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Roku: An Expanding Ecosystem, Valuation Is Still High
Stock Analysis & Ideas

Roku: An Expanding Ecosystem, Valuation Is Still High

Roku (ROKU) is the prominent TV streaming platform in the U.S. by hours streamed. The company aims to be the streaming platform that unites the entire TV ecosystem of viewers, content publishers, and advertisers.

Through its TV streaming platform, Roku is focused on enabling consumers to access the entertainment they love, empowering content publishers to organize and monetize large audiences, and providing advertisers with its unparalleled capabilities to engage viewers. In other words, this is a case of an all-in-one TV ecosystem. I am neutral on ROKU. (See Analysts’ Top Stocks on TipRanks)

The Business Model

With the streaming industry becoming increasingly saturated by the quarter, it’s important to understand Roku’s business model, which can be broken down into three parts.

Scale: Growing the Number of Active Accounts

Roku’s scaling strategy involves offering an affordable lineup of stand-alone streaming players that connect to a user’s TV. Moreover, to improve its users’ experience and to implement an enhanced audio experience, the company also offers its Roku Smart Soundbars and Roku Streambars. The Streambar enables the Soundbar to connect to its streaming platform. Again, affordability is key here.

Engagement: Increasing Streaming Hours

In line with every streaming platform’s primary goal, other than growing its user base, is growing the total streaming hours. By offering users a broad range of content and richer streaming experience, Roku achieves higher user engagement. Streaming hours on Roku’s platform grew from 37.8 billion hours in 2019 to 58.7 billion hours in 2020.

Monetization: How Does Roku Make Money?

Roku generates revenue by monetizing its users’ engagement on its platform in a variety of ways. This includes video advertising in ad-supported channels, subscription services, and other brand sponsorship and promotions.

Therefore, each individual user on Roku’s platform is able to generate unique revenue pathways for the company based on whether they’re buying content, enjoying ad-supported content, or simply opening the Roku home page.

Growth and Margins

Roku’s business model clearly does have a place in the steaming industry, despite the overall saturation. The company’s revenues have been growing by the quarter. Its LTM (Last-Twelve-Month) revenues stand at approximately $2.3 billion, and its 3-year TTM (Trailing-Twelve-Month) revenue CAGR (Compound Annual Growth Rate) stands at 56.5%, and is accelerating.

With scale, Roku’s margins have also been expanding. Gross margins have grown from around 30% to over 50% in the past four-and-a-half years, while net margins have climbed from -25% to over 10% during that same period.

However, keep in mind that Roku’s margins are fundamentally expected to be compressed, as the company does not produce any of the content itself.

Wall Street’s Take

Turning to Wall Street, ROKU has a Strong Buy consensus rating, based on 13 Buys, two Holds, and one Sell assigned in the past three months. At $462.50, the average ROKU price target implies 43.1% upside potential.

Valuation & Final Thoughts

Following Roku’s gradual growth and ongoing margin expansion, the stock’s valuation has also been expanding. Roku went from trading at a forward price-to-sales ratio of around 7x in 2018-19 to around 13x currently, despite the stock’s recent decline.

While this makes sense from a margins expansion perspective, the stock seems to be pricy from a P/E perspective, regardless. Roku is trading with a forward P/E of about 178x. The company is expected to grow its earnings per share rapidly in the medium term, which may justify the current multiple.

Still, for a company that does not own/produce the content catalog but instead provides the distribution, I wouldn’t buy at the current valuation levels. For this reason, I am neutral on the stock, though I appreciate the company’s potential to be the leading TV content distributor in the long run.

Disclosure: At the time of publication, Nikolaos Sismanis did not have a position in any of the securities mentioned in this article.

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