Roku's (ROKU) stock is getting a lot of attention after it reported stellar second-quarter results due to 57% year-over-year revenue growth to $156.8 million beating the analyst forecast of $141 million. Compare this to 37% year-over-year revenue growth in Q1. However, as I stated in my Q1 article, the platform revenue is where Roku will continue to see a majority of the gains. The video streaming platform revenue was up 96% during the period to $90.3 million with player revenue up 24% to $66.5 million.
Some of the analysis below is taken from an article I wrote last quarter on Seeking Alpha. The information has not changed, but the stock price is beginning to adjust to Roku's product-market fit. I do expect some correction from today's stock pop, but these fundamentals are why I've been long on Roku from the beginning (and beating out Amazon Fire Stick isn't one of them). I do expect Roku to experience some volatility on its path to becoming a large cap stock, however, specific industry trends are supporting Roku, and ultimately, these trends will win out.
1. Blood In The Water:
Roku offers 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, this quarter's 22 million active subscriber base would rival Comcast (CMCSA) for the place of second largest distributor of content in the United States. Only AT&T (NYSE:T) has more with 47 million DirecTV subscribers.
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.
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 (NASDAQ:AMZN) 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 (OTC: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 has been eclipsed by the platform revenue (platform revenue stood at 45% in Q4 2017 compared to 57% in Q2 2018). 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. The launch of live news in mid-May and the World Cup in June also contributed to platform performance in Q2.
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. Most recently, Roku has announced offering the Roku Channel on the web in the United States which will serve people who do not have a set top box or television. Don't be surprised if their next move is to take this web channel global. For instance, while India has roughly 180 million television sets, the country has nearly 300 million smartphones which a global Roku Channel could potentially reach.
Bottom line is that 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 22 million users and a $5.75 billion market cap that narrows in on this staggering market trend. Compare this to Charter Communications, which has a $69 billion market cap and only 16 million users.
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 overabundance 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.
Disclosure: I am/we are long ROKU.
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: I am not a financial advisor (although should you need one, there are plenty to choose from). I am a tech evangelist and tech industry insider who writes about the underlying technology of public companies. Follow me if you want more information on technology trends and analysis.