This article was originally published on Forbes on Jan 21, 2021,11:20pm ESTForbes on Jan 21, 2021,11:20pm EST
Netflix came in strong with the recent earnings and there is no reason to expect Roku will not also come in strong especially as Covid and stay-at-home orders have accelerated the shift towards Connected TV.
It's easy to compare Roku's roughly 50 million users to Netflix's 200 million and to assume Roku is a much smaller company or lagging the subscription behemoths, such as Disney Plus. This is a mistake as the ad-based video-on-demand (AVOD) market is a newer market than subscription-video on demand (SVOD). The AVOD market is distinguished from SVOD because it's primary driver is pay-TV ad dollars rather than the cord-cutting trend or subscribers.
About $10 billion is spent on Connected TV ads compared to $70 billion on pay television ads in the United States alone. Pay-TV ad spend is now expected to decline by 15% to $60 billion this year due to the postponement of live sports and also due to an increase in cord-cutting from covid.
Here's something to consider – cord-cutters aren't going back to cable, and this places Pay TV ad budgets in a dilemma. These budgets have not cared much for mobile or desktop. Despite the sheer number of data scientists and (frightening) level of behavioral targeting used by Google and Facebook, Pay TV has held on to an impressive level of ad spend at about $70 billion in 2019 compared to $87 billion on mobile. One reason is that advertising on the television is more effective – no amount of data collection can change the video completion rate achieved when you're sitting in your living room.
Although these budgets have not migrated to mobile or desktop in the past, those advertisers now have an opportunity to use data to personalize the advertising while viewers are in their living rooms. Roku and AVOD are the best of both worlds – combining data for targeting and high completion and viewability rates — and this creates a unique market from SVOD. For reference, completion rates on Connected TV ads are as high as 97% with 100% viewability, according to a study by Benchmark.
Below, I review Netflix's earnings as it's essential to keep an eye on exactly how long a winner can run in the OTT media category. I also review Roku's upcoming earnings and what to look for.
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Review of Netflix Earnings:
Netflix surpassed expectations again in Q4 despite many believing the increase in Disney Plus subscribers and HBO Max would weigh on Netflix's subscriber results.
To be fair, the real test is yet to come as dining out, travel, and return-to-work patterns begin to normalize. Netflix is guiding conservatively for Q1 with 6 million net additions.
Revenue grew 21% YoY to $6.6B, topping consensus estimates by $20M. Net adds of 8.5M came in well ahead of expectations calling for 6M. Netflix now expects 2021 free-cash-flow to be “around break-even” versus previous guidance of -$1B. The company also intends to explore a share repurchase program moving forward:
“Combined with our $8.2B cash balance and our $750M undrawn credit facility, we believe we no longer have a need to raise external financing for our day-to-day operations…As we generate excess cash, we intend to maintain $10B-15B in gross debt and will explore returning cash to shareholders through ongoing stock buybacks, as we did in the past (2007-2011)."
Competition has been one of Wall Street's primary concerns regarding Netflix. In Q4, Netflix maintained a healthy lead over the competition with 29% market share. In Q4 2019, Netflix had 31% share of the streaming market. Keep in mind, the market is growing overall so a smaller percentage can still represent subscriber and revenue growth.
Q4 US Video Streaming: Share By Brand – NIELSEN, CREDIT SUISSE
Despite the modest decline in the share of minutes watched, it is evident that competition did not bite into Netflix’s net adds in 2020.
NETFLIX SHAREHOLDER LETTER
This supports the thesis that other streaming services, namely Disney+, are complementary to Netflix. Netflix just completed its best year in history while Disney+ and other new streaming services became available. Consumer behavior is showing that consumers prefer to have multiple subscription services.
In Q4, Netflix had 57.2M global app downloads versus 53.5M for Disney+. In Q4 '18 and '19, Netflix had 53M and 58M global app downloads, respectively. These numbers indicate that the success of Disney+ is not coming at the expense of Netflix. Instead, Disney+ is a complimentary service helping to further the acceleration of streaming to the TV.
Streaming to the TV gained significant market share versus all other TV usage during the pandemic.
NIELSEN
Streaming to the TV now owns over a 20% share of the market. The increased demand for streaming during lockdowns represents the acceleration of a trend that was already in progress.
Although I do not own Netflix stock, I track the company closely as I’m invested in other opportunities in this space. I’ve remained bullish on this stock when others doubted its position as new competitors came on the market.
I have also written extensively about why Roku is one of the best ways to play AVOD market growth. Our first entry in ROKU came in the $30 range in 2018, and we remain bullish on the name moving forward. You can read my first article covering Roku in 2018 here.
An investment in Roku does not force investors to choose which streaming service will be #1, as Roku benefits from the success of a broad range of AVOD publishers. Advertisers are planning out strategies to reach cord-cutters effectively, and Roku stands to be a main beneficiary. Roku is positioned to capitalize on AVOD market growth and has now launched an omnichannel marketing platform to extend first-party data for mobile and desktop targeting. This last part is key because Roku can now capitalize not only the $10 billion currently spent on CTV ads and the soon-to-migrate $70 billion from Pay TV – but Roku will offer additional targeting on mobile and desktop with first-party data – opening up the entire $200 billion+ ad market.
For Q3, Roku reported 73% year-over-year revenue to $452 million. Platform revenue increased 78% YoY, and gross profit was up 81% YoY.
In the past, investors have been critical of Roku for dipping sub-60% on margins. I defended the company, stating margins are rarely an issue for an ad-tech company. Roku added 2.9 million incremental accounts with average revenue per user (ARPU) up 20% to $27.00.
Roku is guiding low for a quarter when most people were stuck at home. In general, this management guides low, stays focused, and is out of the limelight. Q4 guidance is for revenue growth in the mid-40% range with a breakdown of platform revenue at 2/3. My guess is Roku will handsomely beat this guidance.
In December, AT&T announced that customers could watch HBO Max on Roku. Part of our early analysis on Roku pointed towards agnosticism working in Roku's favor and the strength of the operating system and number of channels. This was a timely boon as HBO Max had become the fastest-growing major streaming service recently per data from Apptopia with 1984 Wonder Woman being released on Christmas Day.
APPTOPIA
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Conclusion:
Over a year later, my statement on why no streaming company will be able to dethrone Netflix in October of 2019 remains true. Disney Plus and HBO Max are great services, as well, but they are not mutually exclusive.
Regarding Roku, we believe first-party data for connected TV ads is a significant trend moving into 2021 and an important distinction from subscription-video on demand (SVOD). Therefore, the main takeaway is that AVOD has an approximate ten-year runway as the trend began taking shape when Roku launched its ad platform in late 2018/early 2019. There were AVOD players in the space before this, but the budgets were negligible. Therefore, the cord-cutting trend is secondary for Roku, whereas Pay TV ad budgets' migration is the primary trend.
There are other reasons that I like Roku, such as owning the whole stack including the operating system, the management, it’s global opportunity, the agnosticism, etcetera– which I have covered in previous analysis. However, I try to keep things simple when discussing my thesis, and the migration of Pay TV ad budgets combined with Roku’s first-party data is why this stock has its best years ahead.
Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.
Roku’s stock price is up by almost 500% over the past two years. Compare this to the S&P 500, which is up less than 25%. That’s 20X more returns than the average stock.
The upward trend has not been on a straight line. Roku’s stock price has had four major drawdowns that average about 52%. Two of these drawdowns were greater than 60%. Being long a volatile company like Roku since its IPO is not easy, and it especially takes increased conviction to stay long Roku as we approach the end of the current cycle. However, for those that were insightful enough to see that Roku is not a hardware play, nor a content generating OTT play, but instead a Connected TV Advertisement play from inception, have been able to hold Roku through the drawdowns despite market noise.
In this report, I will look at the fundamental case for buying Roku stock. I will also perform a technical analysis of the company’s stock price as entry and exit is crucial for high-growth stocks. This technical analysis reflects the choppy reaction to the company’s third-quarter earnings report.
Roku’s Fundamental Background
Roku is one of the most misunderstood names in technology. A common argument against Roku is that it is a small company with no moat in the streaming industry. They also argue that competition from cash gushing companies like Apple, Google, and Amazon will threaten its lead. In reality, the opposite is true. Roku may be small in comparison, yet it still leads with 39% market share in OTT hardware in the United States compared to Amazon in second place at 30%.
In the most recent quarterly release, the company announced that its users had grown to more than 32.3 million. This is nearly double what the company had in Q2 2017 with 15 million users. The average revenue per user has grown from $11.22 in Q2’17 to more than $22.
The ad platform segment of Roku’s business is the fastest growing and most important. It is also a high-margin business. In the 2017 financial year, the segment had more than $225 million in revenue. This revenue rose to $416 million in 2018. In the most recent quarter, the platform segment grew by 79% to more than $179 million.
