Roblox – IPO Note 1

I just skimmed Roblox S-1. As there will be many S-1 teardown and takes on the internet, I only write down high-level thoughts that I still remember without checking the document again. I might put together a simple model and charts later.

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[November 22nd, 2020]

What is Roblox?

Roblox is a User-Generated Content (UGC) platform holder that provides proprietary tools for developers/creators to design, build, distribute/publish, operate, monetize, and analyze applications (called experiences)/digital items compatible to the platform. Roblox is a multi-sided platform that connects users, creators/developers and other stakeholders (influencers, brands… the scope of this depends on the future development of the platform).

With social features, the platform and the experiences on top of it have the potential to enjoy direct network effect. In terms of relationship between users and developers/creators, the platform might have indirect network effect. I have a feeling that those network effects are kicking in but still in the very early stage because the growth is not exponential enough and it’s driven by extreme external event. In addition, we don’t have enough time to confirm the pattern. Even if we confirm the platform is enjoying network effects, its growth pattern might be different from those of carefully selected comps because platforms are not created equal and dynamics nature play important role in real world.

Roblox runs on top of several device-OS-App Store platforms like iPhone-iOS-App Store platform.

Focus on the Supply Side

Since Roblox is a UGC platform, its success is aligned with third party developers/creators. Technology trajectory will follow sustaining technology path. Everything is to assure that it’s easier for developers/creators to thrive on the platform. Investment in supply side ecosystem is indispensable. These investments in technology and supply side ecosystem is like content creation that will eventually attract users so it’s relatively difficult to distinguish this investment from user acquisition cost. Roblox claims their growth primarily comes from organic channel, earned channels and word of mouth. I didn’t notice they mention other additional user acquisition initiatives in the prospectus so I would assume their go-to-market will be as-is.

There’s no contractual restrictions that prevent developers/creators from multi-homing but even if they can make their experience/content cross-platform, their experience/content might not be economically viable as a standalone application outside of Roblox platform. In terms of content distribution, Roblox owns large enough dedicated user base for its developers/creators.

However, if developers/creators can create a well-recognized IP, then it might be easier to make the IP reach other platforms.

It is Roblox that is partially cross-platform (it’s not on Sony PlayStation or Nintendo Switch probably because Roblox doesn’t have much audience on console), not the experience or content on the Roblox platform.

The Business Model

Roblox in aggregate monetizes users via microtransaction on digital content at this moment. Users need to purchase virtual currency, Robux, from Roblox to spend on experiences, enhancements in those experiences or other digital items sold by developers/creators. Users can purchase Robux via one-time purchase or via monthly subscription. Roblox takes a cut when developers/creators exchange Robux for real money with Roblox. The time difference between Robux purchased, spent and exchanged might generate cashflow for Roblox. Generally speaking, this type of business generates attractive cashflow at scale especially when there’s no large spending on user acquisition.

From developers’ perspective, the monetization is not limited to microtransaction. They can adopt other monetization methods depending on the business model of their experience. One interesting thing is that while Roblox takes a cut on digital item transaction but it might not rake monetization method like advertising within experience.

Power law applies to both user side and supply side on Roblox platform. The conversion rate of user base by my estimation is around 1.0%-1.5% and roughly 0.14% of developers/creators earned more than 10K on Roblox platform for the twelve months ended September 30, 2020.

Growth Opportunity

Apparently, expansion in age demographic and international markets are most attractive sources of growth. The user base looks relatively small compared to other leading global social utility providers. If the vision of Roblox is to become a utility, infrastructure or metaverse, then it has a very long runway. However, Roblox doesn’t disclose much information about go-to-market. Roblox has a JV with a subsidiary of Tencent in China but I don’t expect this initiative to take off even though they must spend lots of effort on how to moderate UGC. Roblox reports its doing well in South Korea so maybe Roblox can try more in Japan. I remember Minecraft does quite will on Nintendo Switch in Japan (over one million physical sell-through).

Improvement in monetization is another way to create growth in financial. It can come from improvement in conversion, average booking per DAU, average revenue per DAU (this means Roblox find other revenue streams such as ads…) or collaboration with brands, merchandize…

Competition

Everyone company that competing for users’ time and developers/creators is Roblox’s competitor. Therefore, Roblox lists many well-known companies as its competitors. This indicates it has very large TAM (maybe so large that Roblox doesn’t even mention it in S-1).

Other Thoughts

Simply put, I would say Roblox platform is a combination of software operating system and digital app store (storefront/marketplace) dedicated to a specific category (Roblox calls it human co-experience) on top of existing device-os-app platforms.

