Roblox's base rate for success 'is not tremendous': Analyst

MoffettNathanson Research Analyst Clay Griffin joins Yahoo Finance to discuss Roblox, which is seeing its shares rise after the research firm initiated coverage at Underperform.

Video Transcript

RACHELLE AKUFFO: All right, we're shifting gears to shares of Roblox currently trading at $36.41 a share and ended the day up about 1 and 1/2% there. But that's after MoffettNathanson initiated research coverage on the gaming platform with an underperform rating and a $19 per share price target.

Well, Clay Griffin, research analyst at MoffettNathanson, a division of SVB Securities, LLC, joins us now to discuss his bearish calls. As we see, quite a difference between where are we seeing the stock ending today and the price target that you have. What are you assessing in the overall business at Roblox?

CLAY GRIFFIN: Well, look, our call is more of a longer term view and one that is trying to take today's price and discern what the market is expecting for this company to be in three or four years. So it's not a trading call by any means. It's more of a long-term kind of definitional call about what this company is and what we think it can be in several years' time because on any basis, this company clearly is being valued off of a future state, not in any kind of near-term metrics or numbers.

And so, look, our view is that despite the move over the last, let's call it year, that there's still quite a bit of expectations that are embedded in the stock price here. And so we really try to look at what's a realistic addressable market for this business. Is it kids? Is it something more? Is it games? We feel pretty compelled. It's actually very much is a games platform. And as such, we need to think about it in the lens of it versus other games and other markets for interactive entertainment.

So when we do that, we think that because profitability is such-- is so far down the road, we're looking at an environment with cost of capital increasing across the board with interest rates, potential of a recession, and what that might mean for near-term monetization. We just feel like the risk-reward is really skewed to the downside for Roblox.

RACHELLE AKUFFO: And obviously, expectations being the key word in this. Still waiting for a lot of this sort of mini metaverse to materialize. But you've said that we're just not sure Roblox's reality will be as grand as its vision. And in a market looking for less evangelism and more meat on the bone, there's plenty of room for the market to lose confidence. So is this a case of not yet, or never going to happen, or somewhere in between?

CLAY GRIFFIN: Somewhere in between. Look, I think-- we see plenty of healthy growth for Roblox. The problem is that the price almost requires extraordinary growth. And so we think that the market that they're trying to address is actually more constrained than that narrative of this open-ended kind of catchall for Metaverse. We're just not convinced that that's necessarily going to be the mass product that we've been led to believe by Roblox, but also others, right?

And so, like I said, you have to tip your hat to Roblox. This really is a unique platform. It's had a lot of success. It really is a tremendous brand with a lot of kids and young adults across the world. But we have to kind of weigh that against the current valuation. And again, despite the significant move over the last year, let's call it, we still think that there's a little too much embedded in the current valuation to justify buying the share today.

RACHELLE AKUFFO: And I want to ask you about the demographic because it does skew younger. About 2/3 of the users there under the age of 17, at least for now. How do you see that helping, or in some cases, hurting Roblox's growth?

CLAY GRIFFIN: Well, I think the debate is around of what happens to those folks as they get into, let's call it, their 20s and young adulthood, let's say, and considering the alternatives that are available to them in terms of this question of can they age up. And our view is that despite the fact that there's tons of content on Roblox, there's only, let's call it, 10 or 50, maybe even 200 games or experiences that really drive most of the engagement.

And when you think about what those experiences are up against when it comes to things like "Fortnite," "Call of Duty," basically any kind of professionally developed game and experience, it's really difficult, we think, for games on Roblox to compete head to head with the type of investment that's happening on platforms like Nintendo or Xbox or PlayStation. So the question becomes, as these folks get older, will they be looking for more, let's say, kind of deeper and more professionally developed experiences?

We think that ultimately, they probably will. It's not to say that people won't have an affinity for Roblox and be invested in the Roblox economy and experience. I think they will. But it's going to take a while. I certainly don't see adult-- folks that are interested in gaming in the adult category somehow viewing Roblox as a really interesting alternative to the things they might be doing on Nintendo or Xbox or PC gaming, that kind of thing.

RACHELLE AKUFFO: I mean, and people certainly have a lot more options. I do just quickly want to ask you because for the first time, Roblox is going beyond what it makes with its in-app purchases with Robux and really exploring some of these ad supported partnerships. What do you think Roblox would have to do to become more profitable? And what would perhaps change your mind in terms of where the revenue growth would come from?

CLAY GRIFFIN: Look, I think if I'm wrong on this call, I think it would have to be in terms of the demand for the advertising inventory that they have. There's clearly just a tremendous amount of engagement and attention on Roblox. So if I were to be wrong, I think that's probably where I would be wrong. Having said that, look, traditionally, it's been really hard for advertising to work in interactive entertainment. So the base rate for success is not tremendous.

And I think that if we-- just going back to what was disclosed at the investor day earlier in September, it really seems as if this is really a work in progress. I don't expect it to really drive any kind of near-term-- any near-term results to any meaningful degree.

But I do-- I would concede that if there is a way that they can effectively monetize the audience that's not paying, which, by the way, is most of its audience-- it's nearly free to everyone-- I think that would probably be where I would be wrong. And I would concede that's a call option. But again, advertising in entertainment-- in interactive entertainment has been very difficult. It's been tried for many times over many years. And so we'll see.

I think for me, I think the branded experiences that have been on the platform are a really good way for the independent developers that create the experiences on Roblox to monetize. I think that's a good thing. But it's unclear to me how big it can be to Roblox for Roblox shareholders.

RACHELLE AKUFFO: Certainly sounds like an uphill battle, indeed, for Roblox. Thank you for joining us, Clay Griffin, MoffettNathanson research analyst. Thank you for your time this afternoon.