Another misconception about Roku is that Roku is in competition with the likes of Disney+, Netflix, and HBO Go because of the subscription service it offers. In reality, the company does not compete directly with these companies, even with its SVOD platform. This is because Roku is mostly in the business of serving adverts and using its data to provide a better ad experience. My partner, Beth Kindig, covers this in more detail in her fundamental analysis (here, here, here) .
The closest competitors to Roku are Amazon and Hulu. Comcast’s Peacock, which will be an ad-supported streaming platform, will also be a competitor, but only domestically. This is because these companies compete for connected TV ad dollars.
Roku has an added advantage because of the vast data it has on its consumers due to owning the hardware. Also, the agnostic nature of Roku’s business makes it favorable for smart TV manufacturers. This is because it does not compete with them on the level that Google or Amazon does.
One final not on Roku, valuation is a constant issue that bears have talked about. It is true that the company appears to be overvalued. The company is valued at more than $15 billion. This is a premium for a loss-making company that is expected to make more than $1.1 billion this year. The company has a forward P/S ratio of 9.9, which is a significant premium. Consider that companies like Amazon, Netflix, and Spotify have a forward PS ratio of less than 6.
Technical Outlook for Roku’s Stock Price
Roku Volume Report
The volume activity in Roku tells us a lot about the current environment we are in, as well as what institutions are thinking. “Smart money,” or institutions, have teams of analysts and professional traders moving large amounts of cash. This typically shows up as massive volume spikes, coupled with noticeable changes in the stock price. The price at which they decide to buy in bulk, or sell in bulk, typically acts as new support/resistance that the price must push through.
What’s noticeable is that around the $127 region, we went from seeing predominantly green volume spikes, to predominantly red volume spikes. The zones in which we are seeing these large liquidations is between the $158-$127 region.
This will be a lot of liquidity to make up, and we usually will see a shift in momentum when the reverse occurs, – i.e., large green volume spikes coinciding with a noticeable shift in price. Until I see us break through the $158-$163 region, with new increased volume spikes, I would be cautious of the current retracement back to new highs.
However, it’s worth noting that this shift could be starting to occur with rising green bars suggesting a renewed interest. I’d like to see institutions take out large positions at current levels before getting excited. So far, the only large volume spikes in this region has been to the downside.
Insider Activity
Insider buying is significantly more notable than insider selling. This is especially true when dealing with a high growth company that just went public; also, there could be numerous personal reasons why insiders are selling. But, it’s worth noting that all the insider activity in Roku since its IPO has been selling with zero buying. Nobody knows this business better than the insiders, and what they do, or do not do, can give insight to where they see growth vs market valuation. It’s worth noting that no insiders are buying their shares at current prices, which I’d agree makes sense if you are a buy and hold investor with a long time frame. However, in the short-term, there could be plenty of momentum left in Roku.
Internal Strength of Roku’s Stock Price
Going into earnings, we had cautioned our readers that $131-$127 was support and resistance was at the $156-$158 region. Any trades in this region on this stock were higher risk. We were correct, as the stock dropped to $119 but quickly bounced back. It has now been climbing and has even posted some marginal gains since prior earnings drop, and we are approaching a critical price cluster.
Simply put, if the stock price breaks $163 and closes well above this price, then I’ll be targeting the above the $200 region before any major drawdown occurs. However, this will require a broader macro bull market. I think it is more likely Roku remains choppy with lower entries available than where it is priced right now.
The internals support this position as well, as of now. In the above chart, the MACD has rolled over, and just recently flipped back up, suggesting strong short-term momentum. Until it breaks above the most recent high on the MACD, this could be a fake-out. The RSI is confirming caution as well. Until we can break the 70 line, which has historically indicated a bullish posture, I’d be cautious on the current uptrend as Roku continues to trade between support and resistance. We are currently oscillating between the 40 line, which has been bullish support and the 70 line, which has been bullish resistance.
Many investors are playing momentum with Roku right now, and we believe this is the correct strategy at current prices. Going long Roku today should be done with stops in place or a systematic exit strategy to protect any gains. Therefore, Elliott Wave is the preferred method for increasing the probability for successful entries on long positions for a momentum trade, as well as set ideal targets for a more long-term time frame.
Above is the 30-minute chart of Roku going back from it’s all time high. My Primary Elliott Wave count has Roku’s stock price completing its larger degree Wave 3 push just above the 138.2% extension at its all-time highs. This is historically a lower top for a typical target for a 3rd Wave, which usually targets the 161.8% extension.
If Roku can break back above the 78.6% retrace and then take back the 138.2% extension around $163, we will likely see a push to the 168.2% extension before any significant drawdown that would constitute a 4th Wave correction (this is shown as an “alt (3)” and “alt (4)” on the chart). As of now, the evidence supports that Roku is in its 4th Wave correction, and as long as it stays below to current resistance, there will be chances for lower entries on a more long-term basis. However, if we close above $163, I will likely add to my current position with tight stops to play renewed momentum as Roku powers to new highs.
As Apple’s stock price powers to new highs, returning over 60% YTD and touting the highest market cap in history, now might be a good time for investors to reflect as Apple trades at resistance. With upwards of $260 billion in revenue, a profit margin of 22%, Apple is a cash-generating machine. It produces around $50-$60 billion in free cash flow annually, with reserves of over $100 billion. It is extremely kind to shareholders, with one of the largest buyback programs on the Street. In fact, Apple has spent around $120 billion in stock buybacks since the beginning of 2018, and kicks out a dividend. Apple is, without question, one of the greatest businesses the world has ever seen.
However, there are times where great businesses do not always make great stocks at times. If we look at the current valuations, Apple’s stock price is trading with a P/S of 4.5, a P/E ratio of around 25 and a price to free cash flow of 20, as of the writing of this report. While these valuations are relatively mild compared to some of the valuations being shopped around in the tech industry, for a company with a market cap of $1.3 Trillion, these valuations suggest future growth in order to justify current prices. It is here, with their future growth prospects that I see caution.
Apple’s Stock Price is Up While Revenue is Down
In 2019, the company had revenue of $260 billion, down from $265 billion in the previous year. Analysts originally expected the company’s revenue to grow to $274 billion, or 5.3% this fiscal year, and around $294 billion or 7% in the following fiscal year. This will be slightly below the 7.2% growth that is expected among information technology stocks.
In the latest quarter, its growth rate was just 1.8%, significantly lower than what other FAANG companies reported. Facebook revenue grew by 28% while Amazon rose by 23%. Netflix and Google had revenue growth of 31% and 20%, respectively. Even Cisco grew by almost 5%. And for further comparison, the US economy expanded by 1.9%.
Apple’s poor growth would have tanked any technology stock, yet Apple’s stock price is up 60%. Though I believe Apple has the cash as well as the capability to pull numerous pivots in its future, the loss in revenue will likely accelerate before these pivots can manifest, which will compress margins, and thus affect current valuations.
iPhone Saturation – Will it Affect Stock Price?
If we dig deeper into their latest revenue report, we discover that smartphone sales declined YoY by 15%. Saturation is an inevitable phenomenon for revolutionary inventions. For example, Utilities and wireless phone coverage were once considered hyper growth sectors at one point in time, but the inevitable saturation took hold, leading these companies to now be considered defensive value plays. Saturation appears to be taking hold in the smartphone market, which is why we are seeing a deceleration in smartphone sales YoY; with an expected 2% fewer sales per year going forward.
Furthermore, with saturation, we see manufacturers start to slash prices to capture fewer units sold. This quarter, Apple reported that iPhone sales declined by 9% since the previous year and that they are also reducing the price of their new iPhone 11. Both news items point to the reality of market saturation.
The iPhone is arguably the greatest tech driver in history, as well as Apple’s primary source of revenue. So, Apple will have to cover the losses with their other products to make up the difference. This is where I see the inconsistency between the stock’s valuations and their current offerings.
Services
Apple’s services generate revenue through various subscription fees. These fees come from several well-known Apple services, including iCloud, iTunes, Apple Music and various types of apps.
Although these services grew by 18% this last quarter, the total revenue generated was only 37% the size of iPhone sales. This level of growth is simply not enough to cover decreasing revenues from Apple’s iPhone sales.
Furthermore, there are also concerns in the service sector. The problem is that the services that Apple offers have relatively lower margins than the iPhone. A good example of this is Apple Music. Apple doesn’t disclose Apple Music’s gross margins, but going by Spotify’s own margins, we have every reason to believe that Apple is similar. Spotify’s gross margin is just 26%, which is smaller than Apple’s iPhone net profit margin. It’s important to note that the services segment of Apple is tied to the iPhone and may experience slower growth as the smartphone market continues to saturate.
Apple +
There’s also a lot of hype around Apple TV+’s potential at filling the growth gap. According to the Wall Street Journal, Apple is spending more than $6 billion on new content, and it’s only likely to go up as the streaming war continues.
