The advent of the metaverse is expected to foster the emergence of digital economies that will parallel traditional commerce. Platforms operating these digital economies will generate revenue in ways that will differ from traditional business models, complicating financial assessment.
In the virtual economy, for example, platform operators will extend credit, creating virtual money similar to banks in the real world. Like the infamously complex Wirecard, these platform operators could one day be part non-financial company and part bank. Measurement of virtual income, assets and liabilities will involve considerable discretion, allowing opportunities for accounting fraud.
Regulators and auditors are well aware of the challenges posed by the metaverse. In the US, both FINRA and the SEC have asserted their regulatory frameworks are technology neutral, meaning their rules will still apply to activities in the metaverse. Unfortunately, enforcement is not technology neutral. It could take enforcement years to catch up to innovations in the metaverse.
This enforcement lag will intensify the need for technology to detect accounting fraud. AI software will be a key part of the solution. The emergent abilities of advanced AI systems means that these systems will adapt as business models in the metaverse evolve. However, those using AI systems for financial analysis will also need to develop an understanding of metaverse companies.
With this goal in mind, this post takes a look at Roblox, arguably the purest large-cap metaverse company. This is a company that exhibits the type of accounting challenges posed by the new virtual economy, which this piece will study in detail.
Transparently.AI’s system has picked up some concerning signals about Roblox’s accounting quality, some of which can be explained by the uniqueness of its revenue model. This informs our contention that metaverse companies require greater scrutiny than companies with more traditional ways of doing business.
Table of contents
The metaverse playground
The metaverse represents a significant evolution in digital interaction. It involves creating experiences that engage an individual’s senses and attention in an immersive environment. As with earlier stages of the digital revolution, it will transform the way that humans interact and collaborate. It will impact how we learn, work, spend and, in particular, how we play.
Nobody knows for certain how the metaverse will play out. It is a competition. Major tech companies are all investing heavily in their own visions of the metaverse. Facebook even changed its name in recognition of the need to transform its business model from social media to immersive digital experiences.
Big tech companies have significant advantages but, as we saw with EVs, legacy business can be a severe handicap in heavily disrupted industries. This is especially true in the metaverse where advancements in programming could prove especially disruptive.
As with the first home computers, gaming is at the cutting edge of the metaverse revolution. The purest metaverse companies are mostly engaged in gaming. Early movers include Epic Games (1991), Unity Technologies (2004), and Roblox (2006).
Revenue models for metaverse are still evolving and these three companies have struggled to achieve profitability in their metaverse offerings.
At this stage of their development, user metrics tend to be as important to investors than revenue or profits. This is based on the expectation that revenue models will improve and the expectation that metaverse platforms will enjoy strong “moats” in future years, conferring monopoly power.
All three companies have been accused of inflating their user metrics at various times. Hindenburg Research, for example, accused Roblox of inflating key metrics related to user engagement and daily active users (DAUs). It also accused the company of failing to protect children from dangerous content on its platform. Roblox firmly rejected Hindenburg’s claims, asserting that its financial metrics were accurate and that it took user safety seriously. Roblox stock fell about 10% following the Hindenburg claims but subsequently recovered.
What is Roblox?
Launched in 2006, Roblox is arguably the world’s purest metaverse company. The company went public on the New York Stock Exchange in March 2021. With a market capitalization of $27.6 billion at the time of writing, Roblox is already a large-cap company.
The Roblox platform hosts a vast array of user-created games across multiple genres, all coded in Lua. These games enable users to interact with each other and digital environments in immersive ways. Roblox defines the number of available games as “experiences.” According to Roblox’s internal data, there are 5.3 million active experiences on Roblox. This vast number of experiences explains why it can be difficult for the company to monitor its content. Put in perspective, Roblox has twice as many experiences as the average number of daily users of the dark web.
As of Q2 2024, Roblox claimed 380 million monthly active users (MAU) and 79.5 million daily active users (DAU). These usage numbers represent gains of 27% and 21.3% on the usage numbers from Q2 2023, respectively. Users are evenly distributed worldwide with 21.5% in the US and Canada, 25.9% in Europe, 25.4% in Asia-Pac and the remaining 27.2% in the rest of the world.
The Roblox platform’s popularity surged during Covid, adding millions of new users and solidifying its status. Growth slowed after the pandemic but has subsequently stabilised at about 20% per annum.
Figure 1: Growth of Roblox daily average users (% YoY)
Source: Roblox
The ratio of DAU to MAU, a measure of user engagement or stickiness, is 20.9%. This means that about one-fifth of monthly Roblox users are using the service every day. A DAU/MAU ratio of 20% or higher is considered good. For top games, the DAU/MAU ratio can be as high as 60%. DAUs spend approximately 2.4 hours on the Roblox platform per day. The average time spent by DAUs on good gaming platforms is approximately 1 hour per day. Roblox gaming duration is comparable to popular games such as Players of Fortnite or Call of Duty, but is less than League of Legends at about 4 hours.
