T.W.I.T. #8: Factor Rotation and Digging Into Roblox

Welcome to T.W.I.T #8, where we review the month to week 48 2020, and dig into Roblox after their S1 filing.

Performance Review

The S&P500 was up 11% for the month, ending up 13% YTD. The Technology sector (XLK) rose 11%. Semiconductors outperformed with the SMH up 18%, whilst Software (IGV) underperformed at 10%. Multiple positive vaccine news this month benefitted riskier factors and brought about sharp reversals, especially in the period from November 3 rdto November 9 th, as we will see below. From a size and style standpoint, Small Cap Value (IWN/SPY) was up 10% in November, 16% quarter-to-date, whilst Large Cap Growth (IVW/SPY) is down 1.6%/2.2% for the same periods.

Koyfin MTD Factor Map

November 9th2020

Markets welcomed the Pfizer/BioNTech’s vaccine news, after a tense week of US elections. That day was significant as Value significantly outperformed Momentum. The Momentum factor tends to perform poorly around turning points in market cycles; it is highly likely we will look back on November 9 thas one of these turning points. The charts from Fintwits below show the severity of movements.

Historic Factor Moves Yesterday!

Momentum with a 15.5-σ move down and value with a 12.75-σ move up!! The biggest ever.

For reference in the chart below, the orange line is 2-σ and the purple line encapsulates 95% of points. Last year’s big moves are called out for perspective. pic.twitter.com/0u6wWfNJPm

- Josh Russell (@wjruss84) November 10, 2020

According to Goldman Sachs, “the ~16% reversal in our l/s S&P 500 Momentum factor (GSMEFMOM) was the largest one-day decline in the factor’s history since 1980 — and it wasn’t even close (-10% in April 2009 was the prior).”

- Thunderdome Capital (@MadThunderdome) November 9, 2020

Roblox: What is it and where is it going?

This month Roblox filed for IPO. This is important as I believe Roblox is the first massive User- Generated Content gaming platform to become public as an independent entity. It gives a glimpse into the future of time spent on the internet.

What Roblox is: A virtual place where people go to play and create with friends. The platform counts 31m DAUs and 7m developers. The virtual places created and played are called “Experiences”. In the 9m to Sept-20, there were 18m experiences on the Roblox platform. The average DAUs spent 2.6h a day on Roblox.

How they make money. Roblox manages a virtual currency, the Robux, that can be used within the platform. Roblox controls the conversion rate for Robux into USD, which stood at $0.0035 as of September 30, 2020. Users can purchase Robux in two ways, as one-time purchases or via Roblox Premium, a subscription service that is billed monthly and includes discounted Robux, access to exclusive in-experience benefits, exclusive and discounted marketplace items, and the ability to buy, sell and trade certain Avatar items. Roblox accepts payments through app stores, credit cards, and prepaid cards. The average price for a Robux for the nine months ended September 30, 2020 was $0.01. Users can also use Robux to purchase items such as clothing accessories and simulated gestures, or emotes, from the Avatar Marketplace. Roblox retains a portion of every Robux transaction and distributes the rest to developers and creators. All Robux earned by developers and creators are deposited into their virtual accounts, and can be converted into USD.

The company recognizes revenue from users ratably over the average lifetime of a paying user, which for the years ending December 31, 2018 and 2019 was 23 months.

How Developers make money. There are currently four ways for them to earn money on the platform. First, through the sale of access and enhancement to their experiences. Second, through engagement-based payouts — called Premium Payouts -, where the platform rewards developers for the amount of time Premium subscribers spend in their experiences. Third, through the sale of content and tools between developers. Fourth, through the sale of items in the Avatar marketplace. The economics from a developer standpoint vary. They receive 30% of Robux spent on the Avatar Marketplace, but 70% of the Robux spent within their experiences, and 70% for items that appear in the Studio Marketplace. Clearly, the incentives are titled towards improving the community, via engagement within an experience, or via tools available to other developers.

