Roblox's growth lifeline is "breaking the circle"

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$Roblox(RBLX.US) On October 31st, Eastern Time, Roblox released its Q3 results for the fiscal year 2024 before the US stock market opened. Here are the key details:

1. Platform activity reaches a new high: This year, the airport Live-ops events held by Roblox performed well. In the last quarter, with "The Hunt" and "The Classic," DAU increased against the seasonal trend. In Q3, the Olympic-themed "The Games," combined with the peak season, ultimately drove platform activity to a historical high. Specifically, DAU increased by 9.4 million, and total user hours reached 20.7 billion, a year-on-year increase of 29%, with both metrics accelerating quarter-on-quarter.

2. New traffic mainly from youth/adult users: Nearly 80% of the new traffic in Q3 came from youth/adult users aged 13 and above rather than children. This can provide a stronger boost for Roblox, which is currently testing video advertising. Since child users do not have independent purchasing power, they are generally considered less valuable by most advertisers.

3. Bookings continue to rebound: The year-on-year growth rate of bookings in Q3 rebounded to 34%, significantly exceeding the market expectation of 22%. Compared to Q2, the increase in bookings in Q3 was notably higher than the traffic increase. This is simple to explain: the purchasing power of youth/adult users is clearly much higher than that of child users. Therefore, when youth and adult users are the main drivers of growth in Q3, it naturally leads to a more significant increase in revenue.

For the Q4 bookings guidance, the company expects to achieve between 1.33 billion to 1.36 billion, a year-on-year increase of 18% to 21%, slightly exceeding the market expectation of 1.3 billion. Meanwhile, the full-year bookings forecast has been raised to 4.23 billion to 4.37 billion, representing a year-on-year growth of 20% to 24%. Compared to 2023, the growth rate remains stable, alleviating market concerns about sustaining high growth.

4. Q4 guidance implies a return to cost control: In Q3, the operating loss was 279 million, slightly better than market expectations. However, as a peak season, the loss rate of 30% quarter-on-quarter did not continue to improve. Breaking down the expenditure details, the main impacts come from two aspects.

1) Developer revenue share fees are directly paid to developers based on the revenue share for the period, but in Q3, the proportion of new revenue confirmed in the current period was lower than in previous periods, leading to a mismatch in financial income and expenditure;

2) Basic trust and safety expenses, which may be related to previous criticisms of Roblox regarding multiple child safety issues on the platform. The additional investment in Q3 is estimated to be used for making some safety upgrades. For example, Roblox recently launched features to help parents restrict children's access to potentially harmful content and functions, such as requiring parental permission for children under 13 to use the "chat function."

However, the management has raised the profit guidance for Q4, increasing the Covenant-EBITDA profit margin from 20% in Q3 to 25%, which implies continued control over other expenses aside from infrastructure trust and safety costs, such as slowing down employee recruitment and reducing the weight of equity incentives.

In the last quarter's conference call, the company stated that it would continue to strictly control expenditures, and the previously set medium to long-term goal of increasing profit margins by 1% to 3% annually remains unchanged.

5. Overview of Financial Indicators

Dolphin Investment Research Perspective

Last quarter, the market ignored the company's positive guidance upgrade and reacted with a sell-off to express expectations of a slowdown in implied growth within the guidance. Although the valuation is not as attractive as in Q1 (due to a performance miss causing panic that hit our conservative valuation position), Dolphin believes there is no need to be pessimistic. Several Live-ops events conducted by Roblox this year have performed well, and the third quarter features the Olympics-themed The Games event, combined with the summer peak season, which is expected to continue to bring positive traffic momentum. Moreover, management expressed that the cautious approach to the guidance upgrade leaves some potential for exceeding expectations.

Since the third quarter, Sensor Tower data has also shown a good growth trend in platform activity for Roblox, so there are certain market expectations for the third quarter's performance. However, the market did not anticipate that the actual performance would significantly exceed the original guidance, leading to a further rebound in Bookings growth. At the same time, the guidance for the next quarter also implies that despite a higher base, the growth rate can still maintain a high growth trend of around 20%.

Additionally, the more positive guidance for Q4 profits has also added more points. After all, many funds are concerned about Roblox, largely due to the persistently high cost expenses, leading to years of losses, and short-term worries about trust and safety costs being significantly raised due to social discussions. Although we also say that looking at Bookings may be more aligned with Roblox's business model than looking at revenue metrics, financial profitability remains a core standard of concern for many funds.

In early October, Roblox was short-sold by Hindenburg Research, which claimed that it had fabricated DAU metrics and user engagement metrics, and mentioned child safety issues on the platform.

