Roku’s earnings report for Q3 is scheduled on a potentially volatile trading day depending on how the broader markets react to the mid-term elections. The uncertainty around this outcome, along with rising rates, geopolitical trade uncertainty, and a host of companies tempering their Q4 outlook has caused a style rotation, which has pummeled tech stocks. Regardless, Roku is a mid-cap tech stock that will continually prove itself against headwinds as the company is poised to become one of the most opportunistic growth stories in the market by 2023.
The reason for this is simple: connected TV advertising combines the high engagement of traditional television with the audience targeting capabilities of mobile. These two previously competing forces will combine to create the next advertising phenom, and Roku will emerge as the tech darling of this ever-important shift in ad dollars.
1. Pay TV Attrition is a Blood Bath
Pay TV has had better decades. The peak for Pay TV user growth in the United States occurred in 2011 when it began an inevitable erosion due to bloated, costly monthly packages, a lack of flexibility for on-demand, and advertising-stuffed programming choices. The following year, pay TV subscribers fell by 8,000 in 2012, which accelerated to 164,000 subscriber losses in 2014. Three years later, those losses grew 20x to a staggering 3 million subscribers (source: Leichtman). And by 2023, live-linear OTT video subscriptions will surpass traditional broadcast TV.
Cord-cutters have driven a formidable marketplace. In fact, the global OTT devices and services market will reach $165 billion in 2025 compared to $29 billion in 2015.
“All TV is now OTT” -ABI Research
Roku offers the most synonymous OTT 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. As of Q2 2018, if Roku were a traditional cable TV company, the 22 million active subscriber base would rival Comcast as second largest distributor of content in the United States. Only AT&T has more with 47 million DirecTV subscribers. Compare this to Charter Communications, which has a $65 billion market cap and only 16 million users or Comcast with a $171 billion market cap with the aforementioned 22 million subscribers. Roku’s market cap is at $6 billion with shares priced at $56 with the same number of users as Comcast.
2. The Next Phenom in Tech is Connected TV Advertising
While I expect Roku to experience some volatility on its path to becoming a large cap stock, specific industry trends are supporting Roku. Previously on Seeking Alpha, I've covered how Roku is vendor agnostic, the company's global potential, and player vs. platform revenue. Connected TV advertising, however, is the most important piece for Roku's trajectory.
Bear with me here as I talk about some of the problems and technicalities in the advertising industry, and why Roku is well positioned.
As Digiday puts it, “Two of the big trends in digital media aren’t compatible: The drive to enforce viewability standards and the shift to mobile, particularly apps.”
Viewability issues are a serious issue for big brands who are averse to mobile in-app advertising because it’s too challenging to track. In addition, many big brands do not need immediate purchases which is called “purchase intent” – and is mobile’s main value over television.
For instance, Coca-Cola doesn’t expect you to buy a soda immediately after seeing an ad. Audi doesn’t expect you to buy a car immediately either. So, a lot of the benefits of mobile aren’t worth the downside of obscured metrics to these big brands. Advertising budgets shifted to mobile because they had to find audiences, not because it’s a superior method to advertise.
Here’s how the two compare:
- Pay TV has high completion rates as viewers are comfortable in their homes and better prepared to receive advertisements.
- There are no viewability issues as the screen is designed for a full-width advertisement. This means 100% viewability.
- Viewers are engaged for lengthy periods of time and want to see the show. Engagement in this setting is far superior to mobile.
- Mobile offers audience data to better target viewers based on individual preferences.
- Mobile has better purchase intent for advertisers who want an immediate purchase.
- Dynamic ad insertion allows an advertisement to be inserted based on personalized interests. (So, I may see a different ad than what you will see).
- Mobile has poor viewability and engagement and offers little transparency on these metrics. This is paramount for ad executives who need to measure for budget allocation purposes.
Connected TV advertising, which is Roku's specialty, combines the best of both television and mobile. It offers 100% viewability and completion rates with the audience data and dynamic ad insertion found on mobile. Forbes covered this in a recent article which stated Ad Supported OTT is the future reporting OTT ads have a 97% completion rate and 100% viewability.
In a recent study by FreeWheel, 200 billion video starts found OTT ads had ballooned from 2% to 32% in a four-year period due to heavier investments from advertisers.
In the Q2 2018 Video Advertising benchmark study released by Extreme Reach, a tech platform for video ad campaigns, connected TV impressions overtook mobile, accounting for 38 percent of all video ad impressions down from 33 percent in Q1.
Here’s a quote from Extreme Reach:
“CTV is clearly on the path to becoming the dominant platform for media consumption, and premium inventory is the most sure-fire audience draw.”
- Mary Vestewig, Senior Director, Video Account Management at Extreme Reach.
AppNexus, the world’s leading independent advertising technology company, announced in July of 2018 that advertiser spend in its connected TV marketplace grew 748% year-over-year versus the second quarter of 2017 and 68% quarter-over-quarter. AppNexus currently sees 20 billion monthly connected TV impressions per month.
From an investment standpoint, the implications of attracting more big brand advertising dollars than mobile is enormous. Big brand budgets have been looking for a solution to traditional television that isn’t confined to the attention span and limited screen size of mobile viewers. With Roku, that option is finally here.
3. Subscriptions are Saturated
Subscription video-on-demand (SVOD) comprises 40 percent of the OTT market with the majority of the revenue coming from the United States. By 2022, SVOD penetration will be 132% of US TV households with many homes having more than one SVOD platform.
Total SVOD is expected to reach 171 million by 2022 – up from 59 million in 2016 reflecting a 53% increase.
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. For definition purposes, Netflix is original content and something Roku or Amazon Prime offers is considered catalog programming.
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).
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, Apple, and now Disney developing its own channel for 2019, 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 OTT will continue to be a solid choice for viewers.
Roku is executing on a market trend that will defy typical growth trajectories. Brand budgets are migrating towards Connected TV as a superior method of advertising over mobile. The Roku Channel launched in October 2017 and is already a top 5 channel by active account research. Investors should keep a close eye on platform revenue, which was up 96% YoY to $90.3 million in Q2. The trailing 12-month ARPU in Q2 increased 48% YoY to $16.60 and was "driven by strong growth in video advertising as we continue to capture more share of TV ad budgets," as the company stated in their shareholder letter. Due to connected TV advertising trajectories, I am long on Roku for the next 3-5 years.
All analysis contained herein should be appropriately credited to Beth Kindig.
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.