Roblox Is a Trap at This Time

Roblox's declining user metrics point to tough times ahead

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Jul 19, 2022
Summary
  • Roblox's stock has fallen off a cliff as of late.
  • User metrics are declining with every passing quarter.
  • It's a tough road ahead as Roblox faces multiple headwinds.
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Shares of 3D game creation platform maker Roblox (RBLX, Financial) shot up impressively during the beginning of the Covid-19 pandemic. Its business experienced parabolic growth with its users staying indoors more often and looking for ways to entertain themselves online. It became one of the top "pandemic growth stocks" last year.

However, the situation has changed now that the worst of the pandemic is over and people are going out again. Thus, Roblox's stock has taken quite a beating. Its stock has shed more than 45% of its value in the past 12 months, and the future doesn't look too bright either. Growth has normalized, and it now expects a much tougher road ahead without the previous popularity boost. Thus, I believe it presents a risky investment option, even for those betting big on the metaverse.

Rocky road ahead

Roblox is essentially an online platform that enables its creators to create, publish and operate 3D virtual experiences, including video games and related virtual worlds. The demand for its offerings rose remarkably in 2020. This can be partially attributed to the pandemic, which led to rapid growth in its revenues and userbase. In the second quarter of 2020, quarterly bookings shot up 229% on a year-over-year basis to $494 million. Moreover, daily active users (DAUs) increased by an incredible 95% from the prior-year period to 33.4 million.

However, these numbers are in stark contrast to the company's metrics in its first quarter of this year. Naturally, it had a tall order in lapping prior-year comps, and ended up with a 3% drop in sales year-over-year. Additionally, DAUs grew 28% to 54.1 million, while hours engaged increased 22% from the same period last year to $11.8 billion.

Perhaps more importantly, average bookings per DAU declined sharply by 25% to $11.67 during the quarter. Hence, it's clear users aren't spending as much on the platform as they did in the quarters prior. Considering the tough comparisons from last years, it's hard to imagine a scenario where Roblox will post strong results in the upcoming quarters. I don't think we'll see a strong summer, as kids will probably be travelling with their families and playing outside more often rather than spending time on Roblox's platform.

Unreasonable valuation

As a popular "pandemic stock," the stock's valuation was driven by immense speculation in the past couple of years. Roblox was trading at a forward enterprise-value-to-sales ratio of more than 24 in November last year, when the metaverse concept had just blown up. The stock still trades at 11 times its trailing 12-month sales, and considering its trajectory, it is likely to lose out more of its value in the coming months.

Moreover, despite posting record sales last year, the company continued to be a loss-making enterprise. Its operating margin came in at -26%, which turned investors awry. Naturally, investors became more focused on the fundamentals when the market froth cleared out. Roblox remained an unprofitable business despite the surge in its top-line growth. The tailwinds have faded away, and things will get more complicated from here on.

Takeaway

Roblox was a massive hit during the early days of the pandemic. Its platform saw massive growth in user base, but even so, its profitability metrics remained in the red. Its stock surged to new heights but has cooled off significantly since then. The future is uncertain, considering how the pandemic is in the rear-view mirror, making Roblox stock a tough stock to get a read on.

That's not to say it will always be a bad investment. Its business model of selling virtual currency and its advertising and sponsored search businesses remain highly attractive. However, it needs to mount a major comeback if it wishes to change its fortunes any time soon. It also needs to find a way to become profitable. At this point, such a scenario seems highly unlikely, and thus I believe it's best to steer clear of Roblox for now.

Disclosures

I/we have no positions in any stocks mentioned, and have no plans to buy any new positions in the stocks mentioned within the next 72 hours. Click for the complete disclosure