At current prices for the service, it’s impossible for Apple to make a profit even with a hundred million subscribers. Apple can still be a contender in this crowded space, but it will likely take time, and be more of a cash drain than a generator in the short-term. Meanwhile, smartphone saturation is only going to continue, which means that Apple TV+ will not be able to solve Apple’s current revenue problems.
Apple Pay
Apple Pay is another service that Tim Cook talks about repeatedly. During the latest earnings call, he revealed that the service had surpassed PayPal in terms of volume of transactions. The service is also expanding into various markets. Additionally, Cook also praised Apple Card, a new product developed in collaboration with Goldman Sachs that promises to expand Apple’s revenue.
Apple Pay has the potential to generate a large cash flow, but there are questions about how big it can get. In the trailing twelve months, PayPal had a gross revenue of $17 billion and a net income of $2.53 billion. Visa and Mastercard had a combined revenue of $38 billion and a net income of $17 billion. So even if Apple were to dominate this market, its consolidated net income will not be sufficient to cover the loss in iphone sales. And, more importantly, it will take time to take market share, which will not solve the revenue issues Apple currently faces.
Apple Wearables
Another area that’s worth looking at are Apple wearables. In the last quarter, revenue from wearables, home and accessories rose by 54% to $6.5 billion. This growth was driven by the success of various Apple products, particularly Apple Watch, Airpods, and BIS products.
These wearables are great products that do have higher margins, just like the iPhone. The big question, however, is if they can grow fast enough to offset losses in iPhone sales. Despite its great performance, Apple’s wearables, home and accessories business is still behind the Mac division, which earned $6.9 billion during the fiscal fourth quarter.
Meanwhile, Apple’s iPhones generated $33.36 billion in revenue this final fiscal quarter, despite a 9% decrease year on year. So the important point in all this is that, despite their tremendous growth, Apple wearables and accessories are just not in the same league as iPhones.
Buybacks and Apple’s Stock Price
Any other tech company with decelerating revenue, and the likelihood of continued deceleration in the near term, while facing an end of cycle environment that will eventually affect the consumer, would not see their share price increase to such valuations. So, it’s worth noting the importance of one of Apple’s key components in their current strategy, which is not a permanent solution.
Apple has turned to buybacks to boost its stock and spend its cash hoard. Since January last year, the company has spent more than $120 billion on buybacks. The question, though, is how effective these buybacks are to retail investors.
Large companies with growth problems have used buyback programs as short-term solutions for sluggish performance. In the short-term, share repurchases can help boost a stock price. However, in the long-term, Apple’s share price growth will depend on the performance of certain specific segments. The chart below shows Apple’s diluted EPS growth in the past five years.
Source: Ycharts
Technical Outlook for Apple’s Stock Price:
Structure
As a technical analyst, I do not go against the trend until I see either a rewarding risk/return set-up at key levels, or a noticeable shift in trend emerges. Apple is currently in an incredibly strong uptrend since bottoming in December of 2018; however, Apple’s stock price is at a significant level.
It’s worth noting that it’s 2019 uptrend appears to be in a corrective fashion – a series of 3 waves up, which is always point of caution. Typically, when I see this, it points to a correction in a larger degree prevailing trend.
Furthermore, if we take the length of the first wave up off the December low to its peak in May of 2019, it went up 51.63%. After bottoming out in July of 2019, Apple’s stock price began the current wave up. You’ll notice that Apple’s share price is at the symmetrical percentage growth of the first wave – 51.63%, which coincides with the 100% extension.
In technical analysis, the market tends to move in symmetry, especially in corrections, and the $258-$262 range will act as major resistance for Apple’s continued charge up. This is exactly what we have seen as well, as Apple’s stock price has been hovering around this level for many trading days. If it can close above the $262 range and hold on to that region, I believe there is a strong possibility that it will trade up to the 250% extension of the 30-year cycle uptrend of around $300.
However, if Apple cannot break above the $260 range, it could retest the $222 price range. If it falls below this range then the yellow target box will be in play, thus confirming that the uptrend from the December low was merely a powerful correction in a much larger decline.
If we look at Apple’s internals, a few points jump out. For one, the volume is decreasing as the stock price is increasing, suggesting there’s not broad participation in this uptrend, and that may be the result of weak buying volume on top of even weaker selling pressure. If this is the case, as soon as buyers get exhausted, we could see a sharp decline.
The MACD is currently at its highest point in Apple’s history, the second highest was in September of 2018. An elevated MACD is a bullish sign, but when we hit extremes, it becomes a point of caution. The RSI is in a current uptrend along with price. If this uptrend breaks along with the price, we could be in for a retest of important support zones. I will be watching the RSI for a clue to a change in momentum.
Knox Ridley runs a premium site alongside Beth Kindig. You can check out her fundamental analysis on Apple on this site.
Roku is a company that has proven nearly every bearish prediction wrong with consistent revenue growth despite being surrounded by steep competition and tech heavyweights in over-the-top media.
Roku investors that have been long since its IPO have lived through three fifty-percent drawdowns. Therefore, the reaction to earnings this quarter was unlikely to phase anyone who has followed this stock for any length of time.
I encouraged my readers to not be phased by market reactions when Roku was priced at $30, when it was priced at $60, and when it was priced again at $30. During that sell-off, I said the company would become a tech darling and reach $100 in stock price in two years, which was bold to predict 200% returns. Of course, the company went on to reach 350% returns in a short time span of about one year.
The market received Roku earnings report on Wednesday after the market closed. Streaming hours passed 10 billion hours in the third quarter, while active accounts increased to more than 32.3 million. The most impressive number in the Roku quarterly earnings was the average revenue per user, which increased to $22.58. This number has more than doubled since the second quarter of 2017.
The Roku earnings report showed that quarterly revenue increased to more than $261 million. Platform revenue grew by 79% while ad revenue more than doubled. This was a 50% YoY growth and was above the consensus estimates of $256.9 million. The company lost 22 cents a share, which was 6 cents above the consensus estimates of 28 cents a share.
Overall, the company beat the consensus estimates, raised guidance, reported strong user growth, and increased ARPU.
However, Roku has double-digit negative EPS and will for some time. Roku financial statements show that EPS is declining QoQ. Its consensus EPS forecast of -$0.28 compared to -$0.09 in the year ago quarter. Annual EPS won’t improve either, per analyst consensus, with -$0.50 ending in fiscal year December 2019 and -$0.43 ending in fiscal December 2020.
We’ve already seen a few companies get crushed by the market if they have a small miss, which is the paradox for growing tech companies who are often penalized by the market by foregoing earnings to capture peak growth, which in turn, becomes rewarded by the market once it materializes into earnings. In other words, if Roku misses anytime in the next couple of years, it’ll be with EPS rather than revenue. The market, which is confused by the many OTT streaming services and hardware players, will penalize Roku. This most certainly will not be the last time the stock sees double-digit pullbacks.
I also foresee the market abandoning Roku and many other solid tech stocks that aren’t profitable yet during the inevitable value rotations. Keep in mind, investors also did this with Netflix, Google, Apple, Microsoft and Amazon during 2009.
Misunderstood Competition is an Edge
As is always the case, the market has a record of underestimating small companies that are battling with other big companies like Apple, Disney, Google, and Comcast. This is why Roku still remains one of the most volatile stocks in the market. This also proves the affinity investors have towards brands rather than technology. Yet, it is the latter that drives growth in new markets.
The nuances in strategy and technology are terribly important to understand in the crowded OTT space as it helps to have conviction when a stock drops 50% or more, yet then goes on to be the best performing stock of the 712 stocks with a market capitalization over $10 billion in 2019.
Let’s break down what I mean by Roku having very little direct competition.
SVOD vs. Connected TV Ads
Roku does not compete with Disney+, Netflix, or HBO Go because these are subscription services. Subscription video on demand (SVOD) is in a category of its own as the opportunity Roku is capitalizing on is Connected TV ads (CTV Ads). Advertisers are paying a premium for CTV ads, which is Roku’s market. The distinction between markets is important, and one that Wall Street missed when discounting Roku as a long-term opportunity by labeling it a hardware company for its first couple of years on the market.
Roku directly competes with Amazon and Hulu, as they compete for Connected TV ad dollars. However, as the market is well aware, data is king as it allows for better targeting. Hulu has to barter data as it’s a single application without a platform or hardware (i.e., it shares and connects third-party data, including with Facebook). Third-party data is always weaker targeting than first-party data and could be subject to privacy issues.
Razor-Razor Blade Model
Discounting the hardware and taking a loss is an excellent strategy to maintain a moat on data for advertising. Both Amazon and Roku own the hardware, and at current prices, the hardware likely causes negative or very thin margins. This is similar to the razor-razor blade model, where you discount the razor to sell the razor blades for life.
This positions Amazon and Roku for first-party data across OTT applications. Anything data related is subject to privacy issues and anti-trust issues. This is at the core of the controversy with Facebook and Google.
