Monday, December 4, 2017

Roku, Next Big Tech Flop or Opportunity?

Roku, Next Big Tech Flop or Opportunity?
By: Michael Molman

            Tech stocks are partying like its 1999, the Nasdaq is up nearly 30% this year, billion dollar startups are attracting capital at the greatest rate since the dot com crash and it’s been the busiest year globally for new stock listings since 2007, with 1,450 companies listing shares (mostly in Asia). Amidst this booming market several high-profile companies have opted to go public, some like Snap and Blue Apron were enormous flops but the average new listing in the U.S is up 32%. One company that has been especially volatile since its IPO has been Roku.
            Roku was one of the first companies involved in the now booming streaming business, and is mostly known for selling small plug in boxes allowing people to stream web content like Netflix and Hulu directly on their T.V. When it went public on September 28th, Roku stock surged 68% to $23.50 a share making it the best performing new listing of the year. Unfortunately, the party did not last long, over the course of the next 5 weeks Roku stock was pummeled on concerns that it would not be able to compete with the likes of Amazon and Apple who had entered the hardware streaming business. Shares hit an all-time low of just above $18, leading up to the company’s 1st earnings report on November 8th. However, Roku’s fortunes changed again as soon as its announced its 3rd quarter earnings which showed how the hardware maker was diversifying. Shares surged over 100% in three days to an all-time high of $48.80. Since then the stock cooled off somewhat but remains volatile. Question is, does Roku deserve a place in your portfolio or is it just another overpriced and over hyped tech stock.

Roku Stock since it went public on September 28th to December 4th. Shares surged over 100% post earnings.
Roku has long been an industry leader when it came to selling internet T.V gadgets, the rise of internet streaming and popularity of services like Netflix made Roku a player in an exciting and growing new field. The problem is the rise of internet T.V has attracted some large players. Roku, a company with a current valuation of just over $3 billion, must compete with the likes of Apple worth almost $900 billion and its Apple T.V as well as Amazon and its Fire Stick, not to mention competition from gaming consoles like Microsoft’s Xbox and Sony’s Play station, which also gives people the ability to stream internet content on their T. V’s. Investors and analysts have long been concerned that Roku would not be able to compete against these tech giants.
So, far Roku has been proving analysts wrong, despite the introduction of new competition Roku has maintained its top position in the market place. In its most recent quarter Roku reported that it sold 35% more units then it did in the same period in 2016. The streaming hardware market also has plenty of room to grow, with only a third of U.S households with internet access reporting that they own a streaming video device. The continued growth of web streaming, and the acceleration of cord cutting (people canceling their cable subscriptions in favor of web streaming services) will continue to benefit Roku in the future.
 Chart showing market share of streaming media players in U.S households. Despite the Introduction of new competitors Roku continues to control the largest percentage of the market.

            Despite being able to continue selling streaming devices in the face of stiff competition, the introduction of competing streaming devices has depressed margins in Roku’s hardware business. Despite unit sales increasing 35% in the 3rd quarter hardware revenue increased only 4% and unit gross profit fell 18.6%. This is another major concern for analysts because unlike larger competitors like Apple who have billions in the bank and can withstand lower margins, Roku cannot. In response Roku is changing its business model, from one that focuses on selling hardware to one that focuses on platform sales. Roku’s plan for continued growth involves selling web subscriptions and advertisements to customers through its T.V gadgets.
            On the surface, this is a great idea since Roku simply does not have the size to compete against the larger tech giants. However, switching from being a company reliant on hardware sales to one focused on software and platform sales is not as easy as it sounds. GoPro and Fitbit, both hyped and flashy companies that had great market debuts have tried unsuccessfully to do so. Both companies are languishing due to heavy competition, sound familiar? Even mighty Apple has had difficulty diversifying outside hardware, with attempts to sell iPhone users on various subscriptions through the platform, not contributing much to Apple’s bottom line. (Alternate revenue streams only make up 16% of Apple’s revenue).
            So far Roku’s ambitions to diversify are proving more successful. In its most recent quarter Roku’s platform sales increased more than 137% from the same period last year to $57.5 million (total revenue was $124.8 million). Platform sales now account for 46% of total sales and 89% of gross profit, this makes sense since platform sales have a gross margin of over 75%. Roku’s user base also continues to increase 42% annually and average revenue per user grew 37%. In addition to selling web subscriptions and advertisements on its platform, Roku has also been licensing its software to smart T.V. makers. This is a big deal considering smart T. V. continue to grab a larger percentage of the total T.V. market. All this means that Roku is fulfilling its promise to diversify away from hardware and focus on other revenue streams. It is easy to see why its stock surged so much post earnings.
            The question is where to go from here? More than 1 million shares of Roku have been shorted since November 8th and short positions now compromise 31% of the company’s total float. Clearly many investors still believe Roku cannot possibly compete against the likes of Amazon, Apple or Google and many see the recent stock gains as unsustainable. This is fair, many people think that Roku’s devices are at a disadvantage since consumers will prefer to link their T. V’s to their other devices, like Amazon Echo home assistance or Apple’s iPhone and iPad. Also, a small but growing minority of young people are opting not to buy a T.V at all and instead watch shows and movies from their laptops and tablets, cutting Roku out of the streaming picture completely. Another potential problem could come from the streaming services themselves. Roku’s business model of selling web subscriptions depends on streaming services like Netflix and Hulu sharing a percentage of their streaming revenue they receive from Roku users. Basically, when a Roku user signs up for a Netflix subscription Roku receives a percentage of that subscription revenue. This model could be at risk as more and more companies enter the hardware streaming space allowing streaming services to negotiate better deals when it comes to sharing subscription revenue.
            Despite these negatives, Roku is still one of the only pure play options for investors hoping to gain exposure to the booming business of web T.V. By cutting prices of its signature units and focusing on growing a user base to which it can sell web subscriptions and advertising, Roku has been able to compete against far larger competitors. The market for internet T.V. gadgets still has plenty of room to grow and if Roku can continue selling its devices and continue growing its user base the stock has the potential to defy the bears and continue surging.

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Disclaimer: This material has been written for informational purposes only, it should not be considered as investment advice. Any investment decision should be made after consulting multiple sources and a financial advisor.