After helping send shares of Super Micro Computer lower in August, short-seller Hindenburg Research has set its sights on a new target: Roblox (RBLX -0.80%). It's not the first time the company has been the subject of a short report as the Bear Cave newsletter also covered the company a few years ago.
Similar to the Bear Cave report, part of Hindenburg's accusations revolve around the platform being unsafe for children, who tend to be the company's largest user demographic. In response to Hindenburg's claims, Roblox pointed to the proactive and preventative safety measures it has in place.
Hindenburg also accused Roblox of inflating user numbers and engagement hours. Roblox pointed to its strong bookings growth and operating cash flow in response.
Hindenburg's claims may be worrisome, but its goal in releasing the short report is to drive Roblox stock lower. It can be hard to disentangle a short seller's financial motivations from the truth of its claims. However, there are two issues facing the company that investors should consider before buying Roblox stock on the dip.
Infrastructure and trust & safety spending
As part of its business hosting a virtual world, Roblox needs to spend a lot of money on the technology needed to keep its platform up and running, as well as the safety of its user base.
Roblox readily admits it has a very young-skewing user base for its virtual world and games. Last quarter, it estimated that among its daily active users (DAU), nearly 41% of them were under the age of 13. That's actually down from two years ago, when that group made up more than 46% of its user base, as older users have been growing at a faster pace.
Through the first six months of 2024, the company spent $448.0 million under the expense line of "infrastructure and trust & safety," up about 3% year over year. While the company doesn't break down this spending in detail, management noted that "moderation and customer support related costs" increased $24.0 million in 2023.
As a result of such expenses, Roblox grapples with structurally lower gross margins than you would normally expect for a gaming platform company. Factoring infrastructure and trust & safety expenses, costs of revenue, and developer exchange fees into a gross margin for Roblox (the company does not report this metric on its own), its Q2 gross margin was just under 30%. For comparison, Electronic Arts' gross margin last quarter was over 84%, while for Take-Two Interactive, it was nearly 58%.
Roblox hopes to continue to improve that number as revenue grows while also turning to artificial intelligence (AI) solutions to help reduce costs. For example, the company said that with the help of AI tools, it was able to reduce moderation and customer support costs $9.9 million in the first half of 2024.
Image source: Getty Images.
High stock-based compensation
Roblox likes to point to its adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) and operating cash flow numbers to highlight the health of its business. However, those metrics exclude the significant amount of stock-based compensation the company is paying out to employees.
And make no mistake, this is a real expense and one that continues to grow. Through the first half of 2024, stock-based compensation rose 24% year over year to a whopping $492.4 million.
That has contributed to substantial shareholder dilution. Since 2021, the company's share count has risen 21%, or more than 112 million shares.
Data by YCharts.
Stay on the sidelines
While investors may be tempted to buy the dip in Roblox stock, I'd stay on the sidelines. Ignoring Hindenburg's claims, the fact of the matter is Roblox is a structurally lower-margin business than other gaming or platform companies, and part of that is due to its need to spend on platform safety for younger users. At the same time, its high levels of stock-based compensation directly hurt the returns of shareholders.
The cash flow and adjusted EBITDA numbers the company highlights are not fully representatives measures of the company's financial progress. The road to GAAP profitability will be very difficult when taking into consideration its stock-based compensation and the other expenses unique to its business.
