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 aim to capitalise on both of these trends in their direct listing on the New York Stock Exchange scheduled for March 2021. This follows the plans Roblox shelved 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 many potential investors because of the company’s encouraging fundamentals. (1)
Founded in 2004, Roblox Corporation is the developer of the popular online game platform Roblox, which was released in 2006. The premise being that users are able to 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 any 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 by allowing users to buy and sell virtual items using a virtual currency named Robux, users are then able to purchase more of this virtual currency using real currency. The percentage of the revenue from in-game purchases is split between the individual developer and Roblox Corporation and is the primary source of revenue for the platform.(3)
Roblox, along with the rest of the wider gaming industry, heavily benefited from the government measures to combat COVID-19 through national lockdowns and work-from-home mandates. This led to a drastic expansion of the consumer base for video game developers. In the case of Roblox, the shutting down of schools in particular 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)
In spite of this, Roblox is still not turning a profit. The company reported a net loss of $253.3 million USD last year, which is substantially more than 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 remains a reliable investment. (5)
Direct listing vs IPO
The registered stockholders of Roblox Corporation are planning to sell up to 199 million class A shares in its direct listing, each share shall be listed at $45 USD. Having emerged from a year of blockbuster IPOs, the developer’s decision to go public via direct listing is a deviation from the norm. There are notable other companies that have directly listed shares in the past such as Spotify, Slack and Palantir Technologies. (6)
A direct listing allows a company to directly sell its shares onto a stock exchange, as opposed to an IPO which involves an investment bank who will mediate the issuance of new shares. One of the primary benefits of going public via direct listing is that you are not required to pay fees to investment banks to underwrite IPOs – PwC estimates that the average underwriting fee is 3.5% – 7% of gross IPO proceeds. There is generally a tradeoff to being able to avoid underwriting fees which is 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) made changes to the rules concerning direct listings. Companies will now be able to auction new shares along with those held by current shareholders, this ultimately allows the firm to raise cash. This recent rule change has made the idea of going public via direct listings rather than IPOs even more attractive as it has negated what was the primary drawback of direct listings. (8)
The management of Roblox claims that its decision to directly list shares was strongly affected by the trading debuts of Airbnb and DoorDash. The stock value of both companies rapidly soared beyond expectations following their IPOs, which subsequently cast 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. Underwriters charge heavy fees for their expertise in pricing shares; it is not encouraging for companies considering going public via an IPO to see a company’s IPO price being dwarfed by its market price after shares begin trading. While certain experts have defended underwriters by pointing 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 large to justify the costs. (10)
Roblox’s decision to directly list indicates that raising cash is not a concern for it 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)
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 been boosted as a result of 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 on equity markets alongside developers deciding to go public to expand their operations.
That being said, Roblox recently released a statement indicating that the rapid growth of the company might slow following the direct listing. The total hours spent on the gaming platform could drop by up to 11% as schools reopen, despite this 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 lower than that of 2020. As restrictions ease and stay-at-home businesses record a more mild revenue growth, the excitement surrounding tech stocks has been the story of 2020 but 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 have started to express a clear desire to avoid lengthy and costly IPOs to go public. There are two possible outcomes that this situation can yield. One, there needs to be a systemic restructuring of IPOs in order to streamline the process in the hope of increasing its desirability for firms. Alternatively, we may begin to see the mainstream status of IPOs flicker as other options like direct listings prove to be more cost-effective.