The market has been brutal to ad-tech over the past few months. It’s certainly been a roller coaster over the last few years for this industry as covid created a one-time event that kept people indoors and resulted in a spike of streaming. After this, there’s been supply chain issues affecting advertisers at the exact time that these companies had high covid comps to clear. In the middle was Apple’s IDFA changes which threw an additional wrench into the mix.
I personally can’t imagine giving up on ad-tech companies because of the double whammy of a high growth hurdle combined with low macro ad spend, but that’s for each investor to determine for themselves.
Roku has been a strong and steady performer in terms of revenue growth and improvement in the bottom line since going public. In six years, Roku has been able to grow its revenue 850% from $398 million in 2016 to an estimated $3.72 billion for FY2022. The Trade Desk will have grown 687% on a lower revenue base while trading 3X higher.
Critics might point out that player revenue is included there, but Roku does pull in around $700 million per quarter on the platform. Critics will also point out that TTD has a much better operating margin – but time will tell if Roku has chosen the correct strategy to own the real estate. To me, this is arguably the better business model considering the average consumer owns their connected TV for seven years.
Unlike Zoom, which guided for some of the lowest growth in the cloud category – and then subsequently missed the guide – Roku is guiding for growth in the top decile of its category. Despite seeing headwinds in Q1, the company reiterated its already-strong guidance for FY2022. The reason mid-30s is considered strong is because the industry is going through two years of tough comps to clear; it shows resiliency to be at the top of your class. Only Snap is in the lead in terms of forward growth right now across ad-tech. Despite the market’s elevator drop following Roku’s earnings report, the company has leverage in its business model and the bottom line has been steadily improving – even with the return to a more aggressive, investment stance with cashthe company has leverage in its business model and the bottom line has been steadily improving – even with the return to a more aggressive, investment stance with cash. We dissect this and more below.
Before I continue, and while I have your full attention given we are in the intro of the analysis, I want to say the real risk to Roku is a lack of account growth. I want to isolate the account growth because the market will throw a lot of darts at a company and it’s hard to keep track of what the real concern is as we go through various growth stages for a single company. This is why management shrugged off Wall Street’s pressure for a perfect bottom line and took a hit on player margin. We revisit this from our Q3 analysis below. Moving into 2022, the management plans to continue to leverage their cash for account growth.
CTV Ads Overview:
I want to state a few reminders as to why the connected TV advertising model is in earlier stages than Netflix’s subscription model. I previously covered this here in an editorial.
- Connected TV ads are at 18% penetration compared to 42% viewing hours and we will one day see 100% viewing hours on connected TV once cord cutters reach a tipping point.
- Roku generates $3 billion in revenue, roughly the size of revenue Netflix did in 2011. Interesting enough, this lines up with the exact number of years SVOD was out compared to AVOD for Roku (roughly 4 years into the market – 2007 for SVOD and late 2017/early 2018 for AVOD).
- Roku has determined that localized originals is the best way to break into a global market, such as Mexico and Brazil. The company is intent on taking Latam with originals. My takeaway from the call is they have enough visibility into the monetization and ARPU to believe this is the best global strategy. The market is beating up the stock price on this, yet this is the very reason Netflix is the powerhouse it is today.
- Leveraging first party data (Roku) to become an ad exchange (OneView) across other properties and channels is a strong business model in the market. If you listen to TTD’s most recent earnings call, you’ll see that having the leading pureplay here isn’t a terrible strategy considering the migration of budgets and ad spend expected to continue to migrate. Our position in Roku is due to the first-party data the company can leverage to continue to participate directly and 100% in this market rather than diversified on markets with lower growth, like desktop or mobile. Here’s a quote from the most recent Roku earnings call: “2022 is a big year for OneView as well. We’ve made good progress with selling OneView into agency holding companies and lots of other advertisers. And I think it will be a breakout year for us. We just last week announced Nielsen DAR guarantees in OneView. This will enable an advertiser to use our data and our ad stack to optimize the age, gender goals when buying from programmers in the Roku ecosystem. We have sold that product with our own media for years. We’re extending it now in what’s an industry first to all impressions on the Roku platform.2022 is a big year for OneView as well. We’ve made good progress with selling OneView into agency holding companies and lots of other advertisers. And I think it will be a breakout year for us. We just last week announced Nielsen DAR guarantees in OneView. This will enable an advertiser to use our data and our ad stack to optimize the age, gender goals when buying from programmers in the Roku ecosystem. We have sold that product with our own media for years. We’re extending it now in what’s an industry first to all impressions on the Roku platform.” My comment: Nice one on timing – when mobile is going through a massive shift.