The top three experiences on Roblox are Brookhaven RP (50.2 billion all-time visits), Adopt Me (36.7 billion) and Blox Fruits (36.1 billion).
A key metric for Roblox is the average age of users. According to recent statistics, Roblox is currently the most popular gaming platform among children aged 5 to 12 in the United States. A study conducted by RoosterMoney in 2020 surveyed 24,000 children aged between four and fourteen in the UK. In this survey, Roblox was identified as the top target for kids’ pocket money spending, followed by Fortnite, owned by Epic Games. Some 58% of Roblox users are under 16 while 21% are under 9 and only 18% are over 25. (This latter stat explains why we are taking some time to explain the business.)
In short, metaverse-style games are enormously popular with the very young who likely view traditional online games in the same way that we in older generations view Pac-Man and Donkey Kong.
The Roblox revenue model
While Roblox boasts impressive user metrics, its revenue model is currently weak in comparison to traditional online gaming platforms with similar metrics. This is partly due to its young demographic but also reflects a unique revenue model.
Roblox’s main business model leverages its internal currency, known as Robux. Robux can be earned and spent on the platform, and can be traded through a proprietary exchange into real-world US dollars. Epic Games also has an internal currency known as V-Bucks, but lacks a proprietary exchange. In the first six months of 2024, users purchased $1.88 billion worth of Robux on the platform. This figure represents 3-to-4 times the growth of the M1 money supply in Panama. From a money supply perspective, the Roblox digital economy is already the size of a small country.
One Robux is currently equivalent to $0.000654.Transactions involving Robux are recorded in Roblox’s own databases rather than on a public ledger like those used in blockchain systems. This means that while users can trade and spend Robux within the platform, these transactions do not have the same transparency or security features associated with blockchain technology.
From a money supply perspective, the Roblox digital economy is already the size of a small country.
While the majority of experiences on Roblox are free, users are able to purchase specific enhancements via one-time purchase of Robux or a subscription service (Roblox Premium).
Developers and creators earn Robux by selling access to games, game enhancements, engagement-based payouts, sale of content and tools among developers, and sale of items to users through the Avatar Marketplace. When virtual items are sold on the platform, the item creator receives a percentage which typically ranges between 30% and 70%. A creator is anyone who produces content for the platform. This might include creating maps and environments, designing 3D models or writing code to enhance games. By contrast, a developer specifically engages in game development on Roblox.
As of Q2 2024, Roblox had more than 2.5 million developers and roughly the same number of creators. These developers and creators are based in over 170 countries. Developers and creators earned $410.68 million on the platform in the first 6 months of 2024 alone. This compares with Roblox revenue of $1,695 over the same period. Both figures grew by slightly more than 30% versus the first half of 2023.
In the year ended Q2 2024, around 16,500 developers and creators met set criteria to exchange Robux for real-world currency. From this group, around 12,000 actually traded Robux for US dollars. Some 695 developers earned more than $1 million on the platform and 96 earned more than $10 million.
As can be expected, Roblox faces an intensely competitive environment. Many players are entering the metaverse industry and some competitors have extremely deep pockets. In this context, Roblox must spend aggressively on R&D to keep its platform cutting edge for developers and, importantly, must keep its platform attractive to developers in terms of revenue sharing. The platform’s reliance on user-generated content is both a strength and a weakness. There is some dissatisfaction among developers who feel that the revenue-sharing model is unfairly structured.
Roblox must balance this pressure against its need to make a profit. Thus far, losses have grown alongside revenues, suggesting to some that the business model is not sustainable.
The reliance on its virtual currency for monetization is a double-edged sword. Longer term, it could confer significant monopoly privileges on the company. In the short term, credit risk on Roblox represents credit risk of Robux and will impact the value of the virtual currency. For the 700 or so major developers on the platform, this raises concerns about sustainability.
Uber took 17 years to become profitable. Tesla took about 10 years. If it succeeds, Roblox appears likely to be in this range.
Roblox from an accounting perspective
Hopefully this brief description of the Roblox business model illustrates that Roblox is not an ordinary company.
The company currently generates income in the real world when it sells Robux but one could readily imagine revenue-sharing models or even taxation models in which it might one day also generate virtual income. Revenue recognition in such an ecosystem would be complex, especially if Roblox began lending accumulated Robux balances.
Robux incurs expenses in the virtual world. The question arises as to how these virtual expenses should be recognized on the income statement and the balance sheet. Should they be recognized as they occur or should they be seen as liabilities until the Robux is exchanged for US dollars? The answer is not as obvious as it first might appear, particularly for developers and creators that have not met the threshold to exchange Robux for US dollars.