If you look at competitive landscape, there are many “games” trying to become a social platform or metaverse. It seems the space is getting more crowed but there’s always a room for an experience platform that successfully leverages cultural or art style stuff (for example anime).

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Slides below might be relevant to this topic.

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Hyrule Warriors: Age of Calamity (Cont’d)

It’s less than a week away from the launch of Hyrule Warriors: Age of Calamity (HW: AoC). I reckoned this game will be a commercial success in my previous post but I didn’t give the idea that to what extent it counts as a success for HW: AoC? Of course, everything is comparatively speaking. Depending on the development and marketing budgets (or even broader strategy of developer/publisher), 3M shipment for one game might be a disappointment while 1M shipment for another might worth a celebration artwork and even secure future development.

Let’s do some math. Since HW: AoC is a Nintendo Switch exclusive, the first way to estimate shipment is via attach rate. The idea of attach rate is based on installed base which is distorted by the development of the platform including household penetration, replacement/upgrade of Nintendo Switch, new/additional purchase of Nintendo Switch Lite. But it’s still a good starting point for this exercise. Another way to look at this is from fan base perspective. The lifetime shipment of The Legend of Zelda: Breath of the Wild (BotW) is a proxy of existing fan base of Legend of Zelda on Nintendo Switch so the cumulative shipment of HW: AoC can be estimated as a conversion of BotW fan base.

Another information comes from The Legend of Zelda: Link’s Awakening remake (2019). As of CY1Q20, Link’s Awakening has sold around 4.4M copies representing an attach rate of 7.9% at that time.

With these information, my predictions for HW: AoC below:

  • The first year attach rate reaches 10% of CY3Q20 installed base (68.3M units). This means HW: AoC will roughly sell 6.8M copies or more by CY3Q21.
  • Lifetime sales exceeds 10M copies making HW: AoC one of the best selling Warriors games.
  • Lifetime conversion from BotW will be around 33% (HW: AoC divided by BotW)
    • This one is to capture the scenario when sales exceeds 10M copies. It might be sooner than my prediction. We will have some color after Black Friday. As HW: AoC counts as Nintendo’s 1P title for this holiday so it’s quite likely Nintendo will mention the sales number (at least for North America) in their press release around Black Friday.

Koei Tecmo will significantly benefit from this collaboration, financially and reputationally. This new title launch will benefit other Zelda games and warm up the sequel to BotW next year.

Game Engine as a Competitive Advantage for Game Developer?

I joined a Hong Kong listed Chinese game developer conference call last Friday.

I don’t remember most of the stuff discussed but the call gave me an impression that the company believes having technical capability in game engine is kind of competitive advantage.

The management mentioned that some of their high quality game are developed in UE4 and they boast some kind of industry leading position (for example, the first Chinese XXX mobile massively multiplayer online role-playing-game, MMORPG, developed in UE4). Of course, the company also has other games developed in Unity3D and it might just want to showcase their research and development capability because Unreal Engine is known for its deep learning curve.

However, the management’s focus on game engine in the presentation indicates they might not be so innovative on gameplay, game genre or exploring new game business model. The capability of game engine and investment in customized engine might make future game development less flexible (from outsider’s perspective). The organization has tendency to keep iterating what they are good at or familiar with especially when the path is justified by previous large investment (suck costs). We can expect the company’s future game portfolio in terms genre will look quite similar today. The company currently focuses on MMORPG and simulation game (SLG) and it plans to release several games in those two genre but only 1 game in new genre.

There’s nothing wrong with the sustaining technology approach mentioned above. It’s understandable a company’s core competency is only in certain genre which links to gameplay, art style, story setting (IP type) and business model (monetization). The problem of this specialization is that it limits the optionality from other genre. If the game developer cannot explore more gameplay or monetization from genre they are good at, the business is just a pipeline while sometimes the revenue stream might be boosted by a hit. As this developer has established portfolio, it’s better than hit-driven, boom-bust business but there’s less growth potential from the business. Market tends to value this type of company by normal level P/E multiple and maybe with some premium if it’s a leading player.

Hyrule Warriors: Age of Calamity

Background of the Game

Hyrule Warriors: Age of Calamity is a Hack and Slash (H&S) game for Nintendo Switch. The game is developed by Koei Tecmo’s Omega Force and will be published by Koei Tecmo in Japan and by Nintendo worldwide.

Concept of the Game

The game is a crossover between Koei Tecmo’s Dynasty Warriors series and Nintendo’s The Legend of Zelda (LoZ) series.

In terms of this specific crossover, Hyrule Warriors: Age of Calamity (HW: AoC) is the sequel to Hyrule Warriors (HW). However, in terms of IP strategy for LoZ series, the story of HW: AoC is set before The Legend of Zelda: Breath of the Wild (BotW) and inherits the art style of the highly acclaimed open-world game.

