Long On Roku - Even If They Miss Q1 Earnings

May 08, 2018 11:35 AM ETRoku, Inc. (ROKU)AAPL, AMZN, BBY, CHTR, CMCSA, GOOGL, NFLX, NLSN, SSNLF, GOOG38 Comments8 Likes

Summary

  • Despite knee jerk volatility, Roku will become a large cap stock in OTT (over-the-top) within 2-5 years.
  • Pay TV operators continue to bleed subscribers and Roku has the best business model to capitalize on these losses compared to highly fragmented OTT and SVOD competitors.
  • Roku has maintained competitive vigor as the number one streaming device in the United States while remaining vendor agnostic. Going global will cement this position.
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Roku (NASDAQ:ROKU) stock prices have fluctuated wildly from being one of the hottest stocks in 2017 with a 400% return from the IPO price of $14 to a high in December of $56. From there, the streaming device maker saw shares drop 42% where it’s been range-bound at $31-$34 per share. That is, except when Amazon (AMZN) announced a fairly irrelevant partnership with a dying brick-and-mortar Best Buy (BBY) resulting in an 11.8% drop.

Or, the announcement of Roku offering access to ESPN+, which bumped the shares up 12%. While some are still confused on Roku’s value proposition, one thing is for certain, Roku's stock is volatile and will continue to test investors’ technological depth on how exactly a hardware company plans to stay profitable ... except, Roku is not a hardware company. Wall Street just (mistakenly) thinks it is.

Ahead of earnings this week, KeyBanc placed a $42 price target on the stock at about 27% above current levels of the shares. Notably, many short sellers lost the gamble when the lock-up expired six months after the IPO date in March with false expectations the market would be flooded with shares. The stock has seen about an 11% decline since March from the price of $39 - not the crash short investors were hoping for. Meanwhile, Roku’s short interest has dropped 38% since its peak from 10 million shares shorted at the end of March to 6.2 million shares shorted by mid-April.

Roku's stock will continue to be volatile as the company expects to continue losing money in 2018 aiming to operate “at, or near, break-even on an operating cash flow basis.” Yet bulls continue to focus on the huge upside potential as the number one streaming device in the United States with $90 million in revenue coming from the ad-supported platform.

Looking beyond the knee-jerk volatility, here are the top reasons Roku will be a large cap stock in OTT (over-the-top) within 2-5 years.

1. Blood In The Water:

The peak for pay TV in the United States occurred in 2010/2011 when it began a predictable erosion. The number of pay-tv subscribers fell by 8,000 in 2012 and accelerated to 164,000 subscriber losses in 2014. Last year, the erosion neared deterioration with the top 10 pay TV operators losing a staggering 3 million linear subscribers in 2017 according to Leichtman Research.

Roku is the most synonymous business model with cable and satellite TV providers and can capitalize long-term on this massive subscriber loss by leveraging its advertising, audience development and content distribution services, which make up 89% of gross margins from the platform. In fact, if Roku was a traditional cable company, it would be the third largest distributor of content in the United States behind Comcast (CMCSA) and AT&T (T) with 19 million active subscribers.

2. Vendor Agnostic:

Roku critics cite too much competition for this mid-cap stock to carry the growth needed for long-term gains, especially from Apple (AAPL), Google (GOOG) (GOOGL) and Amazon who all have a play in the hardware market for OTT video streaming services. However, this weakness is actually Roku’s strength. The Roku operating system, Roku OS 8, is a robust, reliable option for OTT streaming and has attracted partnerships with 1 in 5 smart TVs in the United States.

Meanwhile, operating systems like Samsung's (OTCPK:SSNLF) Tizen continue to be plagued with bugs. But by being vendor-agnostic, Roku has still been able to secure a partnership for their free ad-supported channel with competing OSs like Samsung/Tizen. In addition, by remaining agnostic, Roku has maintained a full menu of original programming while corporate spats between Google (YouTube) and Amazon Prime restrict content choices.

