Roblox goes public via direct listing

There were two prominent features in 2020 that are likely to continue their momentum into the new year: robust equity markets and the rapid growth of stay-at-home businesses. Video game company, Roblox Corporation, aims to capitalise on both these trends in their direct listing on the New York Stock Exchange scheduled for March 2021. This follows Roblox’s shelved plans to go public via IPO in December last year, as well as a round of Series H funding which raised over $500 million USD and valued Roblox stock at $45 per share. Having attained a total valuation of $29.5 billion, the planned direct listing has caught the attention of investors owing to the company’s encouraging fundamentals. [1]

Company Overview

Founded in 2004, Roblox Corporation is the developer of the popular online game platform Roblox, which was released in 2006. The premise of the game is that users can program their own games and also play games created by other users. Games are created using the company’s proprietary engine, Roblox Studio, which is coded under an object-oriented programming system to manipulate the environment of the game. Users do not require coding experience to create their own games and the platform is predominantly directed at children, with 54% of its active users being under the age of 13. [2]

Roblox is able to monetise its platform is by allowing users to buy and sell virtual items using a virtual currency named Robux, which can be purchased using real currency. The percentage of the revenue from in-game purchases is split between the individual developer and Roblox Corporation and is the platform’s primary source of revenue. [3]

As was the case with the wider gaming industry, Roblox heavily benefited from the government measures to combat COVID-19 through national lockdowns and work-from-home mandates. This drastically expanded the consumer base for video game developers. In the case of Roblox, the shutting down of schools proved to be heavily beneficial for the developer’s sales as the hours that children can spend playing video games increased greatly. As a result, the company’s revenue grew 82% in 2020 to $923 million USD, with bookings more than doubling to about $1.9 billion USD. Meanwhile, operating cash flow grew more than five-fold from $99.2 million in 2019 to $524 million in 2020. [4]

That being said, Roblox is still not turning a profit. The company reported a net loss of $253.3 million USD last year, which is a substantial increase from its $71 million USD loss in 2019. The high expenses incurred are a product of infrastructural and R&D investments but are also a result of developers converting Robux back into US dollars, which amounted to a cash payout of $328.7 million in 2020. Meanwhile, the developer’s impressive valuation of $29.5 billion USD represents 30 times its sales, which is above the industry average and conjures fear of a market correction further down the line. However, Roblox’s sustainable business model,  robust growth rates and lack of direct competition have all led investors to believe that its price-to-sales ratio would decrease and that Roblox stock is a reliable investment. [5]

Direct Listing vs IPO

The registered stockholders of Roblox Corporation plan to sell up to 199 million class A shares in its direct listing, with each share being listed at $45 USD. Having emerged from a year of blockbuster IPOs, the developer’s decision to go public via direct listing represents a deviation from the norm. Notable companies that have directly listed shares in the past include Spotify, Slack and Palantir Technologies. [6]

A direct listing allows a company to directly sell its shares onto a stock exchange, as supposed to an IPO which involves the issuance of new shares as mediated by an investment bank. One of the primary benefits of going public via direct listing is the savings made from fees that are paid to investment banks to underwrite IPOs – PwC estimates that the average underwriting fee is 3.5% – 7% of gross IPO proceeds. Traditionally, the tradeoff to being able to avoid underwriting fees would be that companies do not raise new capital as shareholders are simply floating existing shares onto the market. [7]

However, in December 2020, the Securities and Exchange Commission (SEC) changed the rules around direct listings. Companies will now be able to auction new shares along with those held by current shareholders, ultimately allowing the firm to raise cash. This recent rule change has negated the primary drawback of direct listings and has made this method of going public an even more attractive alternative to IPOs. [8]

The management of Roblox claims that its decision to directly list shares was driven by the trading debuts of Airbnb and DoorDash. The stock value of both companies soared beyond expectations following their IPOs, which subsequently casts doubt on the ability of underwriters to accurately determine the right price for shares. [9]

The trading performances of Airbnb and DoorDash reveal issues within the IPO market. With underwriters charging heavy fees for their expertise in pricing shares, it is not encouraging to see a company’s IPO price being dwarfed by its market price after shares begin trading. While certain experts point to the fact that we are currently in a slight “IPO bubble” where investor excitement surrounding an IPO would lead to an inflated share price, the gap between a company’s underwritten IPO value and its actual market value is too wide to justify the costs. [10]

Roblox’s decision to directly list indicates that it is not concerned with raising cash at the moment. After securing its latest round of private funding, the company’s cash and cash equivalents (CCE) surged 197% year-on-year in 2020. Roblox’s relatively high liquidity bodes well with investors, especially under volatile macroeconomic circumstances. [11]

Looking Ahead

Roblox’s move toward Wall Street has several key implications. Its $29.5 billion USD valuation is a testament to the strength of the video gaming industry, which has received a boost from the pandemic. As the average time spent on video games increases, the rapid growth of the gaming market will undoubtedly increase the industry’s presence in equity markets as developers decide to go public to expand operations.

That being said, Roblox recently issued a statement indicating that the company’s rapid growth might slow following the direct listing. The total hours spent on the gaming platform could drop by up to 11% as schools reopen, although the number of daily active users is still expected to grow up to 9%. The company’s CFO, Michael Guthrie, claimed that while the firm is likely to see absolute growth in most core metrics, the rate of growth in 2021 will be significantly below that of 2020. As restrictions ease and stay-at-home businesses record milder revenue growth, the excitement surrounding tech stocks, which has been the story of 2020, may begin to waver. [12]

Roblox’s direct listing also has broader implications for the IPO market. Combined with the rise in popularity of SPACs as an alternative method of accessing public markets, companies are expressing a clear desire to avoid lengthy and costly IPOs going public. This situation can yield two possible outcomes. One, there needs to be a systemic restructuring of IPOs, streamlining the process to increase its desirability for firms. Alternatively, we may begin to see the mainstream status of IPOs flicker as other listings prove to be more cost-effective.