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In the previous article "Roblox: Can't Swallow the 'Big Pancake' of the Metaverse", Dolphin mainly discussed the business model and competitive advantages of $Ryder(R.US)oblox.US, pointing out that the key to Roblox's future growth lies in "breaking barriers", and the key to breaking barriers lies in reducing the revenue sharing in the industry chain and attracting more professional developers to accelerate the development of high-quality content.

Only when the age barrier is broken, the overall willingness of platform users to pay and the advertising value can be increased, thereby bringing about sustained high growth in Roblox's performance and matching the market's "preference" for its valuation.

However, there are also disadvantages. Increasing revenue sharing/increasing investment in platform tools will weaken short-term profitability, and the current situation of GAAP losses may not be reversed in the short to medium term.

Fortunately, the current US inflation data has dropped rapidly, and although the Federal Reserve is still talking about raising interest rates, market expectations have eased. In this macro environment, the market's tolerance for Roblox's losses will also increase significantly, as long as the losses do not expand too dramatically, it should not affect the market's valuation judgment of Roblox.

So, under different expectations, what is the reasonable value range for Roblox? Dolphin attempts to find the answer through this article.

I. Difficulty in profitability is not a problem, cash flow is not that bad

For growth stocks, a common problem that needs to be diagnosed is the difficulty in short to medium-term profitability and high financing needs. If Roblox has short-term financing risks, it will be detrimental to minority shareholders, whether it is borrowing in a high-interest environment or issuing new shares.

In the previous article "Roblox: Can't Swallow the 'Big Pancake' of the Metaverse", Dolphin discussed that Roblox did not suffer losses and even had advantages in the revenue sharing of the game industry chain, so its cash flow is relatively healthy. Therefore, although it appears to be losing tens of millions to billions of dollars every quarter, the free cash flow does not look so bad.

This is mainly due to the cautious recognition method chosen by Roblox in revenue recognition:

Similar to the recognition criteria for games, revenue is only recognized when players use exchanged Robux to actually purchase goods or services. If the purchase is for Avatar decorations, it is recognized on a period-by-period basis according to the user's lifecycle (currently estimated by the company to be 28 months). Rational Discussion on Roblox's Valuation

1. The current high valuation is still betting on the future metaverse

Roblox has always had a relatively high valuation, surpassing both gaming companies and social media platforms in terms of P/E ratio. The only competitor that can challenge it is Unity.

(1) Before the metaverse is truly realized, the platform competition continues. Unity, as a technological tool, has a higher growth certainty compared to Roblox.

(2) The reason why SaaS companies can match high valuations is mainly because their ecosystems are open to the outside world, allowing them to provide their products and services to all downstream customers. When there are enough customers, their server costs can be sufficiently low.

Although Roblox also provides a development engine and its developer customer base is expanding rapidly, the games developed by these developers can only be distributed and monetized within Roblox's ecosystem, essentially operating within a closed-loop ecosystem.

Whether developers can achieve satisfactory monetization depends on the prosperity of Roblox's ecosystem itself. Conversely, Roblox's ecosystem also relies on the products developed by developers.

Therefore, the Roblox engine is not targeting all developers, but rather developers who can accept certain limitations. While this customer base may seem large in number and provides a low entry barrier for ordinary users to develop games, in reality, it fails to attract many high-quality developers. High-quality developers are often the ones who can leverage a larger scale of monetization value. Without a sufficient number of high-quality developers, it is difficult to achieve cost dilution through economies of scale and improve profit margins. Currently, the market's consensus expectation is that the revenue CAGR for the next two years, 2023-2024, is only 22%. This indicates that the market's valuation preference is more focused on Roblox's long-term growth potential. In simple terms, the market somewhat acknowledges the metaverse vision presented by the management.

2. Dolphin's viewpoint: Not pessimistic in the short term, but cautious in the long term

Although Dolphin has doubts about Roblox's medium to long-term vision, it must be acknowledged in the short term that Roblox has passed the impact of offline traffic regression and is continuously confirming a positive trend at the bottom.

In the first quarter of 2023, the platform's user ecosystem returned to an accelerating expansion trend, with a net increase of 7.3 million DAU users. This single-quarter net increase is second only to the strictest period of epidemic lockdown in the second quarter of 2020.

Furthermore, the average daily usage time per user has also started to increase since the first quarter of this year. This is also reflected in the accelerated growth of the total usage time for all Roblox users in the first quarter.

However, when looking at the situation by age group and region, there is limited room for further improvement in user penetration rates in North America and among users under 13 years old.

Nevertheless, in the first quarter of this year, the average daily usage time per user started to increase (0.6%), which accelerated the overall platform activity.

There are various reasons for the regression of traffic, but it is related to the enrichment of non-low-age games, the addition of non-gaming content such as music, and the strengthening of social attributes on the Roblox platform, such as the game "Frontlines" that we introduced in the previous article.

However, no traffic can grow indefinitely, whether it is a social platform without content restrictions or a vertical gaming platform. So, where is the ceiling for Roblox's traffic growth? First of all, the management's vision of reaching 1 billion DAU is just a dream. Dreams are good to have, but valuation should be grounded in reality. Currently, institutions mainly predict based on the penetration rate of young gamers worldwide, which means that the growth rate will enter a period of obvious slowdown.

