Another listing, another soaring stock price. Roblox’s New York Stock Exchange direct listing kicked off at a $42 billion valuation on Wednesday, up 43% from a funding round in January. Like so many technology-flavoured companies that have gone public either in initial public offerings or via special-purpose acquisition companies, Roblox loses money on an accounting basis. But unusually, it boasts positive free cash flow – more than $400 million of it in 2020.
That’s a function of its hybrid nature. It makes software for other people to develop games and the like. Roblox invests in its infrastructure, but it’s the community that creates the games themselves. The variety brings in more users than Roblox could on its own. Yet they buy the company’s virtual currency, Robux, to spend in games, and they use its platform as a social network.
The positive cash flow provides a sharp contrast with, say, a pre-revenue electric-vehicle startup like Lucid Motors that plans to invest hundreds of millions of dollars before it will earn meaningful revenue, or even an established ride-sharing app like, say, Lyft which is still burning cash.
It’s one reason Roblox could choose the option of a direct listing, which in its tried and tested form doesn’t raise new cash. It also makes the company a plaything for a discounted cash flow valuation.
How might investors justify Roblox’s current value? Assume bookings – the total cash coming in, essentially – increase 50% a year from 2021’s estimated level through 2025, 25% through 2030 and 10% through 2040, then remain flat thereafter. Suppose free cash flow is 15% of bookings, a bit better than the 2018-20 average, and apply a discount rate of 10%. That brings a present value approaching $50 billion.
At a 15% discount rate, perhaps a more appropriate figure given the risk of achieving such rapid growth, the present value drops by half. That shows why DCFs are a blunt instrument for high-growth businesses – and also why risk-on and risk-off sentiment in markets, akin to investors applying lower and higher discount rates, is critical to companies like Roblox.
With support on Reddit forums like those that powered GameStop shares to improbable heights in January, Roblox’s early market capitalisation may have gotten ahead of itself. Still, its cash flow is a feature investors can justifiably value at a premium.