The Motley Fool sent out another internal tease in their Investor Digest this week, as a pitch to upsell their readers to Tom Gardner’s Discovery: IPO Trailblazers service ($1,999/yr, no refunds)… so, naturally, we wanna know what it is, right?
We’ve covered this IPO Trailblazers newsletter a few times — it was started as one of the “portfolio” services at the Fool a year or two ago, with Tom Gardner putting in a million dollars to bet on newly-public stocks that he thinks have at least 400% upside, and the marketing launch was well-timed because it happened to hit in late February of 2020, and started out with their “FAZER” stocks (what they called the “next FAANG”). Turns out, those were mostly smaller tech growth stocks that were perfect for the pandemic “work from home/play from home” tech boom and did fantastically well last year (“>FAZER, in case you’re curious, is still also being used in some of their promos, and is still Fastly (FSLY), Appian (APPN), Zoom Video (ZM), Elastic (ESTC) and Roku (ROKU) — I own the “F” and the “R” in that group).
Should be a quickie today, the clues are pretty thin… but here’s how the pitch got my attention:
“THIS UNDER-THE-RADAR STOCK JUMPED 32% IN MAY – AND WE BELIEVE IT HAS PLENTY OF ROOM TO RUN!”
And this is apparently one of their favorites within this service…
“One of the top stocks on our Discovery: IPO Trailblazers portfolio’s watchlist jumped 32% in May! ….
“Now, for investors who wonder if they’ve missed the boat on this stock’s returns…
“We believe this stock is in the early innings! Especially since the company just went public in March, less than 90 days ago!”
OK, so a brand-new stock, has been doing well despite the market for IPOs and hot stocks getting a little bit less hot in February and March. What else? They tell us which sector it’s in…
“… investors are gobbling up stock in the company because it is starting to make headway into the $65.4 billion video game industry!
“… the demand for gaming is steadily growing.
“An estimated 244 million people in the U.S. play video games daily!”
So… what does the company do? More clues…
“… what’s unique about this stock is that although it is in the gaming industry, it’s not a game.
“It’s a platform that allows anyone to build games — and profit from them – whether they are developers or not!
“It’s literally like YouTube for gaming.”
That makes me feel old… I still remember when Yahoo and Mark Cuban were scoffing at how much Google overpaid for YouTube, and how worried investors were about the rich premium Eric Schmidt agreed to (they paid $1.65 billion for YouTube, which was less than two years old at the time, in 2006, but had already shot ahead of still-giant MySpace in user-generated video hosting). Even five or ten years later, people were arguing about whether YouTube would ever be profitable and earn back Google’s investment… which seems terribly quaint now. YouTube’s profitability is still not disclosed, but it is on pace to bring in at least $25-30 billion in revenue this year for Google (almost as much revenue as Netflix, for some context).
Apparently the connection to YouTube is that the platform enables developers to build their own games…
“You see, the reason why this company attracts over 32 million daily users, despite the pandemic, is because the content is not made in-house.
“Games are created from the users who know exactly what they want to play! And this keen insider knowledge keeps gamers coming back each and every day.”
But wait a minute, apparently it’s so super new that it’s not actually even a recommendation yet…
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“It is so green, that it’s still not an official recommendation here at The Fool.
“It’s completely under-the-radar!
“Which is why we believe investors have a chance to learn all about this stock before most investors take notice.
“It is one of four radar stocks recently released in our Discovery: IPO Trailblazers portfolio (which has beaten the market by 2x)!”
So what’s the stock? The Thinkolator quickly confirmed that this is, as many of you will have probably guessed already, Roblox (RBLX), the video gaming platform that is hugely popular with children and did indeed go public, to quite a bit of fanfare, just a few months ago. That was a direct listing, not an IPO (which means they registered the shares for trading on the exchange, but did not create and sell new shares for that purpose or get the backing of an investment bank), and launched with what they called a “reference price” of $45 on their first day, but the actual trading began at about $65… and, yes, the shares did “jump 32% in May” as teased (though from the recent highs, they’ve now fallen about 10%).
