Investing In The Roku Lifestyle?
The streaming lifestyle, it appears, is here to stay. If we weren't already glued to our couches before, the pandemic made damn sure that we slowly became integrated into our couch cushions while the dulcet tones of Carole Baskin blared out over the soundbar. Today, there are more options than ever to stream. You have the heavy hitters like Netflix, Amazon Prime, Hulu Live, HBO Max, YouTube TV and Disney+. Then you have the second class citizens of the streaming world like Peacock and Apple TV+ (though "Ted Lasso" seems to have vaulted this one to the top of most peoples' minds). You have tier three which includes the dross of the internet on Paramount+ and *shudder* Discovery+ .
Speaking of shuddering, you also have networks like Shudder for horror movies or Britbox for your favorite subtitled shows where they're allegedly speaking the same language. Next up, dig through 50 feet of shit and then you end up at the bottom of the barrel of streaming services. These are the ones I'm pretty sure not even the employees watch, and I'm looking at you Fubo TV, IMDBTV and Tubi. RIP to Quibi which would have been the shining gold turd in the punch bowl of this class, but luckily that one was dragged behind the woodshed in time to save the dignity of a few founders and even fewer investors. Hell, streaming has been around so long now that it even has a pretty established graveyard. Prayers up to BOOM and TCM Filmstruck, both services I had a personal hand in designing and launching in my 9-5 life several years ago.
But this begs the question: with so many streaming services available to the public nowadays, what's the best way to access them? You could drop $500 on an Xbox and have a horrible user interface to deal with. You could grab a device manufactured by one of the big guys like Amazon with their Fire Stick, but then you risk getting dragged into a custody battle like the only child in a divorce court. So where do you go? Well, plucky underdog Roku might have your answer.
Today, I'm going to take a look at Roku as both a device manufacturer as well as a recurring revenue business to see if this red-headed stepchild of the streaming industry is worth a look. Let's go!
Top-Line Numbers
2020 FY Revenue: $1.78 billion (+57.53% YoY)
2020 FY Net Income: -$17.51 million (+70.79% YoY)
2021 Q3 Revenue: $679.95 million (+50.54% YoY)
2021 Q3 Net Income: $68.94 million (+432.44% YoY)
Market Capitalization: $30.80 billion
What Is The Business?
As is standard practice for companies in the streaming game, Roku has a few different segments that drive their main sources of revenue:
Hardware sales
Platform revenue
Original content
Hardware Sales
Roku is a rare breed of streaming service in which they actually produce their own set-top boxes, referred to as OTT (over the top, as in over the television) products. This was the start of life at Roku, and their game originally was to provide low-cost ways to stream other services in your home. Since then, Roku devices have gotten a little more expensive, but have included new features like the ability to stream in 4K and faster chip-sets. They recently got back to their roots, however, when they announced an exclusive deal with Walmart to sell an entry-level $15 streaming stick, seemingly a shot across the bow of Amazon and Google alike. In Q3 of 2021, this segment generated approximately $97.4 million for the business and was their second largest revenue generator. As a fun side note, this business segment also includes the licensing agreements for the buttons on their remotes. They've even figured out how to monetize the remote!
Platform Revenue
This is actually the largest segment of Roku's revenue at present. This segment entails the software partnerships they have with television manufacturers, as well as the advertising therein. RokuOS, named "Roku TV" in their consumer facing materials, boasts an impressive 15 television manufacturer partners worldwide, and their OS also powers the set-top boxes I described a minute ago. According to The Motley Fool, the combination of the TV partners and proprietary set-top boxes has seen Roku leap to #1 in the United States for television operating system usage, capturing a 38% market share.
The volume of RokuOS users also begets extreme advertising revenue for the company, as they farm out the space within their app to external ad vendors and partners. This advertising and partnership revenue clocked in at a company-record $582.5 million in their Q3 earnings report, an 82% increase year-over-year.
Original Content
Curiously for a streaming service, this is the newest part of their business. I mentioned the dramatic implosion of Quibi in my intro, and Roku were the direct beneficiaries when they purchased all of Quibi's library (minus "Reno 911") for $100 million in 2021. I'll talk more about this in a minute.
How Did They Get Started?
Roku was started by maybe the only person ever born in England to attend Texas A&M University. That's one hell of a culture shock. Anyway, Anthony Wood is an electrical engineer who apparently has quite the entrepreneurial spirit. In the mid-1990's, he pioneered an invention called the "digital video recorder," or "DVR." Immediately this sparked a war between his company, ReplayTV, and TiVO that was ended in 2002 when Wood sold his company.