Roku is again set apart here, as the company only does OTT. The company does not share the data beyond the OTT player it owns. Amazon, however, is collecting data in a way that could come under anti-trust scrutiny as they take e-commerce data and broker this on the OTT player, which is anti-competitive with other ad exchanges.
Amazon is well aware of this, and is being proactive rather than reactive by opening up its demand-side platform to other DSPs, such as The Trade Desk, which was announced in July of this year. On a side note, Facebook learn from Amazon’s playbook as reputational damage is hard to shake.
Roku, however, does not need to worry about this as data never leaves the OTT hardware that they own, where they have a first-party relationship.
Valuation:
Connected TV ads are ballooning because they combine audience data with the viewability and completion rates of linear television. Roku’s valuation at 14 price-to-sales seems high at first, yet the one-year forward price-to-sales is trading at 9.3 due to the forward growth opportunity in Connected TV ads. Roku earnings estimates for 2020 and 2021 are $-0.29 and $0.6178 respectively. Therefore, the market may still be lukewarm with knee jerk reactions throughout 2020.
For example, last November, video-first SSP Beachfront reported that ad requests for CTV had increased 1,640% from November of 2017. While this is only one company’s growth in a single segment, the opportunity is so ripe, it’s hard to quantify. More astonishing is that Connected TV ads surpassed mobile last year for capturing the largest number of impressions and video completion rates.
Roku’s revenue growth will be exciting; however, the company is not likely to be profitable until 2021. In the third quarter Roku income statement report showed that revenue grew by almost 60%. This was almost double that of Netflix and triple that of Google.
Traditional metrics show that Roku is not a cheap company to own. Its forward EV to EBITDA ratio of 393, which reflects the lack of profitability. It’s not surprising the stock is trading in the range of $127-$131 following earnings, which was former support.
Depending on macro trends, we could see Roku trade around $100 again as this is an important psychological level, as shown below. It is also along the 50% Fibonacci Retracement level and along the 200-day exponential moving average. Long-term, I see Roku as one of the most promising tech stocks on the market and have provided projections to my premium subscribers.
Knox Ridley, technical analyst, will be covering Roku in-depth with technicals next week. He has guided many successful entries on this stock for our premium members, including entries lower than $100.our premium members, including entries lower than $100.
A version of this analysis appeared in MarketWatch prior to earnings on November 6th, 2019.A version of this analysis appeared in MarketWatch prior to earnings on November MarketWatch prior to earnings on November 6th, 2019. It has been updated and lengthened post-earnings.
Momentum swings in both directions. Last week, we woke up to Roku at a 20% drawdown in a single trading day. In fact, within 2 weeks, Roku’s price has fallen 39% from its all-time highs. If you are new to Roku, it would be easy to panic. However, for those that have been involved with Roku from its IPO didn’t even flinch. Within 2 years of trading, Roku has had 3 drawdowns of around 50% from peak to trough. The largest drawdown has been 64.47%, and without a strong conviction, there’s no way an investor could sleep while holding Roku for the long haul.
Whenever we see the market get it wrong, again, on Roku, and the technical break significant support, as a Roku investor, I don’t get afraid, I get excited. It’s times like these that I look to add to my Roku position as I have personally outlasted every Roku drawdown since it went IPO. The point of this report is to gauge the probability of Roku’s current drawdown, which can act as a reasonable point of entry.
Elliott Wave
Roku’s impulsive chart pattern is unfolding nicely. My primary count has us completing a blow-off top 3rdwave, highlighted in the blue numbers, where the explosive 3rdwave, with peak technical momentum, pierced the upper range of the trend line. We are currently starting the 4thwave down and when we zoom into the 1-day waterfall event, we can see a clear 5-wave pattern down, insinuating a 5-3-5 correction is underway. I estimate this correction will take us to the 50% – 61.8% retrace level ($96-$77), after we get a corrective bounce.
These levels not only coincide with the trendlines developing, but they also coincide with the 100% extension and the 78.6% extension. I see this area as a strong region to expect the pullback to find support, and depending on the broad market, could be an excellent place to add to, or begin building a position.
Basic Technical Analysis
Some of my favorite gauges for market health and actionable decision making is based on basic trendline/momentum data.
First off, I anchored a Volume Weighted Moving Average (AVWAP) to the December low, which is the momentum line highlighted in pink. This moving average clearly shows that, even with a near 40% drawdown, the bulls are still in control. This moving average lines up perfectly with the 200-Day moving average, highlighted in blue. These 2 levels will act as major support as they move into the targeted support ranges, strengthening the support within this region.
Moving onto the broken support regions, you’ll will notice the 3 separate tops (one of which we are currently experiencing). Below these tops you’ll notice the line in the sand support region, highlighted in dotted black. Roku has definitively broken through the current support, after breaking a significant trend line, also highlighted in black. Notice the red arrows. There are 3, all lining up with the exact moment the RSI, MACD and price broke their respective trend lines from the December low.
I would urge you to be cautious trying to buy the dip too soon in Roku. I do believe we will see a corrective bounce from over sold levels, but I expect it to be corrective before we see the final drop into the 50% – 61.8% retrace zones. You’ll notice the histogram in the MACD, dropping to levels we have never seen with Roku. When we see such a sharp drop in the MACD, more times than not, it’s an indication of too soon, too fast, which leads to the very least a bounce. Also, you’ll notice that the RSI is right on the 30 line, indicating oversold levels as well.
However, while we are looking at the RSI, I want you to notice how many times the RSI broke the 40 line, which in a bull market the RSI will usually not break, and then dropped to the 30 line. Three times this occurred, and 2 of those time lead at least a 50% drawdown. I use this as further evidence to hold off on adding to Roku at these levels.
In conclusion, I believe the $96 level will be the next support region that Roku will react to. It’s due for a bounce, I’m expecting at minimum to the $115-$120 region, but this bounce should be corrective before we drop to the 61.6% region. I will look to add to my position around this price cluster.
Connected TV advertising is in my top three favorite tech trends for serious gains in the near term of 2-3 years, and therefore, the opportunity requires a lengthier analysis. CTV ads offer investors a sizable opportunity, which has not been available for over a decade – since the early proliferation of mobile devices. The CTV ad market will take at least until 2021, and perhaps until 2023-2025, until the market is mature and the gains slowdown.
Roku and The Trade Desk are first movers in connected TV advertising in their respective categories of OTT platform/player (ROKU) and third-party ad network (TTD).
Roku investors are speculating the Roku Channel can compete with the big 4 for time spent on over-the-top applications: Netflix, Amazon Prime Video, Hulu and YouTube. Investors in The Trade Desk are speculating the third-party ad network can stave off competitors, which are likely to appear in droves over the next two years as the ad-tech space is the most crowded space across the technology sector with little IP to speak of. Those are the risks while the runway for this opportunity is quite long.
1.1 Overview of Connected TV Advertising
Connected TV advertising is taking market share from mobile for a few reasons that are important to understand.
The first is that brands with the largest ad budgets prefer television advertising as opposed to desktop or mobile.
I’m referring to companies such as McDonalds, Geico, Budweiser, Pizza Hut, Coca-Cola, Macy’s, BMW, Mercedes, Toyota, Loreal and Nike, for example. Big-budget brands have struggled over the past 10-20 years because mobile and desktop are not as effective for brand messaging yet these mediums have been stealing the eyeballs and are fueled by data.
Budweiser ads are not plentiful on mobile or social but they continue to pile in the ads for televised sports and pay dearly for Superbowl ads. Beer drinkers are also on mobile but Budweiser can’t measure the impressions because the screen is small, the customer is distracted/on-the-go and these brands need at least 30 seconds for a proper impression. Mobile and desktop are better for companies that want clicks and “purchase intent” rather than brand impressions.
However, despite the high cost of TV commercials, they do not offer data on the audience who is viewing the ad. The only information Budweiser has to buy an audience on traditional television is the content that is being watched (football). If Budweiser has determined that men between 25 to 45 are the heaviest beer drinkers, with Connected TV ads, they can now target them specifically on television. Perhaps Michelob Ultra wants to target people who are health conscious. They can do this with audience targeting through Connected TV ads rather than wasting money on showing ads to people who are not health conscious (general football audience) or guessing on what health conscious beer drinkers watch in the evening. They can buy the exact audience “health conscious.” Pizza Hut can buy a college student audience. Geico can buy an audience of income earners in the $40,000 to $70,000 range. State Farm can buy families who own homes. Mercedes can buy audiences who make over $150,000. Macy’s can buy audiences of families who have children for school shopping ads.
These brands can buy audience targeting on television – and this has not previously been the case.
Connected TV takes the best part of mobile (audience data) and combines it with the best part of television (brand messaging). This is a very important trend for brand dollars that should not be dismissed as “eyeballs migrating to OTT.” The opportunity is much larger than represented by the number of people who are cutting the cord as Connected TV ads are not merely a 1:1 ratio. Rather, these ads represent a higher ratio as the demand (advertisers) consider the medium more valuable. This places Connected TV ads in a league of their own.
