Roblox (NYSE:RBLX), a leading 3D experiences developer, saw its shares plummet more than 20% after reporting first-quarter earnings two weeks ago. The company is facing short-term headwinds, which are masking its long-term growth potential. Despite delivering a decent Q1 performance, Roblox lowered its guidance for full-year bookings growth from around 20% to 15%, forcing analysts to slash their expectations for earnings growth this year.

Although RBLX stock is likely to recover from this sharp decline, I am neutral on Roblox, as I believe the company still has to prove its ability to convert top-line growth into profits.

Roblox Is Investing in Growth

Roblox is investing in several growth areas to maintain the stellar growth rates it has posted in recent years. For context, since 2019, the total revenue of the company has grown by double or triple digits annually.

First, to reach a wider audience and enhance discovery within the platform, Roblox recently introduced a new feature on the homepage named Top Picks. As revealed during the first-quarter earnings call, this feature has enabled creators to purchase traffic strategically and increase their visibility on the platform. Roblox also revealed that the company is investing in machine learning algorithms and AI to optimize the Top Picks category to promote more visibility.

Second, the company is expanding to the physical world by planning to host a few live events every year to drive brand visibility, connect with existing Roblox users, and target potential customers. The idea behind these live events is to offer a curated content experience to showcase the potential of the platform. One of these live events was concluded recently during Easter, named Hunt, and the event was a massive success, according to management.

Third, Roblox is trying to woe creators by offering them a larger revenue share, which may lead to long-lasting competitive advantages. For instance, creators will now receive 100% of the net proceeds from the sale of tools and plugins. Introducing dynamic pricing across the platform is likely to encourage creators to focus on developing high-quality experiences within the Roblox platform, which, in turn, will keep subscribers engaged.

Fourth, following the footsteps of many other online content platforms, such as Netflix (NASDAQ:NFLX), Roblox is planning to sell advertisements on its platform. The company ended the quarter with more than 77 million active users after adding six million net new users during the quarter. In addition to partnering with retail giants such as Walmart (NYSE:WMT), Roblox is rolling out self-serve video advertisements as well.

Roblox will have to invest aggressively to create a data-rich platform for advertisers to draw insights from their marketing campaigns, which will play a crucial part in attracting high-value advertisers to the platform. Management, during the Q1 earnings call, confirmed that the company is investing in these capabilities. In the long run, advertising should emerge as a major source of revenue for Roblox, leading to higher average revenue per user.

Roblox Is Facing a Few Headwinds

Not everything is positive for Roblox. Active user growth decelerated from 22% in the previous quarter to 17% in Q1. This deceleration primarily resulted from performance issues on low-end devices and sub-par content discovery. As highlighted in the previous segment, management is working on optimizing the platform to address these challenges. Although the outcome of these efforts will only come to light in the coming quarters, early data from the Top Picks rollout gives hope.

Monetization remains the next big challenge faced by the company. Despite having access to a large user base, Roblox has failed at monetization. To increase bookings per user, Roblox is investing in improving the performance of the platform and enhancing content discovery. The expected growth of the advertising business may prove to be a saving grace for the company here, but investors will have to wait for a few quarters to assess how advertisers and users are responding to this new offering.

The lack of profitability despite stellar revenue growth is also another concern. Roblox reported a net loss of $1.1 billion for 2023 on the back of a net loss of $924 million in 2022. The cash-flow profile of the company has improved, and the company reported free cash flows of $191 million in Q1 compared to just $82 million in the corresponding quarter previous year.

Although this is encouraging, the lack of GAAP profitability is likely to keep its stock volatile in the market, especially in the absence of a catalyst to suggest this will change in the foreseeable future.

Is Roblox Stock a Buy, According to Analysts?

After digesting the Q1 earnings and observing the 22% decline in stock price the following day, research firm MoffettNathanson upgraded Roblox from a Sell to a Hold, citing that the recent weakness in stock price has made the company more attractive.

Meanwhile, Piper Sandler analyst Thomas Champion slashed his Roblox price target from $56 to $40 after the earnings report, citing the platform’s weakening user engagement. BMO (NYSE:BMO) Capital analyst Brian Pitz took a different stance after the earnings report and maintained his $57 price target for Roblox, mentioning the company’s proactive steps to mitigate the challenges identified by both the market and the company management.

Overall, based on the ratings of 20 Wall Street analysts, RBLX earns a Moderate Buy consensus rating. The average RBLX stock price target is $42.16, which implies upside of 27.4% from the current market price.

The Takeaway: Roblox Can Grow, But Not All Is Perfect

The market sell-off following Q1 earnings has created a margin of safety to invest in Roblox compared to the average price target of Wall Street analysts. The company has a lot of room to grow and is aggressively investing to capture these opportunities. However, the lack of profitability, even after years of exponential revenue growth, raises questions about the company’s potential to grow earnings sustainably in the long run.

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