You probably know about Roblox (NYSE:RBLX) if you have young children or nieces and nephews. If this is your first time hearing of Roblox, it’s a place where you can find over 30 million immersive experiences, from games to concerts and almost everything else. In Q3, 13.4 billion hours were spent in the RBLX universe by 58.8 million daily users. It’s great that each account comes with credits called Robux that can be bought with real money. With Robux, people can buy upgrades for their avatars and unlock new things to do in the game. I assume that many other people are spending money in the Roblox universe, which could be an interesting investment. I want to invest in the company now that I know more about it, but the financials scare me. Roblox stock has lost 72.79% of its value in a year, and I don’t see how it can make money again. Even though Roblox has a lot of cash on hand, it needs to find a way to make money, or it could keep going down.
Roblox is not worth what it is worth because they have never made a profit, and its losses keep increasing
Before I looked into RBLX’s finances, I wanted to see how Mr. Market rated the company compared to other video game developers. Electronic Arts (NASDAQ:EA), Activision Blizzard (NASDAQ:ATVI), and Take-Two Interactive (NASDAQ:TTWO) were all compared to Roblox. These companies run video game franchises like John Madden Football, Call of Duty, World of Warcraft, Red Dead Redemption, and Grand Theft Auto. Since RBLX is a much younger company, I will also look at its price-to-sales ratio in addition to its free cash flow (or FCF) multiple. Even though I’m not too fond of P/S, many investors do, so I wanted to see how it compared to what could be called its peers.
Roblox is worth $19.02 billion on the market, while Take-Two is worth $17.13 billion, EA is $34.43 billion, and Activision is $58.82 billion.
The P/S multiple for Roblox is 8.59x, which is the highest of the group. Activision trades at 8 P/S and made $5.14 billion (332.17%) more money than it did the year before. The P/S for EA is 4.73, while the P/S for Take-Two is 3.96. Given that Activision makes an extra $5.14 billion in revenue and trades at a slightly lower P/S multiple than Roblox, it seems like Roblox trades at a significant premium.
Price to FCF is one of my favorite ways to compare companies. Each investment is the present value of all cash flows that will happen in the future. As an investor, I consider a company’s FCF valuation when I come up with my investment thesis. I’ve been talking about free cash flow (FCF) for years because it’s one of the most important ways to measure a company’s value. This is an interesting valuation metric because it hasn’t been discussed much. After considering the cash needed to run the business, FCF shows how much cash a company has. FCF is a better measure of profitability than net income because it doesn’t count expenses that can’t be paid with cash and includes spending on equipment and assets. It’s also harder to lie about or change because of how businesses count taxes and other interest costs. This is also where businesses get the money they need to pay off debt, reinvest in the business, pay dividends, buy back shares, and buy other companies.
Take-Two is currently trading at a negative FCF valuation because it has made a negative FCF for the first time in ten years. I’ll need to learn more about this in the future. After its most recent earnings, Roblox has made $372,3 million in cash from operations and spent $313,9 million on capital expenditures. This gives it an FCF over the TTM of $58.4 million. Considering that the company’s market value is almost $20 billion, this is a small amount of FCF. Today, Mr. Market has put a value of 325.61x on Roblox’s FCF. This price doesn’t make sense to me when I think about Roblox as an investment. At its current value, Roblox would cost $19.02 billion to buy for a company that makes $58.4 million in free cash flow (FCF). If RBLX increased its FCF by 10% every year, it would take 36 years to reach $19.27 billion in total FCF. That’s not a good way to spend money.
Over the last 12 months, EA has made $1.58 billion in free cash flow (FCF). The price-to-FCF ratio for EA is 21.86x. ATVI has made $1.67 billion in free cash flow over the last twelve months (TTM), and its price-to-free cash flow multiple is 35.22x. Even if you say that Roblox has a lot more growth ahead of the legacy companies and give it a price to FCF valuation that is twice that of Activision, its price to FCF would be 70.44x. The current price is too high compared to the larger competitors, and paying 325.61x Roblox’s FCF is too much since the company is still losing money and the losses are getting worse.
Roblox’s finances are terrible, even though the company has a lot of money
Roblox’s top-line growth is slowing, and its gross margin is decreasing below 20%. Something else is needed. In 2020, Roblox’s sales went up by 81.73% from the previous year, and in 2021, they went up by 107.73%. From the end of 2019 to the end of 2021, Roblox’s income grew by 277.5%, which added $1.41 billion to its annual income. This is a great accomplishment, but Roblox has yet to be able to keep growing at the same rate. In the TTM, Roblox’s revenue has increased by 15.4% year over year, much less than in previous years. There was no transition time because sales grew quickly.
I need help finding a way for the business to make money in terms of net income. In 2018, Roblox had its best year in gross profit margin, which was 31.7%. This has gone down to 19.4% in the TTM. The cost of sales for Roblox keeps going up from year to year, using up the company’s remaining capital to pay for operating costs. Roblox’s operating losses went from -$390.6 million to -$761.5 million, a 94.96% increase from the previous year. After taking out all of its costs, from sales costs to operating costs, RBLX spent $2.98 billion on its business in the TTM, but only made $2.21 billion in sales. Seeing its operating income loss grow over time makes me doubt that things will get better soon from a business standpoint. Lastly, RBLX’s net loss has grown year over year, even though the company has never made a profit. I’m not comfortable paying a price to FCF multiple of 325.61x for a company that has never been profitable on the bottom line and keeps losing money.
Even though Roblox’s losses keep increasing, the company has a lot of money and can handle the losses. Roblox’s balance sheet has $3.02 billion in cash and $988.7 million in long-term debt. Returning to the income statement, Roblox pays $36.9 million in interest costs. After taking out the $17.2 million in interest and investment income, the net interest cost is $19.7 million. Roblox could pay off its long-term debt with a check, but if it has a fixed rate, management shouldn’t worry about the $17.2 million in net interest costs.
Based on how things are going now, Roblox is well-capitalized because it can keep losing money for a few years without taking on more debt. What worries me are their margins and how fast they think they will grow in the future. To become profitable, Roblox will need to either make a big jump in sales without a big jump in costs, or make a big jump in sales while cutting costs by a lot. Every business exists to make money, and Roblox will have to do the same at some point.
Bottom Line
Over the next few quarters, I’ll keep an eye on Roblox stock. If its price drops to a level that makes sense to me or its income statement improves dramatically, I might add it to my portfolio. Roblox is not in immediate danger, but if this keeps up, I don’t see how Roblox can keep running without burning through cash, issuing shares and diluting shareholders, or taking on debt. I think Roblox is worth too much, and it’s crazy that it trades at 8.59x P/S when it makes $58.4 million in FCF while ATVI makes $1.67 billion in FCF and trades at 8x sales. Even though there is no clear way to value stocks, Roblox doesn’t seem to fit in with its industry. I’m staying away because the share price may keep going down until Roblox is more operationally strong.
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