Here’s how the company describes itself:
“Roblox’s mission is 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 powered by a global community of millions developers who produce their own immersive multiplayer experiences using Roblox Studio, our intuitive desktop design tool.
“Roblox is ranked as one of the top online entertainment platforms for audiences under the age of 18 based on average monthly visits and time spent (Comscore). Our popularity is driven purely by our community of users and developers.”
If you want to get a handle on Roblox as a business, their first quarterly Investor Letter is probably a good place to start (or the Investor Day presentation, if you want to make a much bigger time commitment). They are growing like mad, like pretty much every online entertainment outlet has during the pandemic, but they were growing pretty strongly before that, too. Probably the biggest challenge, at least in my mind, is whether they can age up and grow with their audience — more than half of their “engagement”, and presumably a large part of the revenue, still comes from kids under 13.
The financials look entirely ludicrous at first glance, since they’re losing money and trading at almost 50X trailing revenues… but while the company does absolutely trade at a premium valuation, it’s not really as bad as that. They make most of their money with their own closed payment system, where users buy their “Robux” currency and use that to buy games or make in-game purchases, with that money shared with the developer of the game, but that currency is treated kind of like a gift card: they get the cash up front, but it doesn’t get recognized as revenue until it’s used.
The company has a brilliant business model in a closed ecosystem, with much of the creative work and game development done by developers of individual projects… and as YouTube and so many other platforms have shown, harnessing the power of developers to generate creative content and sharing the sales and/or ad revenue with those developers can be a really great and hugely scalable business. I just don’t really have a handle on what the future looks like for Roblox.
There are several “platforms” and “game engines” that enable reasonably easy user creation of 3D, immersive video games, with Unity and Unreal probably the other two big ones that most people have heard of (Unreal is what powers Fortnite, and is owned by Epic Games, which is not publicly traded but does have Tencent as a 40% owner). Between Roblox and Unity, I confess that Unity Software’s (U) appeal is a little stronger for me, since I see it as having a wider addressable universe given their focus on non-gaming 3D immersive video… though there’s also something to be said for building something unique and more fully enclosed and more directly monetized like the Roblox ecosystem, instead of largely just selling software subscriptions like Unity (though Unity does also publish games for small developers and help them monetize those games through both advertising and sales, it’s not their only focus like it is for Roblox).
That initial preference I have might just be because I remember my kids being really into Roblox five or years ago, when it didn’t look at all impressive to me, and it’s probably locked in my brain as something less capable and more of a “kids only” platform than it really is (I didn’t “get” Minecraft either, and that remains insanely popular)… but today Roblox is roughly twice the size of Unity (and twice the “guessed” valuation of Epic Games, for that matter, though if Epic went public or if they win their big lawsuit with Apple that could easily change). And yes, Roblox is also growing faster than Unity, and has better margins… and that’s pretty impressive.
I expect I have a bit of a blindspot with Roblox — it is certainly expensive, it’s a premium-priced video game development platform and user-focused ecosystem, but it might still work out well for investors. There’s a bit of trepidation going around about most of the video gaming stocks these days, given fears that people will cut back on their gaming time now that the world is opening up and there are other things to do post-pandemic, and that might present us with buying opportunities in lots of gaming-related stocks as the next couple quarters roll through… but it does seem likely that gaming will continue to grow as an entertainment and social medium, and if Roblox can keep kids engaged in the platform as they become young adults, instead of watching them graduate to Fortnite and Call of Duty and Grand Theft Auto, perhaps they’ll continue to surprise us with huge revenue growth.
Right now, if you want to justify an investment in Roblox you’ll probably look first at the cash generation — they are not technically profitable, since those Robux that they sell in a given quarter sit on the books as a liability until they are spent, but they are generating quite a lot of cash from operations, and that will eventually trickle through as revenues and profits. Cash from operations in the first quarter, if you ignore the one-time costs associated with the direct listing, would have been about $216 million. The business grew at about 80% last year, which is probably not sustainable, that was a huge acceleration from 56% the previous year, driven by kids being stuck at home (and by lots of people having new time on their hands to develop new games)… but even 50% growth in 2019 was impressive.