We are in the early days of Connected TV ads and already see a $20 average revenue per user. This is 200% more than social ads, such as Twitter, at $9 ARPU. It took Facebook over a decade to surpass $20 per user while we can trace the relevant emergence of Connected TV ads to late 2017/early 2018.
1.2 CTV Ads by the Numbers
Mobile’s share of programmatic video will peak in 2020 at 53.9%. By 2021, mobile’s share will dip below the 50% mark due to the rise of CTV ads. To illustrate the growth of CTV, SpotX saw the share of impressions it serves through connected TV increase from 15% in Q1 2018 to 33% in Q1 2019. Innovid also saw CTV ads jump from 13% to 27% and Extreme Reach reported an increase from 15% to 44% over the time span of a year.
To date, CTV ads account for $8.2 billion of the $70 billion spent on global TV advertising in 2018. Data is driving personalized ads with data-driven video increasing 79% in 2018. Customized ads combining localization and personalization can generate over 12,000 unique versions with the largest customized ad having over 200,000 customized versions. This provides an engagement lift of over 78%.
According to CMO.com, an eye-tracking survey revealed that TV commands 2x the active viewing attention compared to YouTube and 15x the active viewing attention of Facebook. Completion rates are also higher on connected TV at 95% compared to 75% on desktop and 72% on mobile. Brands are convinced they should integrate with digital audience data with 28% saying they have already done so, but 68% plan to do so by September 2019.
SECTION 2: The Trade Desk
The Trade Desk is a “demand-side” or “buy-side” ad platform which allows advertisers to buy ads in an auctionlike format through real-time bidding. This is an automated method for buying and selling inventory that eliminates the need to call up an agency or salespeople to place the ads. The official term for this is programmatic, and the trend is popular in ad-tech, with over 50 demand-side platforms that transact programmatically. By utilizing machines instead of salespeople, the cost of the ads goes down and both parties (supply/publishers and demand/advertisers) prefer programmatic due to fewer middlemen and higher returns.
Strong drivers for The Trade Desk include omnichannel capabilities, which is the ability to buy ads across many channels, such as mobile, video, audio, display, social and native. The universal ad ID is another important differentiation as it offers an anonymized ID that helps track users, target audiences and provide attribution. This feature is rare for a third-party ad networks and helps The Trade Desk compete with first-party data companies (Google, Facebook, Amazon, Snapchat, Pinterest, etc.) To further compete with first-party data companies, The Trade Desk buys data. This is combined with the brand advertisers’ data on a data management platform for targeting purposes.
Differentiation in this category is essential for investors in The Trade Desk to track closely. Risks are noted below, with the primary risk being the competitive ad ecosystem, which includes many companies that are able to copy ad-tech features as there is very little IP and/or complexities with these products. There is also little loyalty from advertisers who will quickly switch to the next best-performing programmatic DSP.
2.1 The Trade Desk and Connected TV Ads
Connected TV ads is one of many revenue segments for The Trade Desk. In the most recent quarter Q1 2019,
The Trade Desk stated CTV spend grew over 300% from a year ago. In previous years, The Trade Desk reported 1000% growth in Connected TV advertising from Q3 2017 to Q3 2018 and 900% growth when adjusting for the period between Q4 2017 and Q3 2018.
“We've never seen an opportunity like CTV before and I don't think we'll ever see one like it, again … It is the biggest opportunity we've ever seen (and) probably ever will.” – TradeDesk CEO
2.1B Amazon Partnership
The Trade Desk shares jumped in late July following an announcement that Amazon Publisher Services is partnering with The Trade Desk and Dataxu TouchPoint, which will allow advertisers access to Amazon’s inventory on Amazon’s Fire TV marketplace. Publishers on Amazon’s Fire TV marketplace will also benefit from increased access to advertisers.
There are a few things to note about this announcement:
• Amazon will likely open up ads to more demand-side platforms with CTV advertisers. The Trade Desk will be competing with Dataxu and Amazon DSP on Fire TV inventory for now. However, it’s likely there will be more demand-side platforms joining as it’s common for the supply side (content publishers) to work with as many buyers (advertisers) as possible.
• It’s not clear if The Trade Desk and Dataxu’s demand will be as competitive on CPMs. Amazon has the better in-house data and targeting information.
• This could be a PR move for Amazon to be proactive on anti-trust while giving up a small amount of revenue (small for Amazon, not small for The Trade Desk)
Regarding the PR move, the motivation behind the announcement may be that Amazon is being proactive in side-stepping anti-trust issues. The Trade Desk and Dataxu are competitors to Amazon’s own demand-side platform Amazon DSP. By giving away a small piece of the Connected TV pie, Amazon protects itself from regulation. If this is the angle, it’s an incredibly smart move by Amazon and third-party ad networks stand to benefit.
2.2 The Trade Desk Financials
The income statement on The Trade Desk is solid for a company of its size. Revenue in Q1 2019 grew 40% to $120M from $85M in the year-ago quarter with positive net income of $10M. Adjusted EBITDA grew from $18M to $24M. Growth YoY has been a consistent 50-60% for over 4 years posting 52% in 2017 from $202M to $308M and 55% in 2018 to $477M.
We already discussed rampant growth in Connected TV advertising, however, The Trade Desk is also strong on mobile at 45% YoY and mobile video at 60%. Customer retention at The Trade Desk is at 95% and has been in this range for 20 quarters, according to the 2018 Financial Results (note: many ad companies claim high retention). Data spend was up 80%, cross-device up 300% and audio up 270%.
However, these numbers come with an outstretched valuation of $12 billion market cap on $500M in annual revenue and $10M in profit. The price-to-earnings ratio is 135 and the price-to-sales is 24, at time of writing.
The Trade Desk advertises that it has been profitable since 2013. This requires caution for buy-and-hold investors. There is very little R&D to be spent on ad-tech as there is no moat to protect. The ad ecosystem is capital efficient because the technology is not complex enough to require a large team of engineers. In technology, being capital efficient right out of the gate can often spell trouble long-term if the development of the product is easy for competitors to copy.
2.3 The Trade Desk Risks
Competitors will not knock The Trade Desk out of position this year, however, the future for an ad network in CTV ads, omnichannel programmatic with a data management platform in the stack, and/or with an ad ID will become decisively hard turf to protect. The early profitability reveals the lack of complexity in the ad-tech stack, and this is true for all third-party ad networks.
The ad industry is highly competitive, and the track record of third-party ad platforms performing well long-term is nearly non-existent following a year or two in the limelight (i.e. Millennial Media, Criteo, etc). This is due to hundreds of competitors globally.
Demand-side platforms are especially at risk as the supply-side controls the relationship. In this case, The Trade Desk is at the mercy of the supply-side platforms who often work with as many demand-side platforms as possible to get the most demand and the highest ad rates on their content. (It’s called supply and demand for a reason, and the supply will, of course, want to increase demand with no loyalty provided to The Trade Desk).
The Trade Desk states the company is “one of the fastest growing and most profitable software platforms in any sector.” This is false advertising. The Trade Desk is a third-party programmatic ad network and this is a very distinct category from software. This statement is especially troublesome.
The company also claims a disproportionate total addressable market as they include TAM that is shared by Google, Facebook, Amazon, all social apps, and all television advertising ($1 trillion industry). The company states a $33B TAM for programmatic, although this is also shared by dominant digital FAANG companies.
Conclusion:
CTV ads are a big enough opportunity for The Trade Desk to continue to perform well. The stable revenue segments of mobile video and desktop are diversified with the explosive revenue segment of CTV ads. There is no reason to believe The Trade Desk will miss earnings.
However, the stock is very expensive and will be penalized due to price in broader market reversals. Please see the technical analysis for buy-and-hold entry/exit scenarios.
Regarding the next 1-3 years: one key differentiator for The Trade Desk is the universal ad ID. If The Trade Desk lost the universal ad ID capability to track users, this would impact the company negatively. On the flip side, Big Tech anti-trust issues or privacy regulations could strengthen The Trade Desk’s market position. The universal ad ID should be watched closely for positive or negative product announcements.
Monitoring the competitive landscape will be essential for The Trade Desk over the next 1-2 years. I expect competitors to appear in droves with at least 7-10 new viable competitors for CTV ads in the next 24 months. If you are a Research Services subscriber, you will know of these competitors in advance.
SECTION 3: ROKU
Roku is the only pure-play CTV ad option that owns its own hardware platform and operating system. This is an enviable position that only Google and Amazon claim, although notably, Roku has more hardware players in households than either Google Chromecast or Amazon Fire TV with 40 million U.S. customers using Roku once per month. Roku also has the advantage of knowing OTT better than any other company as the original provider of set-top-boxes. Connected TV ads and OTT hardware is the company’s 100% laser focus.