Distribution channels. Roblox depends heavily on the Apple App Store and the Google Play store. The S1 quotes: “For the nine months ended September 30, 2020, 34% and 18% of our revenue were generated on Apple App Store and Google Play Store, respectively. For operations through both the Apple App Store and Google Play Store, we pay 30% of any money paid by users to purchase Robux to Apple or Google, as applicable.”

Cost dependencies. The biggest area of spend is in “Payment processing and other fees”, which accounts for 26% of bookings YTD; this cost item scales relatively linearly with bookings and is paid to the distribution channels and payment processors. Then comes developer earnings, 17% of bookings YTD. Developer earnings are costs related to developers’ and creators’ accumulation of earned Robux and the subsequent exchange of those Robux for real-world currency. They too scale linearly with bookings, but the mix of Avatar vs other will influence it, as the economics are quite different. The other main costs can be, and have been so far, amortised with scale. They consist of compensation and benefits; costs related to salaries and benefits provided to employees as well as agents working on Roblox trust & safety teams. As of September 30, 2020 Roblox employed over 830 full time employees, of which approximately 80% were engineering and product personnel, a ratio that they have maintained over time and intend to continue to maintain.The 1'700 trust & safety agents across the globe are not employees. The final major cost item is linked to the infrastructure, as Roblox operates data centers and online points of presence, or PoPs, around the world which include over 18,000 servers as of September 30, 2020. They also use AWS, and have a contract running until November 2021.

Other dependencies. Another key element of the platform is the Lua scripting language that underpins the creation of virtual worlds, virtual goods and services. Roblox has made the Lua scripting language available without charge, and benefits from the development of an active community of Lua programmers like those which have emerged for other software platforms. If developers were to find the Lua scripting language or the platform complicated or inferior to other scripting languages, the community would become less active. Note that they have developed their own gaming engine, so from that standpoint, they do not need to pay anything to Unity nor Unreal (EPIC).

The user base is young. This may be the most distinguishing part of the platform. 54% of users are under 12, which makes it even more important to moderate content. It creates an interesting funnel for developing cohorts with increasing purchasing power, as well as familiarity with its development tools. That creates a lot of stickiness.

China. Roblox is not yet present in China, but partnered with Tencent. In February 2019, they entered into a joint venture agreement with an affiliate of Tencent. Under the joint venture agreement, they created Roblox China Holding Corp., of which they own a 51% ownership interest. Through a wholly-owned subsidiary based in Shenzhen 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 intends to publish and operate a localized version of the Roblox Platform as a game in China under the name “Luobulesi.” The licences have not yet been granted, but that should come.

What comes next?

Grow User Base. Roblox has currently 31.1m DAUs, with an estimated 150–180m of MAUs. That is a pretty large number; Fortnite peaked at 250m, Minecraft sold 200m units, Xbox live has less than 100m. Compared to existing social networks though, Roblox remains small. Snap for instance had 238m DAUs as of Oct-20. The platform could expand geographically (Asia) and into new demographics (Female). Intrinsically, there is nothing that prevents Roblox from attracting more female gamers, since it is UGC.

Improve the technology. The graphics on Roblox remain simplistic, and it seems important for their future that they upgrade them. Another key area of improvement we could see is in the developer analytics side, to improve user monetization and retention, making the platform more appealing to developers. This will be very important to attract developers going forward. Finally, there are no ads on Roblox; but the mobile app economy leaves on ads. One possible way for Roblox to increase revenue and improve developer economics would be to develop an ad network.

Acquisitions. This year, they acquired Ceebr Limited, a company that operated a platform that teaches children age 6–13 to design, program, and play their own games. Like other game distribution platforms (Tencent, Microsoft), we should expect them to buy some of their best developers to control the content release schedule and reduce dependencies on the major developers.

That’s all for T.W.I.T. #8, Week 48 2020.

Originally published at https://kinesisinvesting.com on November 29, 2020.