Roblox $RBLX S-1/A Risks Analysis Part 2 and commentary on the lockup period
Final take on the risks/rewards in the Roblox S1 Filing
Hello World!
No lines of code this time. Just finishing my write up on the risks listed on the S-1/A for Roblox. Obviously the IPO hype train is running full speed ahead after the Doordash and C3.AI IPOs blew the doors off the market (even Pubmatic had a great first day). Will the momentum last in time for Roblox to see a surge? We will find out next week.
For those of you who didn’t see Part 1, here is a link. However I’ll give you the cliff notes version. After analyzing the majority of the risks section these were my major takeaways:
6 Risk factors that I found highly important in the first part of the risk factors:
34% of revenue is attributable to the Apple App Store and 18% of revenue to the Google Play Store. 68% of all engagement was via Apple or Android devices. Roblox has to pay 30% of all revenue from these stores to Apple and Google respectively.
Roblox has been targeted in the past by sexual exploiters and pedophiles to either expose children to pornography or attempt to solicit them via chat or in person.
The majority of Roblux users are under the age of 13. This demographic may be less brand loyal and more likely to follow trends, including viral trends, than other demographics. These and other factors may lead users to switch to another entertainment option rapidly.
🚨Roblox states that their user metrics may overstate actual DAUs, hours engaged and ABPDA. 🚨
🚨🚨For the nine months ended September 30, 2020 total chargeback expense to us from ‘unauthorized, fraudulent or illegal use of Robux and other digital goods on our platform, including through unauthorized third-party websites or “cheating” programs’ was approximately 5% of bookings🚨🚨
Developers are not tied or bound to use Roblox platform and can move content if they wish
Of the risk factors to me ones that really stand out are #4 and specifically #5. I think the other ones are very serious but also relatively obvious risk factors. Based on these two factor, I think any valuation models would need to view this as an extremely high risk investment given the company’s own uncertainties as to the legitimacy of bookings and metrics.
After finishing my article I went ahead and took a look at the rest of the risk section. There wasn’t too much worth writing about, but still I’ll give you a quick list and some analysis of the other risks not included in my write up in part 1.
If the security of our platform is compromised, it could compromise our and our developers’, creators’, and users’ proprietary information, disrupt our internal operations and harm public perception of our platform, which could cause our business and reputation to suffer.
This is true of most every internet and technology based company
Operating as a public company will require us to incur substantial costs and will require substantial management attention.
This is true of all public companies
We anticipate that our ongoing efforts related to privacy, data protection, safety, security, and content review will identify additional instances of misuse of user data or other undesirable activity by third parties on our platform.
Management says in part:
Our internal teams also continually monitor and address any unauthorized attempts to access data stored on servers that we own or control or data available to our third-party customer service providers. As a result of these efforts we have discovered and announced, and anticipate that we will continue to discover and announce, additional incidents of misuse of or unauthorized access of user data or other undesirable activity by third parties.
Not gonna lie, that’s somewhat startling language, but it all depends on how bad these breaches have been.
The expansion of our platform outside the United States exposes us to risks inherent in international operations.
True for every business that expands internationally. However it is interesting to see that Roblox has users in 180 countries and developers in 170. 67% of DAUs are from outside of North America as are 32% of bookings.
We may not realize the benefits expected through our China joint venture and the joint venture could have adverse effects on our business.
I’m going to copy in some of this section as I think it’s relevant not only from a downside risk POV but even more so for an investor’s bull thesis
In February 2019, we entered into a joint venture agreement with Songhua River Investment Limited, referred to as Songhua, an affiliate of Tencent Holdings Ltd., a leading internet company in China and one of the world’s largest gaming companies. Under the joint venture agreement, we created Roblox China Holding Corp., referred to as the China JV, of which we own a 51% ownership interest. Through a wholly-owned subsidiary based in Shenzhen named Roblox (Shenzhen) Digital Science and Technology Co., Ltd and branded “Luobu,” the China JV is engaged in the development, localization and licensing to creators of a Chinese version of the Roblox Studio and also develops and oversees relations with local Chinese developers. Tencent currently intends to publish and operate a localized version of the Roblox Platform as a game in China under the name “Luobulesi.” Prior to publishing Luobulesi, Tencent must receive a publishing license from the National Radio and Television Administration of the Chinese government that entails a review of the content of Luobulesi to confirm that such content is not in contravention with the requirements of Chinese law. This publishing license has not yet been issued and we do not have an expected issuance date for this license. Luobu’s focus is on creating opportunities for local Chinese developers to learn Roblox Studio for building and publishing experiences and content.
They then proceed to talk about US/China relations and the trade war…then this….
In addition to market and regulatory factors, any future success of the China JV will require a collaborative effort with Tencent to build and operate Luobu and Luobulesi as together, they will form the exclusive basis for growing our penetration in the China market. In addition, upon the occurrence of certain events, such as a termination of certain of the contractual relationships applicable to Luobu, a change of control of us, or the acquisition of 20% of our outstanding securities by certain specified Chinese industry participants, we may be required to purchase Songhua’s interest in the China JV at a fair market value determined at the time of such purchase. Any future requirement to purchase the interest in China JV from Songhua may have a material adverse effect upon our liquidity, financial condition, and results of operations both as a result of the purchase of such interests and the fact that we would need to identify and partner with an alternative Chinese partner in order for operations to continue in the China market.