Many investors over-estimate original programming and subscription services. According to Nielson, only 20% of time is spent on original programming while 80% of time is spent on catalog content. Meanwhile, Netflix is spending $8 billion per year to produce original programming. Many ad-supported choices have subscription fees, such as Hulu and YouTube TV, which forces consumers to pay for subscriptions while still seeing ads.
Overall, there is subscription fatigue in the OTT space with individual channels charging $8+ for single channels to $45+ for YouTube TV. These fees add up to more than a cable bill, in some cases. Roku’s growth has come from executing well on a channel that is entirely free and supported by ad dollars – a welcomed business model compared to the competitors.
Pay TV attrition funnels into Roku’s addressable market. For every dollar AT&T and Comcast lose, Roku is situated to gain. In 2011, pay TV subscribers fell by 8,000 in 2012 and the losses accelerated to 164,000 in 2014. Three years later, the losses grew 20x to 3 million subscribers. By 2023, live-linear OTT video subscriptions will surpass traditional broadcast TV.
Beyond Connected TV ads, Roku is a hardware player and operating system. In Q1 2019, the company estimated that one-in-three smart TVs sold in the U.S. were Roku TVs. I originally covered Roku’s partnership with smart TVs in early 2018, and why being vendor agnostic would be a boon for future growth. In other words, in the arena where Apple, Amazon and Google compete, Roku is a neutral party. TCL, RCA and Samsung/Tizen chose Roku.
The global OTT devices and services market is expected to reach $165 billion in 2025 compared to $29 billion in 2015. As stated in the introduction, there is phenomenal growth being reported across CTV ads with triple-digit and even four-digit growth percentages. As a pure play option, the majority of Roku’s revenue comes from capitalizing on this opportunity.
Notably, Roku has a significant amount of proprietary data for advertisers to leverage. By owning the viewing platform, Roku is able to collect data across OTT apps.
1.1 Roku’s Global Potential
I first covered Roku’s global potential in May of 2018, and we have yet to see Roku’s global expansion. I believe Roku will become a large cap stock with global execution and could reach a $100 billion valuation from the cheap hardware proliferation in global markets combined with the free-supported ad channel and primary driver of platform revenue.
The low price point for the hardware coupled with the free content should be very desirable in emerging markets. Roku’s OS has 3,000 channels compared to the next competitor with 1,300 channels. This variety will do well for global audiences who have varying tastes in content. Roku also has a free mobile app that can reach the 3 billion smartphones in the world, 80% of which are Android due to the cheap average sales price.
The bottom line is that Roku has maintained the lead in the United States as the top streaming media player by helping reduce costs for cord-cutters. Their business plan is to keep costs very low for their customers. It’s only a matter of time before they bring this to the billions of people overseas who want to reduce the cost of television.
2.2 Roku’s Financials
In 2017, as a newly public company offering investors transparency, Roku revealed lackluster revenue growth leading up to its IPO. In 2015, annual revenue was $319M, and in 2016, the annual revenue was $398M. This is why some investors had a hard time buying the stock when it listed in September 2017.
The revenue turnaround is easy to understand when compared with the trajectory of CTV ads as analyzed by this report. CTV ads were nascent in 2017 and started gaining traction in 2018. Roku soon began posting revenue growth of $512M in 2017 and $742M in 2018.
Most recently, Roku reported 79% growth YoY in Q1 2019 on its ad platform revenue with total revenue at $134M.
Roku is not profitable with net income of negative $10M. Adjusted EBITDA is positive $10M.
In order to lock-in market share, Roku offers its hardware players at low prices, which eats at margins. In Q1, Roku lowered prices of its hardware by 4% YoY. Roku spends heavily on R&D at $55M in the last quarter to help maintain its lead as a top OTT player and ad platform. That’s nearly 40% of revenue spent on R&D. In Q1 2019, Roku had $265 million in cash and short-term investments.
This quarter, Roku’s outlook calls for 42% year-over-year revenue growth to $223 million at the midpoint. Adjusted EBITDA will be a loss of roughly $7.5 million in Q2 at the midpoint. This is due to product development and a new lease. Keep an eye out for Roku beating on revenue and missing on net income or adjusted EBITDA over the coming year as the company fiercely protects its turf with R&D during this time of golden opportunity in CTV ads.
2.3 Roku’s Risks
The majority of time spent on OTT is on Netflix, Amazon Prime Video, Hulu and YouTube. These channels comprise 75% of viewer time. In addition, the OTT market is heating up with the entry of Disney as a major player. Although most of these subscription channels do not directly compete with Roku for brand ad budgets (they are subscription channels), they do compete for time spent on Connected TV. Please keep in mind, these are viewing habits for the United States and global markets will change the trajectory of subscription vs ad-supported — with ad-supported being favored.
On hardware, Google Chromecast and Amazon Fire can reduce prices to lock-in users with little effect on the mega-cap companies’ bottom lines. Roku may need to continue lowering prices on the hardware player to remain competitive. Amazon’s DSP remains Roku’s biggest competitor.
Conclusion:
Investors do not need to choose between The Trade Desk and Roku. Rather, investors need to get these companies at the right price for the highest returns. The Trade Desk has potential over the next two years and requires monitoring for a buy-and-hold strategy beyond this. Roku has potential for the next five years and may have a sudden, upward trajectory with global expansion.
From a tech analyst perspective, Roku has a better moat than TTD. Amazon and Google have not been able to shake Roku — and there is no evidence that this will occur in the future.
Roku will likely report strong revenue growth into the foreseeable future. The profitability could spook Wall Street, and there may be surprises in the operating expenses, but subscribers to Research Services should use this to your advantage as you are now well aware of the CTV ad opportunity.
Connected TV advertising is going through a lucrative and important transition right now that will remain stable during economic downturns due to the free price point and the CPG brands who buy TV ads. I do not believe Roku is expensive relative to its growth potential. However, the technicals show weak internals and there may be better buying opportunities with patience. Please see the technical analysis for more information.
How Roku and The Trade Desk Compare:
• The Trade Desk has the same market cap as Roku with nearly 35-50% less revenue.
• Notably, TTD has better cash flow and is marginally profitable.
• Roku’s Cost of Goods Sold is bloated at 50% or more of revenue, which is a negative. Roku has thin margins on the hardware player revenue as it’s cheaply priced to get people locked into the ad platform.
• Roku does spend 2x more on R&D than TradeDesk, which is a positive as they should be investing to maintain their lead.
• I favor Roku between the two but CTV ads are a big enough opportunity to add both to your portfolio at the right price and/or to buy calls.
SECTION 3: Technical Analysis
Provided by Knox Ridley
Section 3.1: The Trade Desk
The Trade Desk has traded in a relatively uniform bullish channel. I currently see it finishing 5 waves up from the December low in a larger degree 5 Wave count. The larger degree 5 wave count has us completing a wave (3), which I believe is playing out now. Below $226, and we will likely see this Wave (4) retrace fall somewhere into the green box – $174-$108. This will be our target to ride Wave (5) to new highs and beyond. If you are not invested in TTD, around $150-$135 will be a good entry.
It should be noted the strength of TTD’s uptrend. It is currently above its 8-Day EMA and-21 EMA. The Trade Desk, like many stocks in the tech sector right now, are making higher highs with decreasing buying pressure. This can be seen in the Pink Arrows, and if you’ve been keeping up with my analysis, you’ll recognize I’m using the term negative divergence frequently. This is when the RSI/MACD is making lower highs while the stock price is making higher highs. This is a sign of weakening buying pressure and an unhealthy uptrend. It typically leads to a correction, unless new material information is released to justify increasing buying pressure.
Another pattern to note is that TTD formed a classic candle stick pattern known as a 2-day reversal. This is when a trend is interrupted by a massive spike up on higher than normal volume, and then the next day reversed in full on even higher volume. This is a signal of exhaustion, and can signal a trend reversal.
You’ll also notice how the 50-day EMA acted as a major support in the picture above. If we break this trend, we will likely find our entry in the green box targeted on the chart. For now, let’s see what TTD gives us.
• Most likely scenario: TTD breaks support at $224, and we wait for a bottom to form, followed by a renewed uptrend to enter a long position.
• Less likely scenario: TTD breaks out to new highs on high volume to $285. If this happens, we will also initiate a position with wide stops.
• Notably Beth is bullish on TTD and does not foresee any fundamental issues. Rather she sees Connected TV ads as an opportunistic trend with a long runway. Keep this in mind for earnings.
Section 3.2: Roku
Since its IPO, Roku has been trading within a well-defined trend channel (in solid blue lines). It has bounced multiple times from the top of the trend line to the bottom channels, trading within a uniform fashion within this band. As you can see, Roku is at the top of the trend channel again, and has been bouncing around the ceiling, trying to break through. It’s worth noting, the more a support/resistance level is tested, the weaker it become – this holds true for the $114 level, which would make a new high, and the $88 support, which is the line in the sand for Roku’s continued advance.