Wood went on to work at a small television and movie-based startup in California called Netflix, where he worked for awhile on their internal "Project Griffin." Project Griffin was reportedly Wood's side project that he managed to drag Netflix into as a principal investor. In 2007, Netflix, fearing issues around third-party licensing agreements, spun Project Griffin off into it's own company, named "Roku." But why Roku? Because "roku" is Japanese for "sixth," and Roku is the sixth company Wood had founded. Easy enough?
Since their spin-off in 2007, Roku continued to capture licensing agreements and advertising market share in the world of home televisions, which eventually culminated in enough momentum to go public in 2014. Since their IPO, the company has rocketed and made Wood a billionaire with his 27% ownership stake in the company, though the company is down from it's all time high in pretty dramatic fashion. Let's talk about how it might get back to those record levels sometime soon, starting with their global expansion.
The Bull Case
Worldwide Expansion
Roku, despite their impressive market share in the U.S, aren't resting on their laurels. They also boast a 31% market share in Canada and declared themselves the kings of streaming in Mexico. Now, it's time for Europe. The company is expanding with physical offices in northern Europe, establishing the newest building in The Netherlands to match their existing offices in the U.K, Ukraine and Denmark. Roku seems to be building on their position of strength and setting up the foundation to be able to more effectively distribute original content. What's that you say? Original content?
Original Content Production
Quibi nonsense, come on down! That's right, I told you it would be back. Using the Quibi back-catalog as a springboard, Roku is reportedly planning to produce more than 50 original content shows in the next two years to populate their exclusive Roku channel of their OS. This channel is free to users that have either a Roku OTT product or RokuOS in their televisions. But why is it free? The advertising!
We already talked about the amount of money Roku raked in with their advertising last quarter, but the filling out of the Roku Channel only serves to see that number balloon, and they're off to a good start. Their first original movie, "Zoey's Extraordinary Christmas," was nominated for a Critic's Choice Award and set all kinds of internal records for the company in terms of viewership on the channel. The future is looking bright for this segment of the business, assuming they continue to knock the cover off the ball with their content.
Traditional TV Continues to Lose
We've all heard about, and maybe even participated in, cord cutting of some type. The major carriers are bleeding users, with an estimated 52% of American consumers expected to have severed their relationship with the major TV carriers by the end of 2022. That's a massive number, which provides ample market opportunity for the streaming middle-class to move in. Netflix, Amazon Prime and Disney+ have already asserted their dominance in a majority of homes, regardless of if you have traditional television or not. It's the second tier of streaming providers that have a new opportunity to move in, and Roku is uniquely well positioned to be able to provide that access point to millions around the world, especially in the U.S market. As the rising tide of cord cutting continues to lift all streaming boats, consider Roku the Army Corps of Engineers that open and close the damn at will.
Recent Key Partnership Agreements
Actually, let's discuss some of those streaming partners. In the world of streaming, the participants don't always play nice. In order to allow access to streaming content from each provider, the companies have to enter a contract with each other than can often result in protracted nonsense bullshit. For instance, did you have a Fire Stick or FireTV when "The Office" made its high-profile move from Netflix to Peacock? Then you were SOL because Amazon and NBCUniversal didn't have a streaming contract, so Peacock was unavailable to you. Did you want to watch "Wonder Woman 2" last December for some reason and you were one of the 55 million Americans streaming their options through Roku? Sorry! AT&T (parent company of the HBO Max service) didn't have an agreement with Roku so you couldn't watch it, which honestly was for your benefit in this instance. WW2 was just awful.
I set all this up to say that Roku has now closed many of those gaps in their partnership agreements, the highest-profile of which is locking up a coveted multi-year deal with Google to continue access to YouTubeTV. This is beneficial from not only a revenue perspective (Roku stock popped 18% on the news), but also a PR perspective as it ends the long-standing feud between the two companies that threatened to boil over in October. PR might seem like a weird thing to highlight here, but a bad run of PR can dramatically affect your direct bottom-line results. Just ask Disney.
They've also secured some non-streaming partnerships which could make their advertising game a bit more interesting, including one with Shopify that allows merchants to build, run and measure connected TV ad campaigns. It's a fascinating partnership that directly takes on a company like The Trade Desk or Magnite, and could see advertising CPM's on Roku's platform explode in the coming years. To get a sense of just how many merchants are on the Shopify platform, you can read my deep dive into that company here.
