Roblox Is Heading Downhill Fast - Stockxpo - Grow more with Investors, Traders, Analyst and Research

Roblox Is Heading Downhill Fast

There is a pattern in the gaming industry that gamers are painfully familiar with. A beloved game starts out strong and may even remain so for years, but eventually, revenue begins to fall off, leaving the company that made the game searching desperately for new ways to bring cash flows back to their former glory.

Almost invariably, they land upon third-party advertising as the solution. For a price, they provide a platform for other companies to advertise their products within the game, whether it be through logos, pop-ups, a special event partnership, optional videos to gain extra in-game rewards or, in the worst case, mandatory videos that players cannot avoid.

Make no mistake, while this is annoying for players, it is an even worse sign for the company itself. The company may brag to its shareholders it is increasing player monetization, and that may indeed be the result it gets at first. However, the more revenue a gaming company derives from ads compared to a game, the more it transforms itself into an advertising company with a platform that depends on a (most likely declining) user base. An ad-saturated model does not lend itself easily to user growth, as users tend to burn out quickly when their attention is pulled in too many different directions.

That appears to be exactly what is happening with Roblox Corp. (

RBLX, Financial), a beloved gaming platform where users can build their own games and play games made by others. As its popularity wanes and revenue declines, it has latched onto advertising to pad its numbers. The announcement caused shares of the company to spike more than 7% on Friday, but I believe that optimism might be misplaced.

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Roblox stakes its future on advertising

In its annual developer conference on Friday, Roblox announced its intention to debut ads next year. Prior to the official rollout, it plans to test ads with certain developers and brands.

According to Manuel Bronstein, Roblox’s chief product officer, the ads being tested are in a form called “portals,” which are immersive ads where users can interact with the brand and be transported to the company’s virtual Roblox community. There is not yet a set format for how the ads will appear, but they could resemble digital billboards or something similar.

The company hopes that advertising revenue will be able to make up for a flagging top line and an even more sharply declining bottom line. As shown in the below chart, the company’s net loss has only grown steeper as the Roblox platform has become more popular. In the second quarter, even as daily active users climbed 21% from the prior-year quarter, the bottom line dropped 25%. Moreover, while daily active users were up year over year, they were down from the record of 54.1 billion in the first quarter.

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There is nothing inherently bad about a company only achieving profitability due to advertising, but in order for this to be a sustainably growing business model, the platform through which the company offers the ads needs to achieve the kind of long-term growth that can bring in top-dollar spending. Alphabet’s (

GOOG, Financial)(GOOGL, Financial) Google is a great example of this, as is Amazon (AMZN, Financial).

That is why advertising is a tough market to stay on top of. Any initial success may soon be stymied if Roblox itself cannot consistently record more users, more play time and higher profits. Even Meta Platforms’ (

META, Financial) Facebook has seen its advertising revenue hurt by a combination of declining popularity and Apple’s (AAPL, Financial) updated privacy policies.

While the general economic slowdown is causing many companies to slash advertising budgets, that is more of a short-term industry concern, though it does mean Roblox will be entering this market in a time of softness.

Little hope for growth drivers to appear

It is possible not all is lost for Roblox just yet. If it can continue growing its user base, it may be able to hold a spot of value among advertisers. However, what are the chances that growth drivers will appear for the company?

For starters, the company’s operating costs are out of control, which means it is starting from one step behind even if it can make a breakthrough on the growth front. It is one thing to be unprofitable due to investments in new products and expansion, but it is another thing entirely to have costs be too high due to structural inefficiencies that have no clear solution, such as payment processing, personnel expenses, stock-based compensation, marketing, sales and data protection.

In its 10-Q for the second quarter of 2022, the company warned investors it is unlikely to turn profitable any time soon:

“We have incurred net losses since our inception, and we expect to continue to incur net losses in the near future… We also expect our operating expenses to increase significantly in future periods, and if our DAU growth does not increase to offset these anticipated increases in our operating expenses, our business, results of operations, and financial condition will be harmed, and we may not be able to achieve or maintain profitability.”

Its high operating expenses tie into the second main reason why the company will likely find further growth difficult: at this stage in its product lifetime, further growth of Roblox’s user base will need sales and marketing expenditure as a prerequisite. Marketing campaigns will increasingly reach people who have already been exposed to Roblox but decided against downloading it in the past.

Two areas where Roblox might still be able to achieve growth are among older audiences (most of Roblox’s current users are children) and internationally. However, if the company’s existing operating expenses are anything to go by, it might be a better idea to make sure the advertising model can reduce the cash burn before proceeding. Catering more to older audiences means investing more in separating adult content from children’s content, while international users are likely to spend less money on the platform, both of which could further reduce margins.

My take

When I look at Roblox, I see a company in decline. While users may continue to enjoy the games on the platform for years to come, that does not necessarily mean user numbers will grow, or that shareholders will benefit.

The business model is unprofitable from an operational standpoint and will likely continue to be so by the company’s own admission, a situation that is likely to be exacerbated by any growth efforts except perhaps advertising.

Advertisers will want an increasing user base with users who are likely to convert to buyers of their own products, but Roblox say daily active users decline in the second quarter, so the company has some ground to make up. It remains to be seen whether the platform will become valuable enough to advertisers to make up for its unprofitable business model.

Additionally, it is a well-known trend in the gaming industry that a previously ad-free game turning to advertising is a sign of an ongoing or impending decline in the number of users or revenue per user. In this case, I think it is more accurate to compare Roblox to games than it is to compare it to platforms, as platforms such as gaming consoles and smartphones can rely on a steady stream of new games from developers for their bread and butter. While users are not guaranteed to decline because of this, it does send a strong negative signal.

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