The upper trend channel has been significant resistance for Roku, marking a short-term top twice before, followed by a decline in price. Today, we are, once again, testing this trend line with some notable differences:
• Roku is staying on the trend line for an extended period. It tried to turn down, found support around $88 and is back on the trend channel again. This is a show of strength, which needs to be factored.
• Negative Divergence: as Roku’s price increases, its RSI is decreasing, signaling a weakening buying pressure (note the pink arrows’ divergences). The same can be seen in the MACD’s peaks – as the price of Roku increases, the MACD is making lower highs. This is a show of internal weakness, which usually precedes a pull back.
• The Volume is decreasing as the price advances. In a bull trend, we want to see volume expanding along with the price. This is a signal that the buying pressure is thinning out.
• The MACD has rolled over from a high point and is pointing down. This is a sign of weakening internals, and usually precedes a pull back.
• Roku has broken the 21 Day Moving Average and is touching its 50 Day (orange).
• Notably Beth is bullish on Roku and does not foresee any fundamental issues. Rather she sees Connected TV ads as a very opportunistic trend with a long runway. Keep this in mind for earnings.
One final point, if you look at the chart below, you’ll see an outside reversal pattern (or bear engulfing pattern). This is when the high and low of the day is at greater highs and greater lows than the day before. What makes this pattern strong is: (1) the more days it engulfs the stronger (2) the larger the engulfing pattern vs the days prior is a show of strength (3) the engulfing pattern happens on higher than normal volume.
This pattern engulfs 7 prior trading days on higher than normal volume. I’d consider it a relatively strong indication of a trend reversal.
Technical Analysis operates within probabilities. The weight of evidence supports lower prices for now. Let’s see how it performs around this area. If it breaks through the $88 range, we could easily see it trade between the $60-$45 rather quickly (green box in the graph). On the other hand, if it can break through the long-term uptrend channel with heavy volume, this will be a bullish reversal.
Conclusion:
(1) With this being one of our highest conviction ideas, we want you to get the best price possible to hold for the long haul. We believe you have a chance to secure Roku in the high $50s to low $60s with patience. For now, we need more information on how the stock trades between the $88-$114 range to improve the odds of the gamble.
(2) Notably Beth is bullish on Roku and does not foresee any fundamental issues. Rather she sees Connected TV ads as an opportunistic trend with a long runway. Keep this in mind for earnings. Roku’s pullback will likely require a broader market sell-off.
Will Roku miss earnings? I believe Roku will miss earnings at times, but for the big picture, Roku is at the center of an important trend in advertising and this will make for decent returns now and sizable returns in the future. I also don’t play the earnings game often with stocks as my analysis does not change monthly or quarterly. My conviction on Roku is high and can withstand trade war news or a fledgling quarter, which is normal for smaller companies on the edge of incipient trends.
What Investors Got Wrong With Roku
The first thing Wall Street got wrong with Roku is that investors thought Roku was a hardware player. Although it is clear now that the ad platform is what will drive the profits, this wasn’t evident in the financials for a few earnings reports. My three pieces of analysis in 2018 were the opposite; I made my readers aware the ad platform was where the growth potential was.
The second thing Wall Street gets wrong is assuming Google or Amazon can dominate over-the-top television because they are Big Tech and smaller companies don’t have a chance. Google struggles here and recently raised the prices on YouTube television to $49, which for the most part, negates the purpose of cord-cutting when you add a few subscriptions like Netflix or HBO Go, and end up at the monthly cost of cable. Amazon is pushing into ads for OTT, however, there will be privacy regulations to face as the data powering those ads is being brokered without consent from e-commerce and Prime purchases. You can ask Facebook how that is going for them.
Roku has all of the pieces to the stack. The hardware is a razor-razor blade model that locks in their ad-supported platform. They’re OTT-only, and this prevents privacy issues for the data they collect from the device (this is why Apple is always in the clear with privacy issues – data stay s on the device).
Interestingly, the consensus EPS forecast for Roku is negative $0.24 compared to negative $0.07 same quarter last year with analyst expectations of declining growth. Meanwhile, Roku had posted EPS of $0.05 last quarter. Here’s a screenshot of Roku’s earnings per share vs. consensus:
TradeDesk is also a Connected TV advertising player and reports on May 9th with analysts expecting declining growth from the previous quarter with estimates at $0.07 per share.
With that said, advertising is driving record profits for many companies who have already reported this quarter, such as Facebook and Twitter. This is why I’m surprised (and don’t necessarily agree with) the low analyst expectations for both Roku and TradeDesk as these expectations of -$0.24 for Roku and $0.07 for TradeDesk are some of the lowest in these stocks’ earnings histories (1+ year or more).
My Opinion “Long on Roku Even if They Miss Q1 Earnings”
That was my headline last May in 2018 even though Roku did not miss Q1 2018 earnings. My stance on this stock remains the same. Roku is a core holding of mine because of the mega trend towards Connected TV advertising. To put it simply, and as I wrote before Q1 2018 earnings were reported, Roku beating or missing earnings is not my focus for a long strategy based on an important trend. I fully expect tech companies to miss earnings from time to time (this creates better buying opportunities). This won’t change my conviction that Connected TV advertising is on an important upward trajectory.
Here’s some more information on the Connected TV market:
“Two of the big trends in digital media aren’t compatible: The drive to enforce viewability standards and the shift to mobile, particularly apps.” – Digiday
Viewability issues are a serious issue for big brands who are averse to mobile in-app advertising because it’s too challenging to track. In addition, many big brands do not need immediate purchases which is called “purchase intent” – which is mobile’s main value over television.
For instance, Coca-cola doesn’t expect you to buy a soda immediately after seeing an ad. Audi doesn’t expect you to buy a car immediately either. So, a lot of the benefits of mobile aren’t worth the downside to these big brands. Advertising budgets shifted to mobile because they had to find audiences, not because it’s a superior method to advertise.
Here’s how the two compare:
Pay TV has high completion rates as viewers are comfortable in their homes and better prepared to receive advertisements.
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Mobile offers audience data to better target viewers based on individual preferences.
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Connected TV advertising, which is Roku’s specialty, combines the best of both television and mobile. It offers 100% viewability and completion rates with the audience data and dynamic ad insertion found on mobile. Forbes covered this in a recent article which stated Ad Supported OTT is the future reporting OTT ads have a 97% completion rate and 100% viewability.
In a recent study by FreeWheel, 200 billion video starts found OTT ads had ballooned from 2% to 32% in a four-year period due to heavier investments from advertisers.
In the Q2 2018 Video Advertising benchmark study released by Extreme Reach, a tech platform for video ad campaigns, connected TV impressions overtook mobile, accounting for 38 percent of all video ad impressions down from 33 percent in Q1.
“CTV is clearly on the path to becoming the dominant platform for media consumption, and premium inventory is the most sure-fire audience draw.”
– Mary Vestewig, Senior Director, Video Account Management at Extreme Reach.
AppNexus, the world’s leading independent advertising technology company, announced in July of 2018 that advertiser spend in its connected TV marketplace grew 748% year-over-year versus the second quarter of 2017 and 68% quarter-over-quarter. AppNexus currently sees 20 billion monthly connected TV impressions per month.
From an investment standpoint, the implications of attracting more advertising dollars than mobile is enormous. Big brand budgets have been looking for a solution to traditional television that isn’t confined to the attention span and limited screen size of mobile viewers. With Roku, that option is finally here.
Please note: I’ve also covered TradeDesk, another stock doing well by capturing the Connected TV advertising trend. You can read that analysis here on FATrader and why the risks with TradeDesk have personally kept me from buying the stock although many of my readers have seen 400% returns on $TTD.
This analysis is not an earnings call. The purpose of this article is to revisit a few trends and predictions I made around this time last year in regards to Roku.
Roku’s earnings report for Q3 is scheduled on a potentially volatile trading day depending on how the broader markets react to the mid-term elections. The uncertainty around this outcome, along with rising rates, geopolitical trade uncertainty, and a host of companies tempering their Q4 outlook has caused a style rotation, which has pummeled tech stocks. Regardless, Roku is a mid-cap growth stock in the tech sector that will continually prove itself against headwinds as the company is poised to become one of the most opportunistic growth stories in the market by 2023.
The reason for this is simple: connected TV advertising combines the high engagement of traditional television with the audience targeting capabilities of mobile. These previously two competing forces will combine to create the next advertising phenom, and Roku will emerge as the tech darling of this ever-important shift in ad dollars.
Pay TV Attrition is a Blood Bath
Pay TV has had better decades. The peak for Pay TV user growth in the United States occurred in 2011 when it began an inevitable erosion due to bloated, costly monthly packages, a lack of flexibility for on-demand, and advertising-stuffed programming choices. The following year, pay TV subscribers fell by 8,000 in 2012, which accelerated to 164,000 subscriber losses in 2014. Three years later, those losses grew 20x to a staggering 3 million subscribers (source: Leichtman). And by 2023, live-linear OTT video subscriptions will surpass traditional broadcast TV[1].