Regarding the issue of user engagement fabrication, Dolphin believes Hindenburg has exaggerated the severity of the problem. **For example, they pointed out that Roblox's DAU did not account for actual unique users, leading to situations where one person has multiple accounts, which is counted as multiple in Roblox's disclosed DAU metrics**

This phenomenon is not unique to Roblox; rather, most platforms disclose DAU and MAU based on accounts rather than specific users. For example, Meta's DAP metric includes instances where the same person is counted multiple times due to having multiple accounts on FB, IG, WhatsApp, etc.

However, the issue with the latter does exist. As mentioned earlier, there has been a significant increase in expenses related to trust and safety in the third quarter. Recently, Roblox launched several features to restrict children's usage by parents, so this type of incremental investment is expected to continue. However, Dolphin believes that based on the Q4 guidance and the company's medium to long-term vision for profit margins, Roblox still aims to further reduce overall spending to improve monetization efficiency.

Therefore, we expect that profit margins will not stagnate as some investors worry; perhaps the pace of improvement may slow slightly at most. This implies expectations for the company's restructuring of its employee team, especially further control and reduction of equity incentives. However, the high growth of Topline Bookings is evidently more important. If it can maintain a compound annual growth rate of over 20% since 2022 as previously anticipated by management, then it may barely support a valuation of around EV/Bookings=6.5x by 2025.

Of course, starting next year, in addition to platform subscription revenue, attention also needs to be paid to the incremental revenue from video advertising. However, currently, due to the limitation of total user numbers, while short-term progress is acceptable, given the trend of brand advertising migrating to social media, Dolphin remains cautiously optimistic and does not recommend setting overly high advertising expectations at this time.

Detailed Financial Report Interpretation

1. Bookings Continue to Accelerate Rebound

For Roblox, which has a subscription revenue model with a relatively high proportion of operating expenses (generally 20-21% compared to Bookings) related to developer revenue sharing, under normal operating cycles, it is sufficient to focus on Bookings and, at most, look at deferred revenue for short-term trends.

In the third quarter, boosted by the Olympic-themed event The Games and the peak season effect, user numbers reached a new high, driving Bookings to grow by 34% year-on-year, significantly accelerating compared to the second quarter.

From the perspective of deferred revenue, the net increase in the third quarter also rebounded, indicating high user activity during the event period, especially among the newly added youth/adult users in the third quarter, who showed strong willingness to recharge and higher payment capacity. However, the increase in the proportion of game and membership recharge in the revenue may have resulted in a slightly lower proportion of revenue recognized during the period compared to previous periods.

Bookings Guidance Increased Accordingly: The company's Q4 bookings guidance range is set at 1.33 to 1.36 billion, slightly above consensus expectations (1.3 billion), implying a growth rate of 18-21%. Although this represents a noticeable slowdown compared to the 34% growth in Q3, it is understandable given the high base from last year's Q4.

Concerns about the slowdown in growth triggered by last quarter's guidance were shattered by a strong 34% year-over-year growth in Q3, and the full-year growth guidance of 20-24% finally met the 20% annual growth target proposed during the 2022 Investor Day.

For the revenue metrics that the market is currently less focused on, there was also an upward adjustment in Q3, including some positive expectations for video advertising.

2. Seasonal Effects Combined with Olympic Activities Accelerate User Engagement

With the support of the Olympic-themed The Games activities, Roblox's user ecosystem has seen a significant net increase driven by seasonal effects, continuing to reach historical highs.

In Q3, the overall net increase in users was 9.4 million, with 80% of this being users aged 13 and above, which translates to an increase of 7.2 million. By the end of Q3, the total number of users across the platform reached 88.9 million, of which 60%, or 53.6 million, were non-child users. Considering that video advertising is only shown to users aged 13 and above, the expansion trend of this user group is quite important and needs to be continuously monitored.

Regionally, all four major regions contributed positive growth in Q3, with strong growth also seen in the high-paying North American market, aside from the remaining emerging markets like Asia-Pacific. As is well known, Roblox's penetration rate among users under 13 in North America is already very high, further demonstrating Roblox's breakout effect among young and adult users in North America.

In terms of user engagement, the average daily time spent per user in Q3 increased by 2.5% year-over-year to 2.6 hours per day, aligning with the historical second-highest position in Q3 2021. The total user hours grew by 29% year-over-year, continuing to accelerate on a quarter-over-quarter basis.

In addition, the growth of Bookings is mainly due to user expansion, with a small portion coming from the stable growth of individual payment capacity.