The Valuation is Compelling (Finally)
For once with one of these things I can finally put valuation in the "win" column. Roku, at time of writing, is currently trading at $221. That's a staggering 50% off its all-time highs back in 2020 when the company rode the "stay at home" wave all the way up to $490. While the company has come back down to earth like their seat belt broke on Tower of Terror, the new trading levels for this company make it a compelling, albeit very strange, value play.
I'll touch on the infinite money-pit that is original content in a second, but their revenue is accelerating quarter-over-quarter and year-over-year, even when they stack their 2021 numbers up against the almost unfair comps of 2020. Their most recent earnings quarter saw revenue jump over 50% and net income skyrocket 432% over the same time in 2020. They're getting more effective and more efficient, but have still seen their shares beaten down over the last 12 months. Well, Wall Street has noticed. 22 Wall Street analysts have weighed in and the company is classified as a "Moderate Buy" by analysts with an average price target of $401, implying an 80% upside.
But big-bank and sell-side analysts aren't the only ones that have noticed. New age lightning rod investor Cathie Wood has waded into the conversation thanks to opening a position in her flagship ARKK fund. Roku now makes up about 5% of her fund, so she's betting big on the future of the company, but just don't look too hard at her recent track record.
The Bear Case
They're Late To The Original Content Game
So $100 million for Quibi's back catalog is a lot, right? In absolute terms, absolutely. In terms relative to their competitors? Not so much. Let's look at the king of the pride, Netflix.
Netflix has seen their budget for original content balloon since they began taking it seriously in 2013. The now-problematic Kevin Spacey led the service's first flagship series, "House of Cards," adapted from the British series, which was met with critical and audience acclaim. Netflix had proven that original content could be developed, and they inadvertently sparked an arms race that is spiraling out of control. How out of control you ask? Very!
2014 saw Netflix enter the market with an original content war-chest of about $3 billion. Since then, that number has skyrocketed to $17 billion in 2021, as reported by the company during their most recent earnings report. And that number isn't just spend on random content that won't perform. Their algorithm is so finely tuned that they know what works and they absolutely blast it. Netflix is adept at opening the checkbook to a variety of projects, each one performing better than the last. 2020 saw the unexpected hit "Tiger King," as well as award-darling "The Queen's Gambit."
"The Crown" cleaned up at this year's Emmy's, and the return of "Stranger Things" is one of the most hotly anticipated releases of the last few years thanks to COVID-related delays. The company also pumps out critical flops that consumers can't get enough of, like "Red Notice," the company's most watched film. They've also found success with international projects like "Lupin" and 2021's out-of-left-field explosive hit "Squid Game." The company can't stop, and won't stop, which puts Roku in a weird position.
We've already discussed that Roku's bread and butter is advertising and OTT, but does the foray into original content leave them in a precarious position? Even Netflix, with their seemingly unlimited balance sheet, has seen original content production creep up to nearly 50% of their annual spend. Roku's positioning in the landscape will be relatively minor at best, but the influx of new shows and content could see them setting money on fire unless the Roku TV channel is a smash hit and they can charge through the nose for advertising. It'll come down to batting average: Netflix can afford to bat like a minor league player because of the sheer volume of content they produce, with the success of the lesser number of hits outweighing the higher number of misses. Roku, in this belabored metaphor, will basically have to be Babe fucking Ruth in order to compete.
So what's the next production for Roku's original content channel? Apparently it's "This Old House," which I could bottle and use as a sleep aid. The only people that show is going to appeal to are those in their 90's and people on hospital beds with "locked in" syndrome.
The Bottom Line
Roku, it turns out, is an incredibly strange company. What started effectively as a hardware manufacturer has effectively pivoted into an ad-tech company with a side of streaming. They not only provide the access point to your favorite content, but they sell ads to you on top of that and are now looking to become your favorite source of content, despite some currently questionable content decisions. The company is taking their partnerships and operating system to the next level simultaneously, all while seeing revenue and income accelerate quarter-over-quarter. The company to me is a screaming "long" and thanks to those of you that requested this one so I could dig into it a bit more!
Short-term: Long
Long-term: Long
The following article is for entertainment purposes only, and should not be interpreted as investment advice. The article represents the opinion of the author, so please do your own research. For individual situations, please contact an investment and/or tax professional. The author does not an investment in Roku Inc.
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