Based on the current effect of breaking the circle and the growth momentum, Dolphin believes that the institution's expectations are not too exaggerated. Currently, the DAU in 1Q23 has reached 66 million. Even if we calculate based on the net increase before the epidemic in 2019,

Now, Dolphin will try to calculate the user scale in the medium and long term under steady state:

1. Children under 13 years old, optimistic net increase of 9 million, pessimistic net increase of 0

According to the penetration rate in North America (Roblox's penetration rate among children aged 5-13 in North America has reached 65%), although there is, theoretically, still room for growth in children under 13 in other regions (Dolphin's calculation shows that the optimistic expectation is that the DAU under 13 will reach 37 million, with a net increase space of 9 million compared to the current situation).

However, the YoY growth of children under 13 in the first quarter of 2023 is only 1.4%. Whether it is a temporary bottleneck or a ceiling, it still needs to be observed for another 1-2 quarters.

2. The user ecosystem is expected to reach 140-180 million in the medium and long term

In the long-term end state, it is difficult to determine how large the Roblox user base can be at this moment because we cannot predict the subsequent effect of breaking the circle. "Breaking the circle" is related to how Roblox introduces high-quality content, including adjustments to the revenue-sharing model and the launch of more development tools.

Therefore, the prediction of how much incremental growth non-child users can bring is based on the assumption that Roblox's circle-breaking actions mentioned above proceed smoothly. We can refer to a similar game with a good reputation called "Minecraft" for comparison.

2022, "Minecraft" has a monthly active user base of 140 million, with an average user age of 24, and a slightly higher proportion of male users. According to the Minecraft-seeds blog, users under the age of 15 account for 21% of the player base, users aged 15-21 account for 43%, and users aged 22-30 account for 21%. Therefore, although "Minecraft" still leans towards teenage users under the age of 21, it is relatively more mature compared to Roblox.

If we assume that the age distribution of Roblox users can reach the same level as "Minecraft" in 5 years (taking into account game development cycles, user acquisition cycles, etc., set as a 5-year period), it means that the proportion of users under the age of 13 will need to decrease from 45% at the end of 2022 to 20%.

2. Revenue Expectations - Focus on Incremental Growth in Advertising

Advertising is the next business curve that Roblox is pushing for, and management expects it to contribute a small portion of revenue starting in the second quarter of this year. However, similar to early-stage TikTok, Roblox's advertising pricing is weaker than that of similar social platforms due to the younger age of its user base.

Due to the high playability and immersion of the game, users spend more time on Roblox compared to general social platforms. On average, each user spends nearly 2.5 hours per day on Roblox, while Snapchat users only spend 30 minutes per day.

However, as more users from different circles and light gamers or users of other content enter the platform, and with the improvement of the platform's social attributes, it is expected that the average user time spent on the platform will decrease. For now, let's take the average of 30 minutes for Snapchat and the current 2.5 hours for Roblox as 1.5 hours, which represents the long-term steady-state user time for Roblox in the future.

Based on the difference in the proportion of adult users and user time spent, let's assume that the current hourly advertising price of Roblox is 1/5 of Snapchat's, and in 5 years, Roblox's advertising price per hour will be 1/2 of Snapchat's (with Roblox's proportion of users aged 25 and above at 30%, only half of Snapchat's proportion). Therefore, it is estimated that Snapchat's advertising revenue will reach 1 billion in 2024, and the advertising revenue in 2028 will be in the range of 2.3-3 billion. **

**Revenue from in-game content payments, based on the scale of 80 million and 140 to 180 million DAU users in 2024 and 2028 respectively, and an average annual ABPDAU of $55 in 2024 and $60 in 2028:

4. Valuation

It is difficult to value a company that relies on future strategic execution to determine its performance. In other words, at present, Roblox's stock price is more influenced by valuation sentiment rather than past performance. Therefore, we can see that during the period of fluctuation in interest rate expectations and before the financial report is disclosed, Roblox's stock price also fluctuates.

The launch of the two generative AI tools has a similar effect on Roblox's stock price, which is more of an emotional stimulus rather than a quantifiable impact on the fundamentals. In addition, it is difficult for Roblox to turn a profit in the short to medium term, so the absolute valuation method of DCF is not applicable.

From a relative valuation perspective, Dolphin expects Roblox to achieve a total revenue of $8.6 to $11 billion in 2028 under steady-state conditions. Based on a 5x PS ratio, the long-term valuation is estimated to be $43 to $55 billion.

However, due to the high uncertainty of Roblox's future revenue growth and the continuous dilution of minority shareholders' equity value (approximately 4% per year) caused by high stock-based compensation, Dolphin assumes that the required rate of return WACC will increase to 15%.

Of course, for growth stocks whose current stock price is mainly supported by valuation multiples, Dolphin will also make a simple assumption: assuming that after Roblox reaches 80 million users through inertia growth, further user expansion fails and advertising monetization has average effectiveness, discounting the future growth potential. Based on an ABPDAU of $50, it is estimated that the revenue for 2024 will be $4 billion, with $3 billion recognized as current revenue, and an additional $500 million in advertising revenue, corresponding to a 5x PS ratio.

**As of the close on July 12th, Roblox's market value is $26.5 billion, at the lower end of Dolphin's valuation range. If there are marginal improvements in the future, the stock price will also have catalysts. However, it should be mentioned that since most of the performance assumptions are based on speculation about future performance and rely more on subjective judgment, the current risk-reward ratio is not high. Roblox: A Promising Metaverse Platform

As one of the few metaverse platforms with great potential, Roblox's process of breaking through barriers is worth paying attention to. Dolphin will continue to track and research Roblox, and welcomes constructive discussions.

Dolphin's Historical Articles on Roblox:

In-Depth Analysis

July 13, 2023: "Roblox: Can't Resist the Temptation of the Metaverse"

Dolphin Research Disclaimer and General Disclosures