Even though I only watched some live streaming during Tokyo Game Show I started writing this post just before the Nintendo Direct Mini so I had the opportunity to try the demo (actually this is my first Warriors game since PS2). I can tell there are many attention to details and integrations that developers (including Nintendo team) want players to feel they’re really in the world of BotW to enjoy a game genre that developers believe better fitting the story setting (a war rather than an adventure).

In this sense, HW: AoC is better to be seen as the prequel to BotW rather than a sequel to HW even though it’s in different genre and developed by third party.

Implication of the Game for Nintendo’s LoZ Series

What we can learn from HW: AoC about Nintendo’s IP strategy for LoZ series?

Nintendo probably plans to use the design theme of BotW going forward to unify logo style (particular) of LoZ games to indicate they are games developed in the BotW era. For example, the logo design of The Legend of Zelda: Link’s Awakening remake (2019) shares the same style with BotW. In addition, while the logo design of HW: AoC follows that of HW, we notice that its logo uses fonts from the BotW. This is even more apparent in it’s Japanese logo which changes English font of “Zelda” to Japanese font of “Zelda” in BotW. We can expect more remakes from original LoZ titles with different gameplay and art style but sharing the same design theme shown on the logo indicating they’re influenced by BotW.

In addition to new elements that BotW introduces into LoZ series, the game also provides “the engine” which serves as a technical and intellectual platform for the series and might be applied to other IP. The engine can shorten the development cycle for similar genre and it can even bring in new ideas to games in different genres. For example, it is relatively easy for Nintendo to make a direct sequel to BotW where they can have more resources to put into story and other enhancement or additions to the game world. In the future, Nintendo can keep iterating on BotW series or it can leverage the engine in other Zelda games or other games. (One noticeable BotW-inspired game might be Genshin Impact. It’s easy to identify elements from BotW and other games but you still quickly realize it’s a different game providing different interactive experience)

There are few things Nintendo can do with LoZ franchise games.
(1) Keep iterating BotW series (Breath of the Wild Universe)
(2) Remake past LoZ games
(3) New BotW-inspired LoZ games with different story line (or parallel universe), genre and gameplay
(4) Last one is least likely but has highest potential: a live game in a LoZ parallel universe built on top of BotW art style and engine

(1) Keep iterating BotW Universe

(1) , (2) & (3) as LoZ Pipeline Category for Nintendo

(1), (2) & (3) are traditional business model for Nintendo’s console games. There’s no noticeable live game developed by Nintendo.

I expect Nintendo to release LoZ games every one to one and a half year. These LoZ games can be categorized in three groups in terms of pipeline sources as shown in the graph above. It’s very likely Nintendo will keep using traditional business model for these games (boxed game in console with some DLCs) in the foreseeable future as long as Nintendo Switch is still relevant.

It seems Nintendo doesn’t have a plan to develop and operate a live game for its IP on Nintendo Switch. Without live game plan, Nintendo will miss some optionality from its IP in gaming. The unwillingness to experiment live game on console in-house indicates the limited upside from mobile gaming. Fire Emblem Heroes is an exception which has apparent product-market-fit. The problem lies in senior management but time will fix this.

Prospect of the Game

Warriors game is in a relatively niche genre. I couldn’t even finish the demo. That said, I believe HW: AoC will be a commercial success supported by Zelda fan base. The game will be easily the best sold Warriors game on Nintendo Switch and probably rank top among the whole Warriors series. Koei Tecmo will reach a new audience base. This is not a Warriors game with BotW skins but a BotW game with Warriors gameplay.

The crossover indicates that Nintendo is more flexible on its IP. Even though Nintendo wants to have a prequel to BotW, that doesn’t mean the game needs to be in the same genre or developed by Nintendo. Depending on what and how the story Nintendo wants to tell, different genre might create better experience and Nintendo might need support from other company for that specific genre. Koei Tecmo has collaborated with Nintendo on other Nintendo IP such as Fire Emblem (Fire Emblem: Three Houses and Fire Emblem Warriors). In the past crossover Warriors games, the Warriors concept/element was used as a platform to host a parallel universe for characters within a franchise (it seems Warriors can easily mix everything together). It’s a little bit different in in HW: AoC, what developers need from Warriors here is its gameplay to support the story setting. I expect Nintendo to use this module approach more often in its franchises.

It’s likely that Koei Tecmo will announce DLCs for this game later. After the success of this game, people will expect more possibilities from BotW and other IP like Fire Emblem.

