There are a lot of things to like about the largest TV-based on-demand streaming platform in the US, starting with its dramatic business growth thanks to the global shift from linear TV to over-the-top (“OTT”) streaming services. The company is consistently delivering powerful top and bottom-line growth, driven by an increasing number of users and higher advertising revenues. It’s also taking initiative to expand into international geographies (to fuel more growth), and it enjoys a very large and expanding total addressable market opportunity. In this report, we review the business, growth, its unique selling opportunity, the financials, valuation and risks. We conclude with our opinion on investing.

Roku (ROKU)

*The purple line is ROKU, total returns. Source: YCharts*

Roku provides streaming players, audio devices, operating system, and accessories that enable users to access over 4,000 free and paid Over-the-Top (OTT) streaming services on their televisions. It also acts as a platform assisting leading content providers such as Netflix and Hulu in engaging and monetizing large audiences. Additionally, it offers advertisers ad inventory and data-driven ad capabilities on its platform to execute a more targeted ad-campaign. Leveraging secular tailwinds arising from a shift towards video-on-demand services for content consumption rather than cord-based traditional television, Roku has consistently delivered strong revenue growth over the last few years. Further, after securing a market leading position in the US, the company is now taking initiatives to expand internationally.

Overview

Roku, Inc. is the largest TV-based on-demand streaming platform in the US. It allows users to access online media content from several streaming services including Netflix, Hulu, HBO, Disney+, Amazon Prime Video, and many others directly on their TV. Users can stream over 500K free and paid movies and TV episodes through the hardware devices such as Roku box and Roku streaming sticks that the company sells or via its built-in software platform for smart TVs. As of Q1 2021, the company had 53.6 million active accounts globally and its users streamed 18.3 billion hours during the latest quarter.

The company operates its business under 2 primary segments: -

Platform Segment: This is Roku’s largest segment and includes revenue generated from multiple sources including advertising sales on its platform, revenue sharing arrangement with content partners including share of streaming service subscriptions, licensing arrangement with TV manufacturers to use in-built Roku software platform, sale of audience data for improved targeted advertisements and many others. The segment contributes 80% to the total top-line of the company.

Player Segment: This segment includes one-time sale of hardware products through which users can access company’s OTT platform. Products offered comprise of streaming players and audio devices including streaming sticks, wireless speakers, smart soundbars, and wireless subwoofers that are sold through retailers such as Amazon, Walmart, etc. This segment contributes 20% of the company’s revenue however the segment’s gross profit margin is low given hardware sales make up most of its sales.

Geographically, it derives over 90% of its total revenue from the US, however, the company has been taking initiatives to expand internationally through launch of Smart TVs and other hardware products.

While Roku allows its users to access several streaming services on a single platform, it also allows content providers to engage users and monetize their content. More recently, the company has seen significant interest from advertisers due to the global shift in advertising from linear TV to on-demand streaming services for better targeting and return on marketing investments. While this shift has been taking place even before the pandemic, lockdown restrictions have accelerated this transformation. This is evidenced by 23% YoY growth in average time spent on subscription-based OTT video-on-demand content in US in 2020 as compared to just 15% YoY growth in 2019 as per eMarketer. To capitalize on this trend, Roku is taking initiatives to further strengthen its platform to attract more advertisers and establish itself as a leader. In 2019, it acquired Dataxu, a software company that helps marketing professionals use data to improve their advertising, and more recently in April 2021, it announced the acquisition of Nielsen’s Advanced Video Advertising (AVA), including Nielsen’s video automatic content recognition (ACR) and dynamic ad insertion (DAI) technologies. This will assist marketers and advertisers in deploying data-driven advertisements in real-time on Roku’s platform and will offer them an opportunity to engage and monetize large audiences.

Large and growing Total Addressable Market (TAM)

As per emarketer.com, US Connected TV (CTV) ad-spending, which includes ads appearing on home screens and in-stream video ads (that appear on CTVs from platforms like Roku), is expected to grow at almost 49% YoY to reach $13.4B by the end of this year. Despite outsized growth in recent years, Roku’s market penetration remains low based on its platform segment TTM revenue. As per the same research, the US CTV ad market is expected to reach $25B by 2024, growing at a 3 year CAGR of approximately 23%. Though the majority of its topline comes from its platform segment with ad-based revenue being the primary source, Roku has multiple other sources of revenue that further expand the long term opportunity. Moreover, as the company enters into international geographies, we expect its TAM to grow significantly.

Investments in Roku TV and Roku Channel have sowed the seeds for long-term growth

While the global shift from traditional cord-based televisions to Connected TVs (CTVs) has provided significant tailwinds to Roku, we believe the company’s strategic initiatives have played a major role in capturing this growth. In late 2014, Roku became the first streaming hardware company to license its Operating System (OS) to affordable TV manufacturers (such as TCL, Hisense, Element, Insignia, and others) to be directly installed in their TV units. Since then, this partnership has turned out to be a major catalyst resulting in strong business growth for both TV manufacturers as well as Roku. While premium brands such as Samsung and LG continue to dominate the Smart TV market in the US, Roku’s budget-conscious TV partners have been consistently gaining market share in recent years. As per the lec.net, TCL and Hisense global TV shipment sales in FY 2020 grew almost 18.5% and 16.5% YoY respectively more than industry leaders Samsung and LG. In fact, 1 out of every 3 smart TVs sold in the US runs on Roku OS, making it the largest TV-based on-demand streaming platform in the US and Canada. More recently, Roku has partnered with TCL in the UK and AOC in Brazil to capitalize on the Connected TV secular shift in the international markets.

