Roku: Executing Well In A Tough Environment

Even though the year to date has seen strong rallies in many tech stocks, many iconic brands remain deep underwater and well below their all-time highs. Investor sentiment has not been very forgiving of growth stocks, where even the smallest slips resulted in huge stock losses.

Year (NASDAQ:YEAR) is an action worth watching during this recovery. The streaming device company has suffered over the past year as slowing advertising has hurt its services platform, and falling hardware sales have investors worried about slowing expansion from the Roku install base. Up over 30% this year, Roku is still down over 65% over the past year – and I think there’s still plenty of steam left for a rebound.

I’m moving my Roku recommendation to very optimisticand up to hold onto my position this year amid a rapid rally, I also added more to my upside holdings. I think expectations on Roku have reset to historic lows, and Roku’s ability to perform well in the face of reduced expectations will be a major catalyst for the title in 2023.

Here is my full long-term case for Roku:

• Roku has done a great job of shifting its business primarily to a services/platform model. At one point, Roku’s revenue split between its low-margin hardware players and its platform revenue was closer to 50/50; now, hardware accounts for less than 20% of Roku’s overall revenue. This increased Roku’s overall gross margins and paved the way for profitability.
• Beneficial services flywheel. The Roku platform is broad, serving as the entertainment hub for all of a consumer’s services. Roku derives both advertising revenue from the free content it serves on its platform and distribution revenue from displaying the content on its homepages. In other words, the monetization capacity of Roku’s platform is vast.
• Advertising spending has yet to keep up with cord-cutting spending. Advertisers have been slower to switch from “linear” TV to streaming than consumers. Roku notes that while 45% of US adult entertainment is provided by streaming services, US companies spend only 18% of their advertising budgets on streaming. So it’s not just consumers’ centuries-old shift from traditional TV to streaming that will benefit Roku; but as advertising strategies also evolve, Roku’s wallet share will increase.
• Active accounts and streaming hours continue to grow. Although the growth rates have certainly slowed from the immediate boost that the pandemic has brought, Roku continues to show steady growth in active accounts and streaming hours, bolstering its monetization capabilities.
• International push. Roku has recently set its sights on aggressive overseas expansion, with recent openings in the UK, Canada and Mexico – representing the company’s next stage of growth.
• Smart home. We’ll discuss that in more detail in this article, but Roku’s push into home cameras and lighting is giving the company not only a new stream of hardware revenue, but a new subscription offering as well.

Roku will then release earnings on Wednesday, February 15. It’s a prudent move, in my opinion, to add to Roku ahead of earnings (as the stock has been off year-to-date highs and the market is eagerly awaiting results). Stay a long time here.

Positive reading from other streamers

First, while earnings reports from other streaming companies don’t necessarily translate to Roku, I think there’s still a positive reading we can take from Netflix’s earnings.

The company added 7.66 million net new subscribers in the fourth quarter (see market breakdown above, with the large, high-ARPU market of the United States and Canada seeing impressive 10% year-over-year growth in a difficult macroeconomic context), far from above internal company expectations of 4.5 million adds and less optimistic Wall Street consensus of 4.1 million adds.

Based on these results, we can hope that Roku also benefited from an increase in streaming activity on its own platform.

Against macro headwinds, Roku still performs well

Here’s the reality we have to deal with: Roku is facing a difficult macroeconomic environment, especially in the advertising space. Companies are tightening their belts, and especially when consumer spending is expected to decline, the propensity to go all out on advertising budgets is much lower.

That being said, Roku made further progress on several key metrics in its most recent reported quarter (Q3, the September quarter). Active accounts have increased by 16% per year and streaming hours have increased by 21% per year, indicating that user engagement is still high. Note that Netflix significantly accelerated net additions in Q4 (from a net loss of 1 million subscribers in Q2, to an addition of 2.4 million subscribers in Q3, to an addition of 7.7 million in the fourth quarter) – so we can hope that Roku exhibits similar behavior when it releases its fourth quarter results.

Additionally, platform revenue is still up 15% year-over-year, despite much of that revenue coming from advertising which is down sharply. The chart below, taken from Roku’s latest shareholder letter, shows that traditional TV “ad-streaming” spend was down -38% YoY in the US:

The company notes that player sales remain well above pre-COVID levels. He expects continued headwinds on advertising in the current environment, but Roku is seizing this opportunity, like many other tech companies, to streamline its workforce and focus on profitability. According to CFO Steve Louden’s remarks on the Call for third quarter results:

Meanwhile, unit sales of Roku players remained above pre-COVID levels and the average selling price was down 6% year-over-year as we continue to protect consumers from higher costs to prioritize account acquisition. Roku users streamed 21.9 billion hours in the quarter, a 21% year-over-year increase as we continue to outpace growth in TV viewing hours traditional. […]

For our Player business, we expect sales to decline year over year and margins to be significantly lower sequentially, primarily due to traditional holiday promotional pricing. For our platform business, we expect these macro pressures to offset what would normally be seasonal tailwinds, and as a result, our platform revenue will be slightly lower on a sequential basis. Additionally, our Q4 player and platform revenue is typically loaded in the back-end, which further reduces our visibility.

As we indicated last quarter, we will continue to slow headcount and operating expense growth in response to the macroeconomic environment, while continuing to make disciplined investments in our most strategic project which will grow both the market penetration of our platform and the long-term customer value. .”

Smart home opportunity

Beyond the short term, I’m also drawn to Roku’s ambitions to become a more complete smart home offering. Roku recently launched a new line of product offerings in this category, centered around a Roku Indoor Camera ($27), Video Doorbell ($80) and Smart Lights (2-packs from $18).

It’s less about immediate material revenue, in my opinion, and more about the potential to attract more subscribers, especially with security products.

As shown in the table above, the company offers subscription plans starting at $3/month that provide cloud video storage for these security recordings, from Arlo (ARLO) playbook. While it’s still too early to tell how much traction Roku will get from these new products, I think it’s a promising move that will boost revenue for Roku’s higher-margin services.

Key points to remember

On top of that, we’ll also remind investors that Roku is pretty well written off from a balance sheet perspective, with $2.02 billion in cash (and only minor debt of $82 million). With ample capitalization, new service revenue streams, and steady platform revenue growth in a tough advertising market, I believe Roku is well positioned to weather the current downturn.