Roblox – Cash flow mirage

Long term prospects but wait for a dip.

• Roblox has the potential to morph into something far more interesting than it is today, but a large cash flow crunch when growth slows down may allow the long-term value investors to get their positions at a much lower level.
• At $38bn, Roblox is expensive but not in the same league as the Tesla driven EV crowd, Snowflake or Palantir meaning that the company should be on the radar of more value-oriented investors.
• Roblox is a platform upon which users can interact with other users through Lego-like avatars normally via games that the users themselves have created.
• Everyone thinks of it as a gaming company, but the reality is that over the next 10 years it may become something far more interesting.
• The main asset of this company is the 31.1m daily active users (DaU) and the large amount of time that they spend on the platform.
• It has also been designed with 3D from the ground up which combined with the fairly basic level of its graphics makes it an ideal candidate for virtual reality (VR).
• I have been very negative about VR for a very long time because of the limitations of the user experience but VR is beginning to make up for its technical shortcomings with fun.
• This was very much how the Nintendo Wii was able to carve out a place for itself in the console world as it was the first to allow users to play tennis using their arms rather than pushing a button.
• The Oculus Quest 2 is starting to move in this direction and while it has a very long way to go technically, there are fun and engaging games available, and sales volumes really picked up in Q4 2020.
• This combined with the simple graphics and engaging nature of Roblox makes it a perfect candidate for VR and I expect that it will soon be available on the Oculus Quest 2 as well as the other cable-free VR devices.
• At the moment it is only available on the VR devices that are tethered to a PC which I think greatly diminishes its appeal for VR.
• The very long term for Roblox has to be a digital ecosystem for VR where users can hang-out or meet virtually in environments that have been created by the users.
• This could be worth substantially more than the $38bn that the company is trading at today however there is always the short to medium term to consider.
• This is where things may come unstuck because this company is very far from profitable despite the positive cash flow that the company headlines its prospectus with.
• This is because of the nature of how Roblox accounts for its revenues.
• I am referring to the booking metric which is a very odd thing for a consumer company to have as an operating metric.
• This is why it caught my attention for further scrutiny.
• In reality, Roblox’s bookings are prepayments received from users that are amortised over the period of the user’s expected life (23 months) on the platform.
• Roblox is free to play but has in-game purchasing for upgrades, costumes, privileges, stickers and other digital items that users buy to enhance their experience.
• For example, if a user spends $100 on the platform (ARPU is a whopping $39), this is recognised as revenue over a period of 23 months.
• So, in year 1 50% of the revenue is recognised in the profit and loss account and 50% of it is capitalised as a liability called deferred revenue which will then be recognised in year 2.
• However, 100% of the $100 received is recognised in the cash flow statement meaning that on a going-concern basis, the cash flow statement is being greatly inflated.
• At the end of September 2020, Roblox had $1.3bn of deferred revenues on its balance sheet of which $904m will be recognised over the next year.
• There is nothing wrong with this other than investors have to remember that there will be no cash flow attached to these revenues as it has already been recognised in the cash flow statement.
• For the 9 months to September 2020, the cash flow from operations was $345m but cash flow from these future revenues was $656m meaning that in reality, Roblox was cash flow negative to the tune of $311m.
• This means that Roblox is investing future revenue receipts in growing the company.
• If there is a sudden slowdown in growth, cash flow will suddenly turn sharply negative potentially requiring the company to raise money.
• The company has $800m of net cash on its balance sheet and so I think that it is in a reasonable position to weather a problem like this but it could make a big dent out in the valuation.
• Growth has been particularly strong recently thanks to the pandemic, making this the perfect time to list as a slowdown from kids returning to school and reality has yet to hit the books.
• It is this slowdown and sharp cash flow reversal that I am looking for before even thinking about looking at this one.