Launched in 2017, Roku Channel is another important growth driver for the company and has gained significant traction in recent months. Roku Channel is a free of charge channel that brings ad-supported content including content licensed from media houses as well as its original content to users. This service is a win-win for both Roku and its users as they get access to thousands of free movies and TV shows on their TV while Roku generates direct revenue from ads published while streaming. As per the company’s estimates, the streaming hours growth rate on the Roku Channel is twice as fast as the overall Roku platform. Since advertisements are the primary source of revenue for the company, Roku channel can become a major business driver as more free content on the platform attracts more users thus landing more advertisers on the platform yielding incremental top-line growth. Along with free services on its platform, it now offers 50 Subscription Video-on-Demand (SVOD) services such as Epix and Showtime, thus enabling company to earn subscription-based revenue alongside ad-based from its Roku Channel.

Robust business growth driven by strong ad spend

Roku reported $574.2M in total net revenue in Q1 2021 representing a YoY growth of 79%. The Platform segment’s revenue was up by an impressive 101% primarily driven by strengthening advertising trends. Total TV ad impressions delivered through its OneView platform (a single platform for advertisers to manage their ad campaigns across OTT, desktop, and mobile app) tripled in Q1 2021 as compared to the same period last year. The Player segment reported a 22% growth in revenue which was attributable to almost 14% YoY growth in the volume of streaming players sold. The number of active accounts crossed 53M in Q1, up 35% on a yearly basis, whereas 49% growth was registered in the number of hours streamed on the platform. This growth was mainly due to the accelerated trend in the shift from linear TV to on-demand video streaming, especially during the pandemic. Platform monetization also improved as evidenced by 32% YoY growth in the company’s Average Revenue Per User (ARPU) from $24.35 in Q1 2020 to $32.14 in Q1 2021. Roku expects $615M in total net revenue for Q2 2021 which represents YoY growth of almost 73% at mid-point.

Consistent performance domestically and sizeable opportunity internationally

As per Park Associates, Roku’s US market share has consistently remained more than 30% since 2015 and currently stands at 36% despite growing competition from global technology giants. It competes head-to-head with Amazon Fire TV which holds a market share of 36% in the US, as well as Apple TV and Google Chromecast that control 12% and 8% respectively. Despite competition from Big Tech, it is important to note that Roku is the only pure play streaming platform operating in the industry and therefore will continue to have an upper hand due to its focused approach towards the streaming market.

While Roku holds an industry leading position in the US, it is currently a much smaller player in international geographies. According to Conviva, an online video optimization and analytics solutions provider that tracks viewing behavior globally, Roku held 8% of the big-screen viewership market in Europe, 4% in South America, and near zero share in Asia. Please note that Connected TV penetration is currently limited outside North America and has only recently gained traction. In Q1 2021, the South American market experienced 240% growth YoY in viewing time followed by Africa and Europe with 149% and 122% growth respectively. We believe as Roku invests internationally, investors should benefit from another powerful source of revenue growth in the future.

Improving profit margins with robust liquidity cushion to fuel expansion

Roku recorded $327M in gross profit for Q1 2021 representing almost 57% of total net revenue as compared to a gross profit margin of 44% in Q1 2020. The 1,290-bps expansion in gross profit margin is primarily attributable to growth in the company’s platform segment which also generates its strongest margins. Adjusted EBITDA increased from -$16M in Q1 2020 to $126M in the recent quarter. As a percentage of sales, EBITDA margins improved from -5% to 22% in Q1 2021. While the company expects its gross profit growth to outpace operating expense increase in Q2 2021, it is estimating Q2 2001 EBITDA margin to shrink to 11% from nearly 22% in Q1 2020 as a result of growing headcount as it plans to expand globally, as well as higher acquisition related expenditure during the quarter. In the long term, Roku’s operating margins are expected to expand as it scales its business.

Roku ended the recent quarter with strong liquidity of $2B in the form of cash and marketable securities. This includes $1B recently raised by the company through its at-the-market offering during Q1 2021. Total outstanding debt stood at just $94M. It recorded $96M in Cash Flow from Operations (CFO) and only $3.7M in capital expenditure.

Premium valuation multiples justified by immense future growth potential

Tailwinds resulting from increased adoption of Connected TVs as people shift from cable to on-demand streaming services have led to a 400% rise in Roku’s share price since the pandemic. It currently trades at a forward price to sales ratio of 18x which is significantly higher than its industry peers. While current valuations are at a premium, we believe that Roku enjoys an enormous market opportunity as it plans to expand globally and can grow into its current valuation multiples as revenue and margins expand over the next 3-5 years.

Risks

Intense Competition: Despite holding a leading position in the North American Connected TV market, Roku may face fierce competition from well-established brands such as Amazon Fire TV, Google Chromecast, Apple TV, Samsung TV plus, and others, as it expands globally. Having said that, we are pleased to see the company consistently maintain and grow its market share even as competitors invest large sums of funds in the industry.

Conclusion

Roku is undeniably a major beneficiary of the secular shift from linear TV to on-demand streaming services. Over the years, it has been successful in expanding its moat through the introduction of several user-friendly offerings such as Roku TV, Roku Channel, and many others. Despite competition from Big Tech, we believe the company remains a quintessential growth stock to own in portfolios. Roku is currently our second largest holding within the Disciplined Growth portfolio, and we have no intention of selling anytime soon.

A Top Growth Stock: Well Positioned to Leverage Global Streaming Tailwind