Clearly, the recognition of Roblox’s expenses and liabilities will involve significant discretion.
Virtual assets on the platform have value in both the real and virtual world and these assets are unique to the platform. In other words, these assets confer monopoly privileges to Roblox which could potentially confer future income earning potential. If so, this should be recognized on the balance sheet as an intangible asset. But how should this be valued? The mind boggles.
Roblox is already demonstrating some of the accounting complications that the metaverse will herald.
The monopoly relationship between Roblox and its developers and creators means that the relationship is not that of a landlord and a tenant. A tenant can move out, but developers and creators cannot easily change premises. In many ways, the relationship between Roblox and its content creators and users is more like that between a government, its business sector and its citizens.
In its current form, Roblox does not lend Robux to creators or developers. One could easily imagine, however, an ecosystem in which Roblox lent Robux to promising developers using virtual assets as collateral. It could equally engage in microlending to users with no collateral for games proving especially sticky.
In short, Roblox is already demonstrating some of the accounting complications that the metaverse will herald.
Roblox on the Transparently system
The core message of the discussion thus far is that the financial statements of Roblox are likely to demonstrate unusual features or patterns relative to the 60,000-plus companies used to train the Manipulation Risk Analyzer (MRA).
As we’ve determined above, metaverse companies are unique. In some cases, the system will interpret their unique features as anomalies consistent with risk of account manipulation. Before examining the accounts, for example, we should expect to see significant non-cash items, unusual growth in other long-term assets, a wacky relationship between measures of production activity (i.e. costs) and revenue generation, and some unusual accruals especially in relation to accrued expenses.
Bearing this in mind, Transparently.AI’s MRA puts Roblox in the 69th percentile of tech stocks globally for manipulation risk. In other words, Roblox is in the bottom 31% of the tech universe for estimated accounting quality and transparency.
Put simply, the system identifies Roblox as a company with some issues in accounting quality. What are those issues? Through machine learning, the MRA has been trained to recognise and assess manipulation risk in companies with reference to 14 risk clusters. These clusters, as they pertain to Roblox, are illustrated in Figure 2.
Figure 2: Roblox manipulation risk overview
Source: Transparently.AI
We can break the risk assessment of Roblox into four main areas:
- Financial strain - gearing and credit;
- Corporate governance;
- Revenue and earnings recognition - smoothing activity, accruals management, asset quality. and investing activity; and
- Anomalies - growth signals, cash quality, and business manipulation.
Financial strain
The AI system identifies financial strain as a very common indicator of manipulation risk, particularly when combined with other risk clusters. It can lead to pressure on the company's management to manipulate their financial statements in order to make their financial position appear stronger than it actually is. This is particularly important for companies reliant on capital raising.
The MRA flagged Roblox for gearing due to its high gearing ratios, particularly the high level of debt and liabilities in relation to equity and also for its high level of leases. Roblox has total gearing that is roughly five times the North American average for tech companies and eight times the median level. Its gearing in relation to debt and leases is even more extreme.
Figure 3: Total balance sheet liabilities divided by total shareholders' equity (%)
Source: Transparently.AI
In addition, the system is flagging a statistical anomaly which identifies a relationship between improving credit data quality and increased manipulation risk. This signal is comparatively rare and would take more space to explain than this post allows. Here we have our first indication that Roblox is not a normal company.
Corporate governance
The AI system has identified several markers of possible poor corporate governance that it has determined have a strong association with account manipulation risk. The first is a high level of stock option issuance to employees in relation to EBIT. The second is an abnormally low level of insider ownership.
Stock option issuance is typically dilutive and the system is wary of companies that engage in heavy option issuance in relation to earnings. The system has identified this as a key risk factor for historical manipulation cases. However, in this case it is understandable. Options issuance is particularly common in early stage and high growth companies such as Roblox, where there are greater challenges regarding positive cash flow generation.
Of greater concern is the low level of insider ownership. Insiders control only 13.5% of the Roblox stock which is less than a third of the normal holding for US tech stocks.
Figure 4: Proportion of shares held by insiders %
Insider ownership includes shares held by directors, officers, related parties, individuals with more than 5% of the outstanding shares and other forms of close ownership. These are represented as a percentage of common shares outstanding. (%)
Source: Transparently.AI
Typically, a high proportion of shares held by insiders and related parties is associated with higher accounting manipulation risk. However, in this case the reverse is true. The system has determined that low insider ownership can indicate a structure that has less effective control, implying weaker corporate governance, when assessed in combination with other signals that indicate higher manipulation risk.
Revenue and expense recognition
The system has identified numerous signals in the Roblox accounts that can indicate aggressive smoothing activity and management of accruals - patterns that the system has identified as having a strong association with historical manipulation cases.