Roku: Q4 Earnings Review and Why the Stock Sold Off
The company reported revenue of $865 million compared to $894 million expected, for revenue growth of 33% YoY. This is a deceleration from 51% revenue growth in the third quarter and 81% revenue growth in the second quarter. The company guided for revenue of $720 million compared to analyst consensus of $748.5 million. EBITDA was also a miss with company guiding for $55 million compared to the consensus for $79.2 million in the upcoming Q1 quarter.
Despite lower growth in Q1, Roku reiterated full year 2022 growth in the mid-30s. I think that’s important to pay attention to as it confirms management believes the supply constraints are temporary. Going into the report, analysts were expecting 36% annual growth. The guide on EBITDA is for $150 million for FY2022.
Gross margin improved which helps to show business model leverage. In Q4, gross margin of 60% grew 24% year-over-year to $380 million. With that said, GM was down sequentially by 4.5 points due to a greater mix of video advertising. The company estimates without supply chain issues on the players, GM would be higher by 4 points, which offsets the sequential decline. The guide on gross margin next quarter is lower at 50%.
In Q4, player revenue declined 9% year-over-year and was up 7% compared to Q4 2019. In the Q3 earnings analysis referenced below, we had stated this was expected as management is (wisely) growing user accounts while Smart TVs are unable to ship. Player unit sales were flat year-over-year and down 4% overall for 2021.
The ad platform also missed analyst expectations at $703 million, up 49% year-over-year, compared to $732 expected. In Q3, the platform grew 82% in the third quarter. Due to video advertising, the gross margin was lower in Q4 at 60.5% compared to 65% in Q3. However, it would be tough to say the platform didn’t have a great year as it grew 80% YoY to help drive the overall revenue growth of 55%.
The EPS is negative at ($0.92) for FY2022 and Bradley discusses this more below in his notes as to what’s weighing on EPS. Notably, ROKU is expected to be profitable by FY2023.
The issue with Roku is not the miss on revenue but the miss on EBITDA. You will see below that operating expenses is the key thing the market is grappling with as the company plans to spend $1 billion on operations. The concern is whether this investment will make it back to the top line. Management states they are increasing headcount yet producing original content also can weigh on operations. We expand on this below in the last section.
Q4 Revenue Miss and Soft Guide:
The company stated the softer than expected revenue was from the “impact of supply chain disruptions on advertising spend.” Rather than dissect an event that is out of the company’s control, I’ll keep this section brief to say we believe this will clear up in time. Roku has been strong on revenue growth since launching the ad platform circa 2017.
As discussed on the call, ad-tech is going through an extraordinary period where advertising spend dropped off significantly in Q2 2020, then made up for it in Q4, which created a tough hurdle to clear in Q4 2021 alongside supply issues. I don’t think there’s much more to expand on here.
Regarding account growth, it was better than expected at 3.7 million, compared to 8.9 million for the year. Total active accounts were 60.1 million, up 17% YoY and higher than the 59.5 million expected. I’ve stated before that there will be quarters where Roku misses on active accounts yet beats on revenue. The reason why this won’t concern us – yet will concern Wall Street – is that Roku can monetize outside of its own audience through One View. We discussed OneView here.
Q4 Negative Player Margin:
After Q3 earnings, we wrote a detailed analysis about Roku’s plan to keep player costs low while smart TVs are delayed in shipments. This strategy was clearly seen in the higher player unit sales that exceeded pre-covid-19 levels despite a supply shortage. This strategy is what helped drive the beat on active accounts — which was to expand while competitors are incrementally weaker.
Below is an excerpt from: Analysis on Q3 2021 Earnings
Here’s one way Roku is seizing the supply shortage: “As mentioned earlier, we chose to insulate our consumers from increased component and logistics costs, resulting in player gross margin decreasing to negative 15% in Q3.”
In addition, the company plans to keep dongles stocked so that if smart TVs sell-out or are too expensive for consumers, they can upgrade their current television with a Roku player.
Here's a question from Laura Martin on the call that is important to understand why Roku could come out ahead in light of supply issues: “But if you're going to sell out of those [dongles] anyway because TVs are running out why would you cut price [of the dongles]? Why wouldn't you double price and still sell out and just and still add as many subs, but at a higher price because you've got dongles in stock when all the TVs smart TVs are running out of inventory at the retail level?”
Here was the answer: “So the supply chain — in the case of players we're not — our goal wasn't to not sell out. We are paying more for expedited shipping for — to get chips get in front of the line for chips.
So, the results of all that is our costs are going up. But we haven't sold out yet. We've just been paying for air shipping and we've been spending money to insulate the retailer and the end customer from pricing issues and supply issues. So far we've been doing that relatively effectively.”. We've just been paying for air shipping and we've been spending money to insulate the retailer and the end customer from pricing issues and supply issues. So far we've been doing that relatively effectively.”