Roku has also built a formidable catalog of 5,000 channels that even Google has not even come close to rival. This is where the discussion as to Roku being a hardware company should curtail as the “player” revenue will soon be eclipsed by the platform revenue (platform revenue stood at 45% in Q4 2017). It’s the latter where the company is making its largest investments including OTT advertising measurement tools, launching the free Roku channel, growing licensing fees and partnering for live TV.

3. There’s More To OTT Than Highly Fragmented Subscriptions:

Previously, viewing data and ratings on SVOD (subscription video on demand) such as Netflix (NFLX), Hulu Plus and Amazon Prime and other OTT content was not disclosed even by Nielsen (NLSN). However, in a recent interview, Nielsen COO Steve Hasker revealed four previously undisclosed statistics about SVOD such as 89.5% of SVOD content is primarily viewed on the television glass whereas 11.5% is viewed on smartphones and tablets.

Of this time, 80% is spent on catalog programming whereas 20% is spent on original content. Meanwhile, as competition increases, the costs for original programming are escalating with Netflix spending $8 billion in 2018 in order to remain competitive for a small piece of the pie (20% of how time is spent). Meanwhile, Roku has held firm on not creating original programming and the statistics support this. The costs for original programming are likely to escalate as HBO, Showtime, and now Apple will continue to compete for this space.

In addition, subscribers pay for quite a few premium $8+ subscription channels, which will eventually lead to subscription fatigue – not to mention mitigate the reason cord-cutters leave pay TV services – which is to lower costs. For a subscriber with YouTube TV ($40) and three premium channels ($24-26), they are paying $65+ per month. This pricing will meet resistance by cord cutters and ad-supported video on demand (AVOD) will be the answer.

Most importantly, original programming will consolidate or bundle (like it has on cable) and Roku is the perfect middleman to do this.

4. Global Potential:

This point ties into the previous two points where agnosticism in hardware and operating system along with building out a free, ad-supported channel will help Roku crush global expansion – especially in the emerging markets. The low price point for both the hardware and free content is desirable for global adoption, plus the 5,000 channels that Roku offers caters to differences in cultural viewing preferences.

Roku has shown competitive vigor by maintaining the lead as the top streaming media player in the United States claiming 37% of devices with nearly 40 million U.S. customers use Roku once per month. It’s only a matter of time until they take this success to the billions of people overseas who can’t afford pay TV or want to reduce pay TV costs.

5. Purely OTT Play:

In reference to the first point, there is an opportunity to capitalize due to massive pay TV subscriber losses such as last month when Charter (CHTR) lost 12% of market cap after reporting 112,000 subscriber losses and Comcast reported a loss of 98,000 in video users compared to a gain of 41,000 one year ago in Q1 2017.

This bloodbath from attrition will continue to accelerate through 2025 when even TV networks are expected to experience a 41% revenue loss. Roku is a very desirable purely OTT mid-cap choice with 19 million users and a $3.29 billion market cap that narrows in on this staggering market trend. Compare this to Charter Communications, which has a $65 billion market cap and only 16 million users.

Conclusion:

In the next 2-5 years, Roku will outpace competitors globally as it continues to be the cheapest, agnostic option with the most channels. Its executive team is experienced in OTT media and advertising, and the platform revenue will redefine how investors see this razor/razor blade opportunity (device player that locks in licensing fees and advertising). The free channel especially is attractive setting it apart from the over-abundance of paid, subscription channels. In addition, live TV will be an attractive space for Roku with the company already recently partnered with ABC News, People TV and Cheddar.


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This article was written by

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Beth Kindig is the CEO and Lead Tech Analyst for the I/O Fund with cumulative audited results of 141%, beating Ark and other leading active tech funds over four audit periods in 2020 and 2021.

Beth has over ten years of experience in competitive and product analysis in the tech industry dating back to 2011. Her experience comes from a decade of analyzing tech companies, tech products, and startups, and when tech overtook oil in 2010 as the world’s most valuable industry, Beth was at the forefront of this change in Silicon Valley. Beth's tech conference appearances date back to 2014 and her analysis began garnering press in the same year. She is known for making bold calls on tech stocks and offers weekly free analysis that leverages her ten years of experience in the private markets.

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Disclosure: I am/we are long ROKU, AMZN, DIS, NFLX, AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Long on Roku since IPO

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