After a 22% post-performance plunge, is it worth buying into Roblox, the "number one stock in the metaverse"?

On Wednesday, Roblox, once hailed as the "number one metaverse stock," announced earnings that fell short of analysts' expectations, causing the company's stock price to plummet by 23% at one point before ultimately closing down 22%. Despite Roblox's Q2 revenue increasing by 15% YoY to $681 million, it fell short of analysts' expected $778 million. The company also reported a basic and diluted loss per share of $0.46, missing analysts' expected loss of $0.44 per share and last year's loss of $0.30 per share. Roblox's net bookings and adjusted EBITDA also failed to meet expectations, with Q2 net bookings at $781 million compared to analysts' expected $785 million, and adjusted EBITDA at $38 million compared to analysts' expected $46 million.

User base and engagement show strong growth

Roblox, the company's namesake game, is one of the top five highest-grossing mobile games globally in 2022. According to the mobile game "Roblox," players spent $861.86 million in 2022. What sets Roblox apart from other online gaming platforms is its allowance for user-generated content. Developers can earn a 30% share of the revenue generated from virtual clothing and avatar sales.

While Roblox's primary audience has traditionally been teenagers and children, the company has been striving to expand its user base across all age groups. In June of last year, Roblox announced that eligible creators could develop experiences containing mature content (such as certain forms of violence, romantic themes, and moderate crude humor) for users aged 17 and above.

Last year, the metaverse market experienced a frenzy, and as a leading virtual video game developer, Roblox naturally rode the wave. The metaverse is considered the next generation of the internet, described by tech experts as a persistent, shared 3D virtual environment. It is a place where people gather to engage in various activities, from gaming to conducting business. It combines technologies such as virtual reality and augmented reality.

Mark Zuckerberg, CEO of Meta (formerly Facebook), describes the metaverse as "a tangible internet where you are present, not just looking at it." Christina Wootton, Vice President of Brand Partnerships at Roblox, states, "The metaverse is bigger than just games. We are leading this new category of human collective experiences. It's an immersive place where people can connect, share virtual experiences, and work, learn, play, shop, and be entertained together."

Following the COVID-19 pandemic, mobile gaming platforms have resumed their growth trajectory, but the market is now overly concerned about future investment increases. Roblox's stock is one of the metaverse stocks worth watching amidst the current stock market rebound, as the company holds potential in the emerging virtual world investment theme.

In the past few years, Roblox has maintained strong growth in key user numbers and engagement, but both revenue and bookings have declined due to significant spending during the COVID-19 pandemic. Now, the growth rate of the company's user data has returned to 20%. Q2 bookings reached $780.7 million, a YoY increase of 22%. The average daily active users (DAU) reached 65 million, a YoY increase of 25%. The average monthly paying users reached 13.5 million, a YoY increase of 19%. User engagement time reached 14 billion hours, a YoY increase of 24%.

Essentially, Roblox's growth rate in key financial indicators and user stickiness is over 20%. User engagement time has actually increased by 24%, which is a very positive signal that the gaming platform continues to attract users to play games on the platform.

With the growth in user bookings and the potential for future operating leverage, the company's stock price has plummeted mainly because the company has invested heavily in the platform to drive growth beyond 2024. Roblox reported that operating net cash for this quarter dropped to only $28 million, slightly higher than the $27 million in the previous quarter.

The company hired a large number of employees last year to enter the metaverse through AR/VR headsets, AI content creation and subscriptions, and other platform plans. Roblox currently has about 2,400 employees, an increase of 500 compared to the previous year, with personnel expenses accounting for 26% of bookings revenue. This ratio is higher than the 22% in the previous quarter.

In the Q2 2023 shareholder letter, the company strengthened its plans to generate operating leverage in the future: as bookings recover and grow by more than 20%, we shared our goals for generating operating leverage in terms of compensation costs, infrastructure, trust, and security. Specifically, we expect the growth rate of bookings to exceed the growth rate of infrastructure and trust and security costs from the second half of 2023 to the end of 2025. We also expect the growth rate of bookings to exceed the growth rate of compensation costs from the first quarter of 2024 through the entire year of 2024 and 2025, thereby generating operating leverage. Roblox announced this plan in 2023, aiming to achieve operational leverage in 2024 and 2025. BTIG predicts that the booking volume in 2024 will reach $4.3 billion. Even with only a 15% increase in booking volume, it would still result in a $600 million annual growth rate, making it easy for Roblox to absorb higher costs in 2023.

Therefore, when the forward sales multiple (EV/S) drops to 5 times, the stock becomes attractive. Roblox has approximately $2 billion in net cash, which can easily cover these short-term investments.

Conclusion

A large-scale sell-off will support a bullish valuation for the stock, but the market may require Roblox to demonstrate operational leverage in the coming quarters before purchasing the company's stock. The key conclusion drawn from this is that Roblox is now much more attractive after reporting a growth in user-related metrics of over 20% and a 20% decline in stock price due to increased expenses. The gaming platform has tremendous opportunities for development in the metaverse and AI fields. With the forward sales multiple dropping to 5 times, the stock is appealing, but patience is still needed before buying the stock.