3. Short-term increase in safety costs, guidance implies continued strict control of other expenses

In the third quarter, the operating loss was 279 million, slightly better than market expectations. However, as it is the peak season, the loss rate of 30% quarter-on-quarter did not continue to improve. Breaking down the expenditure details, it mainly stems from two aspects.

1) Developer revenue share costs are directly given to developers based on the revenue share of the current period, but in the third quarter, the proportion of new revenue confirmed in the current period is lower than in previous periods, leading to a financial mismatch between income and expenditure; Dolphin mentioned in "Roblox: Unable to Consume the 'Cake' of the Metaverse" that Roblox's method of confirming income and cost expenses is noteworthy, thus from the perspective of "expenses/Bookings," the rate change is more aligned with actual operating conditions.

2) Basic trust and safety costs, this may be related to the previous criticisms of Roblox regarding the repeated occurrence of child safety issues on the platform. The additional investment in the third quarter is estimated to be used for making some safety upgrades. For example, recently Roblox launched features to assist parents in restricting children's access to potentially dangerous content and functions, such as requiring parental permission for children under 13 to use the "chat function."

However, management's profit guidance for Q4 indicates that the Covenant-EBITDA profit margin will be increased from 20% in Q3 to 25%, implying that aside from infrastructure trust and safety costs, the effectiveness of continued control over other expenses, such as slowing down employee recruitment and reducing the weight of equity incentives, is being realized.

Of course, from the comparison of the expense rate of Bookings, the trust and safety costs in the third quarter did not completely drag down performance. In the last quarter's conference call, the company stated that it would continue to strictly control expenditures, and the previously set medium to long-term goal of increasing profit margins by 1% to 3% per year remains unchanged.

The procurement value of equipment and intangible assets in the third quarter is still decreasing in absolute terms, providing space for future optimization of infrastructure costs.

In addition, more than half of the employee expenses are non-cash equity incentive payments, so it appears more favorable for both Adj. EBITDA and cash flow metrics. Since the second quarter of last year, the overall number of employees has continued to increase , resulting in a 20% growth in SBC expenses in Q3 2024. However, this ultimately had little impact on cash flow, and due to a significant increase in subscription revenue during the period, while Capex has been decreasing, more surplus cash was generated. The free cash flow in the third quarter was 218 million, compared to a slight net inflow in the same period last year, resulting in a dramatic year-on-year growth rate of 266%.

Similarly, the adjusted EBITDA metric excluding SBC expenses, when restored to the original calculation method (which means adding net deferred revenue to Adj. EBITDA, i.e., deferred revenue - deferred costs), showed a year-on-year increase of 176% in Covenant Adj. EBITDA for the third quarter, with a profit margin (%Bookings) of 19%, an increase of nearly 1000 bps year-on-year. Coupled with the company's profit guidance for 2024, this implies an increase of 1100 bps in Covenant Adj. EBITDA, exceeding the previous management's optimization pace communicated to investors (100 bps to 300 bps per year).

At the same time, due to the gradual optimization of SBC, the equity dilution ratio has also gradually decreased to 2.7% in the third quarter.

Dolphin Investment Research "Roblox" Historical Articles:

Financial Report

August 2, 2024, Q2 2024 Conference Call Summary: Roblox: Cautious Guidance, Just to Leave Room (Q2 2024 Conference Call)

August 2, 2024, Q2 2024 Financial Report Review: Roblox: Guidance Raised, Why is the Market Still Unsatisfied?

May 11, 2024 Q1 2024 Conference Call Summary: Roblox: Revenue Guidance Downgrade Due to Caution, Growth Rate Recovered in Early April (Q1 2024 Conference Call Summary)

May 10, 2024 Q1 2024 Financial Report Review: Roblox: Key Metrics Fall Short, Growth Concerns Arise Again

February 8, 2024 Q4 2023 Conference Call Summary: Roblox: Positive Growth Guidance Driven by Strong User Data Performance (Q4 2023 Conference Call)

February 8, 2024 Q4 2023 Financial Report Review: Roblox: No Desire to Miss Out on Growth or Loss Reduction

November 8, 2023 Q3 2023 Financial Report Review: Roblox: Seizing the Peak Season to "Clear Previous Shame"

August 11, 2023 Q2 2023 Conference Call Summary: Roblox: User Experience First, Maintaining Ecological Expansion (Q2 2023 Conference Call Summary)

August 9, 2023 Q2 2023 Financial Report Review: Roblox: Profit Shock, Breaking Through High Valuation

In-depth

July 18, 2023: Is It Worth Betting on the Metaverse with Roblox?

July 13, 2023: Roblox: Unable to Digest the "Big Pie" of the Metaverse

Risk Disclosure and Statement of this Article: Dolphin Investment Research Disclaimer and General Disclosure