Streaming has taken the media world by storm over the past decade with Netflix Inc. (NFLX, Financial) taking the charge in 2007. Since then, streaming channels and smart TV platforms have proliferated and put linear TV channels at risk of extinction. One of the pioneers of this streaming world has been Roku Inc. (ROKU, Financial).
Its streaming platform allows users to find and access a variety of TV shows, movies, news and sports programs. The company provides digital advertising and related services as well as content distribution services. Roku also manufactures, sells and licenses smart TVs under the Roku TV name. Other devices include streaming players, audio products and smart home products and accessories.
By some measurements, Roku’s market share is very high. In a recent survey, industry trade journal Cord Cutter News found that more than 70% of consumers who are dropping their cable or satellite service use a Roku device and stated, “Roku is the clear leader in the world of cord cutting and is almost twice as popular as its next competitor.”
In terms of smart TV market share, the Roku operating system was the number one selling smart TV operating system in the U.S. The company’s 38% share of units sold in the fourth quarter of 2022 was more than the next two largest TV OSs combined. Internationally, the Roku OS was the top-selling smart TV OS in Canada and in Mexico, where market share grew to 30% of units sold.
Founded in 2002, the company currently has a market capitalization of $9.2 billion.
Financial review
Roku falls under the category of companies who have never made money, and may never make money, at least according to GAAP net profit standards. For the fourth quarter of 2022, the company reported on Feb. 15 that platform revenue increased 5%, but device revenue declined 18%. The platform gross margin was a software-like margin at 55.8%, but the device gross margin was -32.1%. Loss from operations was $250 million and adjusted Ebitda was -$11.6 million. The levels of stock compensation are atrocious and came in at $104 million for the quarter, which represented 17% of operating expenses.
The free cash flow story for the year was also not great as operating cash flow was $11.8 million, but capital expenditures were $161.7 million, creating a large burn rate for the year. Luckily, the balance sheet remains strong with almost $2 billion in cash and no long-term debt.
Other metrics seem decent but somewhat meaningless unless the company can generate improved margins on improving metrics. For 2022, active accounts reached 70 million, which was a net increase of 9.9 million accounts from the prior year. Streaming hours increased by 14.3 billion hours to 87.4 billion for the year. Average revenue per user grew to $41.68, which was up 2% compared to the prior year. With operating expenses increasing 71% in the fourth quarter, one would think the ARPU growth would need to have increased significantly.
Valuation
There are no positive GAAP earnings estimates for the foreseeable future and the company is even forecasting negative Ebitda for the first quarter of 2023. Price-to-revenue and relative valuations are the last refuge for investors trying to value money-losing companies. Roku sells at roughly 2.3 times 2023 revenue estimates. This compares to standalone streaming companies at 1.5 times, SaaS companies at 5.7 times and general media companies at 2.2 times revenue. The average of those three sectors is 3.1 times, which may make Roku undervalued on a relative basis. However, relative valuations are fraught with risks as in a market downturn, all stocks can go down, along with the relative valuation.
The company pays no dividend and does not buy back shares.
The average price target for Roku stock by 21 analysts that cover the company is $71.78. The highest price target is $90 and the lowest is $36.
Guru trades
Gurus that have purchased Roku stock or added to their positions include Catherine Wood (Trades, Portfolio) and Jim Simons (Trades, Portfolio)' Renaissance Technologies. Investors who have sold out of or reduced their positions include Joel Greenblatt (Trades, Portfolio), Baillie Gifford (Trades, Portfolio) and Paul Tudor Jones (Trades, Portfolio).
Summary
Roku certainly has the pedigree and history to be a successful stock in the new streaming world, but still faces headwinds. A recession will negatively impact the advertising market and, therefore, affect a major revenue stream for the company. Ad-related views may also shift away from ad-supported content and move toward subscription only. Lastly, the competition among streaming channels and smart TV platforms is intense and does not seem to be abating.
However, the company does have strong brand recognition and the continual launch of new Roku smarts TVs should help drive higher levels of subscriptions. The macro shift to digital advertising should also benefit the company.
Nonetheless, the company needs to accelerate the efforts to generate free cash flow or the stock will likely be rangebound. That prospect is still several years away, so there is potential for more downside ahead for Roku's stock.
