Roblox Q1 earnings preview: dual challenges of declining profits and slowing user growth

Roblox is headquartered in San Mateo, California, USA, and focuses on providing online gaming services. The company primarily relies on cash inflows from user consumption through the virtual currency (Robux) within the platform and in-platform advertising. Therefore, it is important to pay close attention to the growth in Roblox's user numbers and the prospects for the company's advertising business.

While players from around the world can access Roblox's gaming platform online, there are significant differences in the business volume of the company across different markets, making it crucial to monitor the business development in each sub-market for a comprehensive analysis of the company.

By region, the company's operations are mainly distributed in North America, Europe, and the Asia-Pacific region, with the North American market accounting for over 64% of the company's total revenue, serving as the most important engine for revenue growth.

Chart: Roblox Regional Revenue Composition

According to third-party surveys, there has been a decline in the overall number of global users and the growth of bookings by teenagers on the Roblox platform in the first quarter, potentially due to the fickle nature of teenage consumers and potential competitive pressures from new game releases on platforms such as Steam.

The slowdown in user growth will undoubtedly have a negative impact on Roblox's bookings, further affecting revenue growth. Since Roblox's gaming business has the largest market size in North America, Europe, and Asia-Pacific, we will now analyze user growth in these markets in detail.

Influenced by the favorable performance of the U.S. Consumer Confidence Index in the first quarter, the number of user orders in the North American sub-market is expected to continue to grow. Data shows that the U.S. Michigan Consumer Confidence Index has risen for three consecutive quarters, indicating a positive development in the U.S. consumer industry during the first quarter.

Chart: Michigan Consumer Confidence Index

Due to the favorable development of the U.S. consumer market in the first quarter, we expect an increase in the North American user base. However, considering the competition from the first-quarter update of the American game Fortnite Creative, we anticipate a slowdown in the year-over-year growth rate of user numbers.

At the fourth-quarter earnings call, company executives expressed that in 2024 the company will achieve double-digit user growth in European sub-markets. Also considering that Roblox has fewer competitors in the European local gaming market, we expect user growth to likely meet expectations. According to Bloomberg consensus estimates, the user DAU for the European market in the first quarter is expected to be 20 million, up 16.4% year-over-year, with no significant change sequentially.

According to Bloomberg consensus estimates, the user DAU for the Asia-Pacific market in the first quarter is expected to reach 18 million, up 23.7% year-over-year, and stable sequentially. However, considering factors such as the return to school for teenagers in the Asia-Pacific region in February, we expect a potential slowdown in the growth rate of user DAUs in the region, possibly falling short of expectations.

Overall, despite a strong expected user growth trend in the European market, considering the potential underperformance in user growth rates in the North American and Asian markets and the fact that revenues from these two markets together account for approximately 75% of total revenue, we expect the company's overall user volume growth rate to slow down in the first quarter, affecting the pace of booking growth.

Chart: User DAU Change (Millions)

Chart: Company Total Revenue Trend (Millions of Dollars)

The U.S. video game advertising business has become a nearly $8 billion industry, expected to break through $10 billion by 2025, and Roblox is well-positioned to capture this significant profit opportunity.

Roblox has long been committed to entering the advertising business to drive revenue growth on its platform. Data from Wells Fargo shows that the number of advertising executive positions at Roblox increased significantly in the first quarter, and the amount of video advertising on the platform has grown substantially, suggesting a positive development in Roblox's advertising revenue.

Chart: U.S. Video Game Advertising Revenue

Since Roblox has announced that its video ads will not be shown to users under the age of 13, the company's advertising revenue is largely dependent on Generation Z users aged 13 and above. Considering that many long-time players are on the company's gaming platform and the number of players older than 13 will continue to rise as the existing players age, this means the platform can target ads to more users, thereby generating significant revenue.

During the fourth-quarter earnings call, company executives also said that Roblox will implement measures such as offering Robux for consecutive sign-ins to retain older players, and work to convert users under 13 into long-term platform users to increase platform value. It is expected that the number of users over 13 on the Roblox platform will continue to rise in the first quarter, driving an increase in advertising revenue.

Chart: Roblox User Age Structure (Millions)

In the mid-to-long term, the company announced a partnership with PubMatic in April, planning to monetize by displaying developer-designed 3D-space virtual ads to users on the platform. Immersive video ads are expected to launch around June of this year, at which point various operators will have the opportunity to place ads on Roblox through PubMatic's automated ad buying tools, and Roblox itself will be able to collect a commission from ad placements. We expect this business to potentially become a catalyst for mid-to-long-term performance growth for the company.

Although Roblox's revenue has been on an uptrend, its expected profitability performance is poor, due to the significant gap between expected revenue and operating cash flow. Company executives stated, "Operating expenses will continue to rise in 2024 as we plan to continue to invest in business development, including increased investments in infrastructure, R&D, and acquisitions."

Chart: Roblox Net Profit Margin (%)

Since its IPO, Roblox's profit margin has plummeted to -41%, yet its operating cash flow remains reasonable at about 16%, meaning there is no risk of financial problems. The issue lies in the fact that this profit margin comes from massive stock-based compensation: Roblox is one of the companies with the highest ratio of stock compensation to sales, currently standing at 3% of its market value.

Some investors consider stock-based compensation as a non-cash expense that does not change cash flows, which is unwise, because if the company's market value decreases and it maintains its level of stock-based compensation, then this action will definitely dilute shareholder value. Furthermore, if the company's market value decreases, the rate of dilution could accelerate significantly.

Chart: Roblox Stock-Based Compensation as a Percentage of Revenue and Market Value

Considering the company's potential underperformance in profitability and revenue growth rate, we expect the company's EPS to see a significant decline. According to Bloomberg consensus estimates, the company's EPS is expected to be -$0.54, a year-over-year decrease of 21.6%, and stable sequentially.

Major banks believe that Roblox's revenue will continue to grow in the first quarter and that the company's recent advertising business could become a significant driver of mid-to-long-term growth. Therefore, they remain optimistic about Roblox’s valuation, which is currently at 38.9x.

Since the start of 2024, the company's stock performance has been below the S&P 500 index; moreover, as of April, Roblox's stock has fallen by less than 16%. We believe that the poor performance expectations for the first quarter have not been fully reflected in the stock price fluctuations. Therefore, there is a risk of a further decline in the company's stock price following the earnings release.

(1) Purchase put options for the company. If the stock price falls as expected, the value of the put options will increase, allowing investors to profit by selling the options or exercising them.

(2) If investors have a higher risk tolerance, they can also consider shorting the company's stock. By selling high and buying low in a reverse transaction, they can profit from the price drop. However, this strategy carries significant risk.