The translation is that they can air ship boxes of dongles and keep them on the shelves because of their small size while TVs sell-out and/or are cost prohibitive for consumers with average of 42% increase in price. “That [TV sales] is down. The market is down 31% year-over-year in part because pricing on U.S. TVs on average is up 42%. And the U.S. TV market is actually down below pre-COVID levels in the corresponding period in 2019.”
When asked why they aren’t doubling the price given the supply constraints (i.e., and appeasing Wall Street on the margins), the answer is that they are actually going to take a hit on the players at about (15%) because they want to keep costs low, which in turn, will grow active accounts. This goes back to the $40 ARPU. Once someone is a Roku user, there are high switching costs and Roku’s advertising flywheel can make up for the loss on hardware.
-END EXCERPT FROM Q3 ANALYSIS
So, Roku missed on player revenue for the reasons we discussed last quarter and this was not a surprise or a concern.
Increased OpEx and EBITDA Miss:
The increase in operating expenses is where the market is grappling with Roku’s long-term story as it could change a signal to the company’s story if producing originals weighs on margins. The management stated it was due to expanding head count yet I’m not sure the market fully accepts this answer in light of the originals being produced.
As stated above, forward-looking EBITDA came in lower with company guiding for $55 million compared to the consensus for $79.2 million in the upcoming Q1 quarter. The guide for FY2022 EBITDA is $150 million. Wall Street analysts were modeling for increased profits given the top line growth. Roku is deciding to go in the opposite direction by investing aggressively. Perhaps Roku management should have tempered expectations a few quarters back about their plans to ramp spending.
The company worded the EBITDA miss like this: “For full year 2022, we plan to maintain adjusted EBITDA roughly in line with 2020 levels on an absolute basis as we continue to invest against a significant opportunity and drive continued innovation on the platform.” Yet, the analyst on the call pointed out that it’s actually not in line with 2020 levels as it’ll be double and closer to $1 billion in operating expenses.
Here is what was asked by Michael Morris of Guggenheim. If I could have timed the moment when Roku went from being down 10% after hours to 30% after hours, I’m pretty sure it was during his question:
“And my second question, I really want to come back to this spending growth next year. By my math, it looks like your spending is going to almost double to well over $1 billion, just using your revenue and EBITDA guide. I mean, it’s a pretty huge number. And Steve, I think you just said kind of goes back to pre-COVID levels or behaviors, but it’s multiples of what you were spending at that time. Now you’re obviously a much bigger company now, but I think this is a really big deal coming out of the call. So, I want to take one more opportunity to ask sort of in more detail what you’re spending on? Like which areas do you think this is going to power? And when we should expect to see the return — the top line on this incremental spend? Thanks.”
The answer management provides to this question is long but can be summarized by these key points:
- Increased headcount and wages as the company plans to expand the team: “In terms of how we usually invest, the main source of investment is people-based. And so, that headcount expense is the largest single line item on our OpEx.”
- The Roku Channel: “The Roku Channel is growing much faster than the platform overall […] Really the scale of The Roku Channel and that growth trajectory is allowing us to invest more in the content. And it’s a combination of licensing. We’ve got 200-plus licensing partners there. But also in 2021, we basically came out with the Roku original side of the house, which we kickstarted with the acquisition of Quibi’s content distribution rights, but we’ve done a lot on that front as wellRoku original side of the house, which we kickstarted with the acquisition of Quibi’s content distribution rights, but we’ve done a lot on that front as well.”
- The Roku TV Program: “And Roku is the leading operating system in the United States right now. We’re making great progress in other countries as well. And we’re just extremely well positioned to keep investing in that leadership position and grow that leadership position as consolidation continues to happen in the TV — in the platform spaceRoku is the leading operating system in the United States right now. We’re making great progress in other countries as well. And we’re just extremely well positioned to keep investing in that leadership position and grow that leadership position as consolidation continues to happen in the TV — in the platform space.”
- After management answered, here was the final answer from Anthony Wood: “But the main driver is we just keep hiring a lot more people as we expand each of these key areas. Just one small example, we didn’t use to make originals. Now we have a whole team working on Roku Originals. We didn’t use to sell TVs in Brazil. Now, we’re building more and more models for Brazil. So those are places — those are examples of places where we increase our headcount.”
Producing originals worked for Netflix, and Roku will not need to do nearly the level of originals as Netflix as it’s only 1 of 4 ways that Roku monetizes. However, the main issue is that Roku isn’t providing too much insight into the budget that will be needed.
If we widen our view, we will see that 2020 was the first year Roku was EBITDA positive and the company is expected to remain EBITDA positive this year. Most importantly, Roku has leverage with a gross profit of $1.4 billion and they are choosing to spend for top line growth.
