This is not investment advice. Do your own research before taking a position in any of the securities mentioned in the post below.
What do they do - ICYMI
Roku makes digital media player hardware in the US; with operations in North America, Brazil, Mexico, UK and smaller operations elsewhere. Their claim to fame was offering streaming media content, via their Netflix co-lab in 2008, where they essential turn old-world TVs into 'smart TVs'.They monetise by showing ads, to support independent channels, cable & others. Their hardware partnerships are shown below
Overview - what's my value-add vs. consensus
Currently, 25 analysts are covering Roku Inc.– with a consensus price target of US$452 (vs. the last close of $313). Given how deeply covered this business is; the question you need to ask yourself is:
What collective insight/pitfalls do these analysts have in their valuation
Is there a catalyst for the pricing of Roku; which might make it worthwhile to consider?
Is a change in earnings structural or temporary
Insight/pitfalls - Comcast & Vizio are growing... but forget them. YouTube is the threat
Looking over a suite of presentations/broker reports, there are a few generalisations that can be made:
Roku is a hardware business: Despite creating a platform (c.85% of earnings) to provide TV on demand - their model is to sell the hardware. Their boxes are loss-leaders (e.g. like gaming consoles) but even then they have been impacted by recent supply chain constraints
For Ads - time slots matter: Evidently, there is a link between captive users & primetime, however, monetisation is many multiples larger for Roku in prime time slots. Theoretically, if everyone watched Roku during the day & switched to Youtube in prime time; their monetisation would fall materially
Non-US scale: Whilst the US is a huge captive market, the lack of traction in its international exposure, relative to its size, is my major red flag. Yes, the company has signed partnership agreements in Brazil/Mexico, however, these business units are yet to truly monetise
Privacy edge: Alot of users choose Roku because they are seen to be data-neutral. Historically, consumers have opted for product over privacy, however, this is an interesting point of difference
Brokers are divided on the competition: Most analysts are generally focussing on Vizio (growing) and Comcast (new), however, I consider the biggest threat is really Youtube. Their competitor landscape is set out as
mega-cap tech (AMZN, GOOGL, AAPL)
TV OEMs (Samsung, LG, VIZIO)
Newer entrants such as Comcast
Compared to Apple, Google's well-documented fights with the Roku platform is evidence of their intention to be a dominant OS.
Youtube's insane ad growth
Vizio - A growing relative threat but smaller user base & ARPU
As you Comcast - I think the issue is that they are focusing on selling it to people (via. the label Xfinity Flex) who have their internet. Whilst this quite a popular internet package; I think it is a barrier to them being a true Roku competitor.
Pricing catalyst - Revenue multiples are high but so too is Rev growth outlook
Recent price dip: ROKU share price is down more +30% off its previous high just a few months ago. However, do not forget they have had a good run; up 12x from IPO and their multiple is 18x sales (vs. 5x sales at IPO in 2015; before Andreesen hopped into the company)
There is a cap on ARPU vs. Netflix: Fundamentally, Roku is closer to a Visa than an Amex. Insofar as the unit economics goes to Netflix (the Amex); yet the platform 'moat' is stronger. For example, even though Roku ARPU (Revenue per unit) grew +46% to $36.5 in Jun'21 (expected to break $41 per above). Yet - this is way less than Netflix ARPU of $175.
That being said; there is far less 'content' risk with Roku vs. Netflix so the valuation parameters for Roku are arguably easier to estimate. In short - you don't need to pray for the next "Squid Games" to come along
Margins are stable/solid: It earns gross margins of c.65% and whilst longer-term EBIT margins are harder to estimate (due to its spend on partnerships/hardware) consensus is around11-13%
Topline growth overseas is key: Roku and TCL have worked together since 2014. TCL wanted an income share agreement, but Roku refused. That's why TCL introduced Android TVs in 2020. Both companies have an intertwined operation (TCL is Roku's ticket overseas, Roku gives TCL a big % of sales) so they won't cut ties immediately, but the lack of monetisation of the international expansion is evidence that Roku needs to diversify OEMs beyond TCL overseas and double-down on its international investment.
Other income: For big influencers/companies, there may be a revenue share agreement that could improve the Roku economics. I consider this an upside that is too early to value for Roku but it has clearly worked for YouTube & should not be forgotten
So without going into immense detail about my valuation; yes there has been a dip in share price, however, it is relative to the weakness of their international expansion & from record revenue multiples. I would consider it is reasonable to assume
Revenue growth should grow c.30-40%; with a cap on ARPU vs. content providers
Gross margin of 65-70% with big costs running through (e.g. 11-13% EBIT margin)
This should yield an ROE of c.15-20% assuming limited further dilution
Personally, I think the unit economics, lack of international traction & Youtube competition is too much to adopt such a multiple. That being said, my valuation of c.$300 p/share reflects that the long-term outlook of advertising TV on-demand is too appealing to completely discount Roku
Is the earnings drop temporary or structural?
When I say earnings drop;this is a minor blip compared to Q1'21; set out below
Multiple income streams = stability: Roku has a unique position in the streaming world, as it has three streams of revenue: AVOD, SVOD and hardware. This provides it with a bigger safety net than most of the comp (even if the hardware itself is not a massive driver).
Future income streams = not an upside; more a reason why growth won't slow : They have experimented with a number of other income sources - Roku Originals and a subscription-based channel (This Old House) and Roku Shopping. My feeling is that this is a reason to believe +30% revenue growth continuing as opposed to a reason to adopt more aggressive revenue forecasts
Privacy may be a point of difference: Unlike Google and Amazon, which are seen as the biggest competitors of Roku, Roku is yet to have a privacy breach/concern. That being said - it has access to a huge amount of data on its platforms so it is difficult to conclude that this is an 'edge'
Rising tide will lift Roku: Even if Roku hits snags with a) new LATAM expansions b) new product types or c) Youtube customer acquisition, I think the tailwinds behind the AVOD market and their dominant market position are too strong to be structurally concerned.
In conclusion, whilst I think the threat of Youtube cannot be discounted; the tailwind supporting growth in AVOD and Roku's strong market share are big factors in their favour. I think the recent share dip reflects more competition and lack of traction outside of the US; but it is not an area for concern for longer-term holders.
For longer-term investors, I think the primary focus should be on a) your entry multiple; which is high today b) the monetisation of prime-time ad timeslots and c) the growth in other income sources (e.g. shopping and subscription services). I think these "effectiveness" factors are more important than the companies efficiency (e.g. ROE, Sales staff efficiency etc) for now. Once the race for AVOD dominance has calmed; shareholders can look for buybacks and strong ROE, but not before
Comments