but also "watching what would happen when a car ran into a building". This germinated his idea to create an immersive, 3D, multi-player platform that mimicked real world physics and helped shepherd into existence the notion of the much hyped metaverse.
Baszucki has built Roblox to bring his expansive vision for what the metaverse should be into reality. From his vision of having users create the metaverse thru easy to use tooling, or his dream to have the metaverse feel like reality thru a physics engine and photorealistic rendering, or his optimistic view that Roblox's civility will spill over into the real world; Baszucki is a big thinker. And his foresight has turned Roblox into the most credible and advanced version of a true metaverse platform.
Baszucki often describes Roblox's main product as the company itself. He sees the company and the way it is organized as a sort of operating system that is enabled to build something as comprehensive and complex as Roblox. As early Roblox investor Craig Sherman of Meritech puts it:
David is not only brilliant, but unconventional. He architects systems vs. assigning projects. Building the Metaverse is extraordinarily complex. Few CEOs could conceptualize, much less manage, this complexity. This is Dave’s superpower: like the founding fathers of the US, Dave is the ‘ultimate systems architect.’ Today there are over 40 autonomous product-development teams working on different elements of the ‘Roblox 'system.’ And they are growing more efficient, not less, as Roblox scales.
A consequence of having such an ambitious vision as Baszucki has is you can't do it alone. You need to be able to hire the best people and empower them to execute the vision. This is exactly what Baszucki has done, bringing in top leadership talent from companies such as Google, Microsoft, Apple, Facebook, EA, Intel, Dreamworks, Walmart, Cloudera, and Sony. The quality of Roblox's talent acquisition is well respected:
The only company in our portfolio we’ve seen hire such high quality people across so many hundreds of positions is Facebook.
- Craig Sherman, Meritech
In addition to his brilliance, Baszucki is well known for his big heart. By all accounts, Baszucki is a magnetic leader who as founder has built a unique culture that has enabled Roblox to build a very successful company.
The best way I know to get some insight on the quality of leadership at a company is to go to the source. What are the employees saying about the leader and company. Below are employee provided reviews of Roblox and Baszucki from Glassdoor. Overall, it's a good rating.
I believe an investment in Roblox requires you to answer two key questions honestly for yourself:
Do I believe the metaverse is real? Throughout the next few years, you will hear lots of hype and lots of criticism of that hype. Will that noise make you want to sell?
Will Roblox be a winner in the next big platform war, the metaverse, or do you think titans such as Meta or perhaps even Apple entering the space will cause Roblox to fall behind?
Covid 19 pulled forward the adoption of the metaverse by a few years. Forced to isolate at home, many people took to 3D online worlds to hangout, celebrate, play, work, attend events and learn. What they discovered is a level of immersion and engagement that makes returning to the 2D "old internet" look like a major step back. Imagine being forced to turn your smartphone in after using it for a couple of years and return to using the old flip phones. This collective realization led to the world's largest social media company make a massive pivot in real time to embrace the metaverse. Facebook realized a 2D social feed will never be enough again. Faced with an existential risk to their core business, Meta made the right decision to move towards the future rather than try to fight it.
Meta's move into the metaverse has put a spotlight on a new platform war that is just beginning. Meta, Roblox, Fortnite, Decentraland and other companies (big and small, old and new) will all compete for their fair share of the metaverse platform economic opportunity.
Since its inception in 2006, Roblox has been building its own version of the metaverse. It started with low fidelity graphics and simplistic games, causing many to underestimate Roblox. It was hard to imagine then what Roblox has become. Roblox has built a significant lead in all of the areas required for a platform to win, including strong network effects, a massive ecosystem of creators, high switching costs, and quite likely the best safety and civility capabilities.
Many dismiss Roblox as a video game for kids. Meanwhile, some on Wall street are anointing Meta as the best investment for a future metaverse that won't be here for another ten years. And, under its nose sits Roblox. The closest to a true metaverse platform.
This is why I'm a long term investor in Roblox (NYSE: RBLX) and as of the publication of this article (February 7th, 2022) I added to my position at closing price of $63.06.
Roblox is a high growth stock that carries risk. Expect a lot of volatility. I recommend, if you are interested in the stock, easing into a position and adding over time as you learn more about the company.
As with any investment decision you make it’s important to complete your own due diligence and assess if the investment matches your risk profile.
-------------------------------------------------------------------------------------------------------------------------- Before making investment decisions please do your own research and/or seek the advice of a professional adviser. This is not a stock recommendation.