I’m sure many of you are familiar with Tencent. That’s a pretty big ally to have in your corner if you are in the gaming market in Asia.
Our results of operations, which are reported in U.S. dollars, could be adversely affected if currency exchange rates fluctuate substantially in the future.
We plan to continue to make acquisitions and investments in other companies, which could require significant management attention, disrupt our business, dilute our stockholders, and significantly harm our business.
This interested me
For example, in 2020 we acquired Ceebr Limited, a company that operated a platform that teaches children age 6-13 to design, program, and play their own games.
I think part of the bull thesis on this company is that they can potentially revolutionize the whole game making process. Obviously an investment like this one in Ceebr kind of lends itself to that thesis.
Our ability to use our net operating loss carryforwards and certain other tax attributes may be limited, each of which could significantly harm our business.
Changes in existing financial accounting standards or practices may harm our results of operations.
Our credit agreement provides our lender with a first-priority lien against substantially all of our assets and contains restrictive covenants which could limit our operational flexibility and otherwise adversely affect our financial condition.
Our estimates or judgments relating to our critical accounting policies may be based on assumptions that change or prove to be incorrect, which could cause our results of operations to fall below expectations of securities analysts and investors, resulting in a decline in the market price of our common stock.
Any legal proceedings or claims against us could be costly and time-consuming to defend and could harm our reputation regardless of the outcome.
Catastrophic events may disrupt our business.
If we are determined to be an “investment company,” it will significantly affect our operational flexibility and our operating results.
The above can be said about most companies
And that’s the end of the Risks Related to Roblox in General
There are also Risks Related to Government Regulations and these are pretty lengthy however many have been covered in the risks related to Roblox in General. They include
Global data privacy
Net neutrality laws
Foreign trade laws
Laws surrounding virtual currencies
Copyright laws / Intellectual Property Risks
Having said all of this, how would I summarize the risks of investing in Roblox?
This is definitely a high risk / high reward investment. Because their business is so dependent on younger children and cyberspace it creates a significantly higher amount of risk than a normal tech company. If you invest in them, I could easily see any number of situations where your investment loses the majority of it’s value. However this is a company that has a truly innovative approach to game development. Seeing a giant like Tencent in a joint venture with Roblox leaves me with some reassurances about the value proposition of Roblox. There is also the risk that this company is regresses post pandemic to a more normalized growth rate. At least the lock up period does give you some protection in this respect:
Lock Up Period! (NEW SECTION)
I’m going to start adding this to any S-1 analysis because it is a very important part of analyzing an IPO investment.
For those who don’t know — the lock up period is what prevents insiders from selling shares right after IPO, thus providing you with a measure of reassurance that they don’t take your money and run on day one. This is Roblox’s lock up period language:
All of our directors and executive officers and certain holders of our Class A common stock and securities exercisable for or convertible into our Class A common stock are subject to lock-up agreements that restrict their ability to transfer such securities for a period ending on the earlier of (i) 180 days following the date of this prospectus and (ii) the opening of trading on the third trading day immediately following the public announcement of our full earnings for the second quarterly period ending after the date of this prospectus (such period, the “lock-up period”) and subject to certain exceptions, without the prior written consent of Goldman Sachs & Co. LLC; provided that beginning at the opening of trading on the third trading day after we announce full earnings for the quarter ending December 31, 2020, up to 30% of the shares of our capital stock and vested securities convertible into or exchangeable for our capital stock held by such holders may be sold, unless the Company, in its sole discretion, determines not to release such shares at that time.
So you get two quarters before they can sell. I’d say this also eases some of the fear around whether the company is a pandemic one hit wonder. If you are concerned that post pandemic usage will decrease, the second quarterly report and more importantly bookings / guidance should give you some things to read into. You’ll have 3 days afterwards to beat insiders to the door.
So this is the end of my risks analysis. Hope you’ve enjoyed/benefitted from this. Be on the lookout for another S-1/A from Roblox any day now with finalized valuation and offering price. I’m not going to do more analysis until I have those details. Hopefully this research helps you. If it does than please subscribe/share.
Just a final note to my subscribers. At some point I will be moving this blog off Substack and to another format. Here’s why:
Eventually, I would like to convert this newsletter into a paid model. The model will be one that is very different from most newsletter and research blogs. Most of them charge upwards of $100-200 per year (or $10-20 prorated on a monthly basis). My goal is to be able to grow this to a scale where I can make a reasonable side income by charging just $1 per month (and I may even make it a voluntary $1 per month). Unfortunately the minimum Substack will allow writers to charge is $5 per month or $50 annually.
While I’m convinced this information can be worth far more than $50 for an individual, my heart’s desire is to create something that is affordable for everyone yet that also incentivizes me to pour my time into research on companies that I might not really want to invest in. With enough scale I can do that, but only if I have an infrastructure that permits it.
For now, I’m just going to continue to focus on growing the subscribers on my Substack while I identify a better medium for my work. When that day comes, I will let everyone know via Substack and Twitter. Hopefully when that happens you will follow me because you continue to find value in my work wherever it may land.
— The Narrative