Mario Kart Live: Home Circuit

Concept of the Game

Mario Kart Live: Home Circuit (Mario Kart Live) utilizes Mixed Reality technology to combine real-time, interactive information captured from physical radio-controlled cars and digital Mario Kart gameplay experience.

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Nature of the Game

Due to physical element in the game mechanics, the game has natural constraints on scalability in different forms.

  • Unlike drone racing which inspired the game, Mario Kart Live has a clear limitation on area defined by wireless communication capability of the hardware. The size of area might be designed based survey of average size of home space and costs of hardware. Nintendo recommends the product is for indoor use only.
  • The game doesn’t support online multiplayer while up to four players can race together via local multiplayer. This means the game can only enjoy limited local network effect due to relatively high price of RC cars and uncertain replayability for potential players.

In the mean time, Mixed Reality element gives the game unlimited possibility and unpredictable fun.

  • There’re unlimited routes that players can design. In fact, they are required to set up track every time they paly. User’s creativity and improvisation is a source of fun for this game. It’s kind of user-generated content (UGC) even though the “content” creator is the “content” consumer. There’s no built-in mechanic in the game to share this type of content. For those who are really enthusiastic about the game, they might go to social media to find ideas to decorate and create obstacle for their tracks. They will find some as it’s not surprising there’s supply of this type of content. Oh by the way, how’s Nintendo Labo doing?
  • Mixed Reality brings teal-time, interactive physical inputs into gameplay, sometimes making the game unpredictable in an enjoyable way. One scenario is playing the game with toddlers or pets walking arounds. Their actions are less predictable adding random factors into the game (which is actually a part of game mechanics). That said, I don’t know how often this magic happens and how much it makes players want to replay the game.

Business Model and Monetization of the Game

The game integrates/bundles radio-controlled car and downloadable-only game software. The game software also serves as the operating system for the RC cars. The bundle is priced at $100. The game has in-game items which can be unlocked using coins earned during the game.

The game has little room for paid DLC, let alone live ops. If the game was solely developed Nintendo, it might get some free updates. Since the game is developed by Velan Studios, the consideration is different from that of platform holder being a sole developer. Nintendo and Velan Studios probably have a flexible plan with production depending on initial reception and additional content depending on installed base, user feedback and user behavior.

The game is likely to collaborate with Tetris 99 to offer special skin. Nintendo might have other plans for this in Super Mario 35th Anniversary campaign.

This product looks like software in a box. However, the hardware and software are so integrated that replayability and scalability are capped in a reinforcing way. Thus, it has limited potential for game as a service.

Prospect of the Game

Due to the limited replayability and pricing, I don’t expect this product to be a hit as Ring Fit Adventure which even has utility value (keeping you fit) . We might see supply shortage on this product for an extended period of time as Nintendo might be cautious about the demand (more like another Nintendo’s high quality experiment). If the product does well, that’s very good. Even if the product doesn’t do well, the game meets Nintendo’s high standard and presents the innovation/novelty to the world. Nintendo can always treats it as marketing initiative under its broader IP strategy. My perspective is that the game is more like a profitable marketing initiatives. The magnitude of lifetime contribution profit won’t be significant for Nintendo. I don’t expect next iteration or live ops plans for this game.

Sides Notes

It seems Nintendo is executing based on an IP platform strategy rather than on game platform concept. Nintendo’s live game or game as a service includes their mobile games (Mario Kart Tour, Fire Emblem Heroes, Animal Crossing: Pocket Camp, Dr. Mario World, Dragalia Lost), Nintendo Switch Online and Tetris 99 (as part of Nintendo Switch Online). Nintendo doesn’t have real live games in their 1P game portfolio (excl. games or services related to The Pokemon Company). What they’re doing with their 1P games on Nintendo Switch is keeping iterating franchises/IP with some add-on or DLC for each iteration. The reasons why Nintendo lacks live game on Nintendo Switch, can’t build a successful smart-device business and sticks with more traditional business mode on game level on their platform are multifaceted and interconnected.

Ring Fit Adventure has high potential to become a viable game as a service and it’s a new IP so it has less historical burden to try some new business models. It’s been exactly one year today since Ring Fit Adventure launched. Not sure if Nintendo has any further plan for this game after seeing its success. In addition to its own sales, the game also drives some adoption of Nintendo Switch Online and adds value to that service.

  • As of the end of Jun. 2020, Nintendo has shipped 3.9M Ring Fit Adventure but it didn’t have a business model for the game that generates recurring revenue.
  • In comparison, Peloton had 1.1M connected fitness subscription as of the end of Jun. 2020. Over the past year, Peloton has added more than $30B to its market cap. Nintendo’s market cap is around $65B.