Overall, Roku is a more complex product story because the strategy is to conquer from many angles. It’s an ad exchange, it’s a content channel, it’s an operating system and it’s a hardware player. It also owns the best first-party data available on CTV ads and I tend to stick with the data in terms of ad-tech. So, that’s primarily the reason we own Roku and continue to own Roku.
A Few More Notes on Roku’s Q4 Earnings
By Bradley Cipriano
The $1 billion in expenses is not overly concerning although an adjustment in expectations as the Street may have believed that Roku’s earnings were quickly scaling, but this was impacted by a slowdown in expenses during covid, and now those expenses need to ramp in the upcoming year to remain competitive.
It looks like the ramp in costs going forward will be driven by headcount and content creation as the company scales. As a comparison, Netflix's operating expenses ramped nearly $1B YoY when it passed $3B in revenues in 2011, which Roku is nearing. Viewed differently, the expected revenue growth in FY2022 of $830 million will be accompanied by a $1B rise in expenses, meaning that each $1 of expenses will drive just $0.76 of revenue, which is the lowest value in Roku's history. This suggests that growth is much more expensive than in prior years.
However, this is likely due to the slowdown in investments made during 2020 and 2021, and the three-year average for the above metric is 1.08x (including FY2022), meaning that each $1 of expenses resulted in $1.08 in revenues. This is above the prior three-year average of 1.04x (2019-2017), highlighting that over a longer time frame, Roku is in fact demonstrating leverage, albeit it is lumpy. FY2021 and FY2022 also includes the Player gross loss headwind that wasn't the case in prior years, the three-year average would be even higher. My takeaway is that the rise in expenses seems in-line with historical trends once we account for COVID.
The lower EPS this year is a headwind to the company's valuation, but it is expected to be profitable in FY2023. The company should be cashflow positive in FY2022 and with $2.1B in cash on balance, likely should not need to dilute shareholders despite the losses. There is also some leverage to improve earnings as there were $82m in one-time expenses during the most recent year.
Below are some one-time expenses included in EPS:
- The $96 million swing in player gross profit, due to lower volumes and higher costs. This was a material impact to the bottom-line during the year. Assuming that they can get player sales back to breakeven, then that’s a $0.37 EPS tailwind going forward. Management states it does not expect player losses to persist indefinitely but will likely persist into H1 FY2022.
- There was $28 million in legal expenses during the year, $10 million of which related to patent infringement issues – this has been a lingering issue with ROKU and may be a lingering issue going forward as there are 14 more patent cases in court from UEIC v Roku. Assuming the $28m is one-time, then this was a $0.19 EPS headwind, but can be a tailwind going forward if the expenses do not repeat.
- $8m in cost from the expansion of office space, likely mostly one-time = $0.06 EPS headwind.
- Revenues accrued from changes in accounting estimates increased $15 million YoY, which is a one-time benefit to earnings and should offset the above one-time expense items.
- In total, $67 million in net one-time expenses (or $0.47 per share impact) pressured earnings during the year. Going forward, there is leverage for earnings improvement if these costs do not repeat.
Regarding Roku’s revenue miss, Q4 was the first-time management had missed their topline guide, and they missed it by $28 million, or 3%. In the prior quarter, they beat by $1 million. The key takeaway is that modeling supply chain issues has been difficult across the board. Roku had previously done a good job of this but was impacted by events that are mostly one-off (shortage of autos and TVs likely hard to predict).
There is a rise in legal expenses including a patent case on the company that cost $10 million, which has been discussed previously on the forum a few quarters back. According to UEIC’s CEO, there are two separate cases against Roku that allege a total of 14 patent infringements.
Due to supply issues, days sales outstanding, which measure how long it takes Roku to collect on its sales, increased to 72 days, well above the average of 60 days. The extension of payment terms may have boosted Q4 sales by ~5%, which is inherently a one-time trend. Unbilled sales are up materially YoY and are high risk sales because they signal that sales were accrued before being invoiced. However, the balance declined slightly QoQ, which reduces the risk that sales have been manipulated. Lastly, Roku recognized $29 million of sales from prior performance obligations due changes in estimates. This is up from $14 million in 2020. While this is not material to sales (<1% of 2021 sales), the $15 million rise in sales from changes in estimates provided a $0.10 benefit to earnings during the year.
In summary, there are puts and takes related to Roku’s 2021 results. Earnings were impacted by numerous one-time trends, but there were also some one-time benefits. Sales are expected to grow strongly going forward, but Roku is taking longer to collect on its sales. We expect to see an improvement in these trends going forward as supply chain issues improve and the ad market normalizes.
Additional Reading:
Roku and Magnite 1-Hour Webinar
The Difference between Netflix and Roku
2021 Earnings Update: Roku and others
Roku 2019 Analysis
Roku Q2 2021 Earnings