Analysts are expecting growth to slow down considerably, with revenue growth of about 30% this year and 20% next year, and I expect that’s probably conservative, partly because nobody is really comfortable with RBLX yet and they don’t want to look foolish — but even if growth does slow to that degree, I’d estimate they could have $1 billion in cash flow from operations this year as long as kids don’t abandon video gaming and go play outside all summer. And while that’s not at all the same thing as ‘earnings,’ it’s still pretty impressive for a fast-growing $50 billion company… and it seems pretty likely that it’s going to reach a meaningful level of real profitability before Unity as well (analysts don’t see U being profitable before 2023, while RBLX will probably be profitable this year).
Looking just at the numbers, Roblox is a better and more impressive company than Unity in almost every way — more reasonably valued, growing faster, with a closed ecosystem and a ton of deferred revenue… I still think Unity is a more interesting growth story in the long term, largely because it has more appeal for real-time 3D commercial work and virtual reality applications, and I’m not entirely convinced that Roblox will remain relevant as its users age up, but I’m now thinking that I might be too cautious on that front. And clearly the sales growth is still strong — over at Amazon, the top four selling items in PC games (ie, non-console) are all Roblox Robux gift cards. They’re not above Xbox, Nintendo or Sony Playstation yet when it comes to video game sales overall on Amazon’s platform… but they’re awfully close — that doesn’t mean as much as it would have a few years ago, since so many purchase are made direct on platforms (including for Roblox) and not through retailers, and about half of Roblox revenue comes from the Apple and Google app stores (which means there’s also a big bite taken by those providers), but it’s a reminder that yes, even though I’m a little skeptical because I associate the platform with children, it’s a big business.
The big risks? Two are clear to me: That analysts might be too optimistic and Roblox sees an actual decline in revenue and engagement this year as schools reopen and kids go back to other social activities; and that over the longer term, Roblox fails to grow its user base beyond kids and teens or fails to capitalize on other potential growth areas, like advertising. There’s a lot of choice in the world of video games, and popular franchises and platforms tend to have good “network effect” power and keep people engaged… but there are plenty of examples of fads and washouts in this business, too.
The Motley Fool folks say this is a “radar” stock, which I guess means that they’re putting it on a watchlist, and that also makes sense to me — it could easily become much more appealing if it drops 50% in the next market crash, but after looking over that Robux deferred revenue and the rapid growth pre-pandemic, and the “seem too soft” analyst expectations, given my personal assumption that video gaming hours in general are likely to continue to grow from this new higher base and not dip or plateau over the next year or two… I decided to do a little more than watch.
Which means I’ll go in on this, but in a bit of a wishy-washy way. I bought Unity on its IPO day last year, the first time I had done that in years, and I’m willing to wait it out for a few years to see if their software platform develops into new commercial applications and builds its market share in gaming. With Roblox, I’m not willing to commit quite as much or be as patient, at least not yet, but the financials are significantly more impressive and the potential is clearly there, so I just bought some $120 call options for January of 2023 as a small speculation — If they can continue to build on that network effect of getting kids and creators more engaged, and the stock doubles in the next year and a half, that will work out well for me… if it doesn’t, I will have been better off owning the shares or staying out of it entirely. As always, I’ll be sure to update the Irregulars as my portfolio and thinking evolve.
That doesn’t really matter to you, though — that’s just what I’m doing with my money. When it comes to your money, it’s your opinion that should drive the bus… so what say ye? Ready to bet on a kids gaming platform? Think it’s a flash in the pan? Can you talk me into or out of this one? Let us know with a comment below… thanks for reading!
Disclosure: Of the stocks mentioned above, I own shares of and/or call options on Amazon, Alphabet, Fastly, Roku, Unity Software, and now Roblox. I will not trade in any covered stock for at least three days after publication, per Stock Gumshoe’s trading rules (and since this is a new options stake in Roblox, and those can be very volatile if they get any attention, I’ll commit to not trade that position for at least a month).