One common indicator of smoothing activity is the volatility of accruals. By adjusting the timing or amount of accruals, a company can influence its reported financial results. The system identifies abnormal volatility in accruals with higher risk of smoothing and hence of account manipulation. The volatility of accruals at Roblox is almost three times higher than sector peers and thus triggers concern in the MRA.
Figure 4: Volatility of accruals %
Accruals in this context refer to non-cash components of the income statement. The volatility of accruals (standardized across companies by total assets) is measured over 5 years where available (minimum of 3 years). Volatility is measured in terms of the standard deviation of accruals
Source: Transparently.AI
However, metaverse companies such as Roblox are likely to demonstrate unusual accruals. Roblox demonstrates very low operating income relative to operating cash flow. This can be a sign of manipulation. Specifically, it can signal risk that a company has misclassified cash inflows from investing or financing activities as cash from operations.
In this case, however, it seems likely that Roblox is recognizing expenses (accrued liabilities) that have yet to be paid. This is precisely what we should expect based on the Roblox business model and, perversely, is an encouraging sign that the company is accounting for virtual expenses correctly.
Figure 5: Accruals relative to total assets %
A proxy measure for total accruals (the difference between operating income and cash from operations) relative to total assets.
Source: Transparently.AI
The system identifies other unusual signs in accruals management at Roblox. Pleasingly, most are consistent with the accounting practices we should expect from the company.
For example, our system indicates that Roblox has unusually low levels of accruals relative to the firm's overall income generation. In fact, its accruals are negative. Ordinarily, the system also interprets this as a risk that a company is manipulating its accounts by inflating its income level. In this case, however, it is an accrual pattern that we should expect.
Anomalies
There are significant anomalies in the Roblox accounts. Most are potentially explicable in terms of the company’s stage of development.
For example, the MRA recognises that exceptionally strong growth in sales, assets and capex has been a key feature of historical manipulation cases. The first can indicate inflated sales, while the last can mean a company is disguising operating expenses as investment spending.
Roblox demonstrates abnormally strong growth in all three areas. While this would ordinarily signal manipulation risk, in this case we think these patterns reflect the reality of the Roblox business. It is growing rapidly and needs heavy capex spend to keep pace with the tech heavyweights.
Of greater concern are certain anomalies in the relationship between cash flow, production activity and revenue at Roblox. Most concerning, the risk cluster for business manipulation is signalling risk of abnormal production and production manipulation.
In simple terms, the system is signalling unusual production (typically approximated as the cost of sales), measured both in terms of levels and changes, in comparison to other measures of activity such as sales and cash flow. This risk measure includes historical comparisons of previous years and comparisons with sector peers.
While abnormal patterns can indicate risk of manipulation, in this case we suspect it reflects very heavy and volatile R&D expenses. Once again, this fits with Roblox’s stage of development and platform building.
Abnormal production signals mirror another potential risk, which is the very high level of non-cash items in funds from operations relative to operating cash flow. The company’s reliance on non-cash items is more than five times higher than regional sector peers.
Figure 6: Non cash items relative to cash flow %
Non-cash items in funds from operations excluding net income, depreciation, amortization and deferred taxes, relative to net cash flow from operating activities.
Source: Transparently.AI
Excess non-cash items to operating cash may suggest that a company is using accounting methods to artificially inflate its earnings by recognizing non-cash expenses or gains in its income statement without a corresponding impact on its operating cash flows. In this case, however, we expect high non-cash items because virtual expenses do not have an immediate cash counterpart.
Summary
The AI system has identified Roblox as a relatively risky company in terms of accounting quality and transparency. This risk is undeniable because the company is under significant financial strain and because the metaverse business model implies a certain lack of transparency.
Roblox looks better on the Transparently system than might have been expected.
To be frank, Roblox looks better on the Transparently system than might have been expected. While the system has identified various risk signals in Roblox’s accounting, many anomalies can be explained by the company’s metaverse business model.
The bottom line? Metaverse companies require greater scrutiny than companies with more traditional ways of doing business, if nothing else to understand the specific accounting challenges thrown up by their new-age business model.
Disclaimer: Views presented in this blog are the author’s own opinion and do not constitute financial research or advice. Both the author and Transparently Pte Ltd do not have trading positions in the companies it expresses a view of. In no event should the author or Transparently Pte Ltd be liable for any direct or indirect trading losses caused by any information contained in these views. All expressions of opinion are subject to change without notice, and we do not undertake to update or supplement this report or any of the information contained herein.
About the author: Mark Jolley has been an investment strategist for almost 40 years and has advised some of the world’s biggest investment funds, public companies and notable investors. In the mid-1990s, as a global investment strategist with Deutsche Bank, Mark produced a daily note read by more than 16,000 investment professionals including voting members of the Federal Reserve and the European Central Bank. In the 2000s, Mark worked as Deutsche Bank’s Asian strategist and then as strategist for China Construction Bank. He is now an independent analyst.