Cord-cutters have driven a formidable marketplace. In fact, the global OTT devices and services market will reach $165 billion in 2025 compared to $29 billion in 2015[2].
Roku offers the most synonymous OTT business model with cable and satellite TV providers and can capitalize long-term on this massive subscriber loss by leveraging its advertising, audience development and content distribution services, which make up 89% of gross margins from the platform. As of Q2 2018, if Roku were a traditional cable TV company, the 22 million active subscriber base would rival Comcast as second largest distributor of content in the United States. Only AT&T has more with 47 million DirecTV subscribers. Compare this to Charter Communications, which has a $65 billion market cap and only 16 million users or Comcast with a $171 billion market cap with the aforementioned 22 million subscribers. Roku’s market cap is at $6 billion with shares priced at $56 with the same number of users as Comcast.
The Next Phenom in Tech is Connected TV Advertising
I’ve covered Roku extensively in previous analysis including strengths on how the company is vendor agnostic, player vs platform revenue and the company’s global potential. Connected TV advertising, however, is by far the most important piece for Roku’s trajectory.
Bear with me here as I talk about some of the problems and technicalities in the advertising industry, and why Roku is well positioned.
As Digiday puts it, “Two of the big trends in digital media aren’t compatible: The drive to enforce viewability standards and the shift to mobile, particularly apps.”
Viewability issues are a serious issue for big brands who are averse to mobile in-app advertising because it’s too challenging to track. In addition, many big brands do not need immediate purchases which is called “purchase intent” – which is mobile’s main value over television.
For instance, Coca-cola doesn’t expect you to buy a soda immediately after seeing an ad. Audi doesn’t expect you to buy a car immediately either. So, a lot of the benefits of mobile aren’t worth the downside to these big brands. Advertising budgets shifted to mobile because they had to find audiences, not because it’s a superior method to advertise.
Pay TV has high completion rates as viewers are comfortable in their homes and better prepared to receive advertisements.
undefinedundefined
Mobile offers audience data to better target viewers based on individual preferences.
undefinedundefinedundefined
Connected TV advertising, which is Roku’s specialty, combines the best of both television and mobile. It offers 100% viewability and completion rates with the audience data and dynamic ad insertion found on mobile. Forbes covered this in a recent article which stated Ad Supported OTT is the future reporting OTT ads have a 97% completion rate and 100% viewability.
In a recent study by FreeWheel, 200 billion video starts found OTT ads had ballooned from 2% to 32% in a four-year period due to heavier investments from advertisers.
In the Q2 2018 Video Advertising benchmark study released by Extreme Reach, a tech platform for video ad campaigns, connected TV impressions overtook mobile, accounting for 38 percent of all video ad impressions down from 33 percent in Q1.
Here’s a quote from Extreme Reach:
“CTV is clearly on the path to becoming the dominant platform for media consumption, and premium inventory is the most sure-fire audience draw.”
– Mary Vestewig, Senior Director, Video Account Management at Extreme Reach.
AppNexus, the world’s leading independent advertising technology company, announced in July of 2018 that advertiser spend in its connected TV marketplace grew 748% year-over-year versus the second quarter of 2017 and 68% quarter-over-quarter. AppNexus currently sees 20 billion monthly connected TV impressions per month.
From an investment standpoint, the implications of attracting more advertising dollars than mobile is enormous. Big brand budgets have been looking for a solution to traditional television that isn’t confined to the attention span and limited screen size of mobile viewers. With Roku, that option is finally here.
Subscription video-on-demand (SVOD) comprises 40 percent of the OTT market with the majority of the revenue coming from the United States. By 2022, SVOD penetration will be 132% of US TV households with many homes having more than one SVOD platform[1].
Total SVOD is expected to reach 171 million by 2022 – up from 59 million in 2016 reflecting a 53% increase.
Previously, viewing data and ratings on SVOD (subscription video on demand) such as Netflix (NFLX), Hulu Plus, and Amazon Prime and other OTT content was not disclosed even by Nielsen (NLSN). However, in a recent interview, Nielsen COO Steve Hasker revealed four previously undisclosed statistics about SVOD such as 89.5% of SVOD content is primarily viewed on the television glass whereas 11.5% is viewed on smartphones and tablets.
Of this time, 80% is spent on catalog programming whereas 20% is spent on original content. For definition purposes, Netflix is original content and something Roku or Amazon Prime offers is considered catalog programming.
Meanwhile, as competition increases, the costs for original programming are escalating with Netflix spending $8 billion in 2018 in order to remain competitive for a small piece of the pie (20% of how time is spent).
Roku has held firm on not creating original programming and the statistics support this. The costs for original programming are likely to escalate as HBO, Showtime, Apple, and now Disney developing its own channel for 2019, will continue to compete for this space.
In addition, subscribers pay for quite a few premium $8+ subscription channels, which will eventually lead to subscription fatigue – not to mention mitigate the reason cord-cutters leave pay TV services – which is to lower costs. For a subscriber with YouTube TV ($40) and three premium channels ($24-26), they are paying $65+ per month. This pricing will meet resistance by cord cutters and ad-supported OTT will continue to be a solid choice for viewers.
Conclusion:
Roku is executing on a market trend that will defy typical growth trajectories. Brand budgets are migrating towards Connected TV as a superior method of advertising over mobile. The Roku Channel launched in October 2017 and is already a top 5 channel by active account research. Investors should keep a close eye on platform revenue, which was up 96% YoY to $90.3 million in Q2. The trailing 12-month ARPU in Q2 increased 48% YoY to $16.60 and was “driven by strong growth in video advertising as we continue to capture more share of TV ad budgets,” as the company stated in their shareholder letter. Due to connected TV advertising trajectories, I am long on Roku for the next 3-5 years.
Roku’s stock (ROKU) is getting a lot of attention after it reported stellar second-quarter results due to 57% year-over-year revenue growth to $156.8 million beating the analyst forecast of $141 million. Compare this to 37% year-over-year revenue growth in Q1. However, as I stated in my Q1 article, the platform revenue is where Roku will continue to see a majority of the gains. The video streaming platform revenue was up 96% during the period to $90.3 million with player revenue up 24% to $66.5 million.
Some of the analysis below is taken from an article I wrote last quarter on Seeking Alpha. The information has not changed, but the stock price is beginning to adjust to Roku’s product-market fit. I do expect some correction from today’s stock pop, but these fundamentals are why I’ve been long on Roku from the beginning (and beating out Amazon Fire Stick isn’t one of them). I do expect Roku to experience some volatility on its path to becoming a large cap stock, however, specific industry trends are supporting Roku stock, and ultimately, these trends will win out.
1. Blood In The Water:
Roku offers the most synonymous business model with cable and satellite TV providers and can capitalize long-term on this massive subscriber loss by leveraging its advertising, audience development, and content distribution services, which make up 89% of gross margins from the platform. In fact, if Roku was a traditional cable company, this quarter’s 22 million active subscriber base would rival Comcast (CMCSA) for the place of second largest distributor of content in the United States. Only AT&T (NYSE:T) has more with 47 million DirecTV subscribers.++
The peak for pay TV in the United States occurred in 2010/2011 when it began a predictable erosion. The number of pay TV subscribers fell by 8,000 in 2012 and accelerated to 164,000 subscriber losses in 2014. Last year, the erosion neared deterioration with the top 10 pay TV operators losing a staggering 3 million linear subscribers in 2017 according to Leichtman Research.
2. Vendor Agnostic:
Roku critics cite too much competition for this mid-cap stock to carry the growth needed for long-term gains, especially from Apple (AAPL), Google (GOOG) (GOOGL) and Amazon (NASDAQ:AMZN) who all have a play in the hardware market for OTT video streaming services. However, this weakness is actually Roku’s strength. The Roku operating system, Roku OS 8, is a robust, reliable option for OTT streaming and has attracted partnerships with 1 in 5 smart TVs in the United States.
Meanwhile, operating systems like Samsung’s (OTC:SSNLF) Tizen continue to be plagued with bugs. But by being vendor-agnostic, Roku has still been able to secure a partnership for their free ad-supported channel with competing OSs like Samsung/Tizen. In addition, by remaining agnostic, Roku has maintained a full menu of original programming while corporate spats between Google (YouTube) and Amazon Prime restrict content choices.
Roku has also built a formidable catalog of 5,000 channels that even Google has not even come close to rival. This is where the discussion as to Roku being a hardware company should curtail as the “player” revenue has been eclipsed by the platform revenue (platform revenue stood at 45% in Q4 2017 compared to 57% in Q2 2018). It’s the latter where the company is making its largest investments including OTT advertising measurement tools, launching the free Roku channel, growing licensing fees, and partnering for live TV. The launch of live news in mid-May and the World Cup in June also contributed to platform performance in Q2.
3. There’s More To OTT Than Highly Fragmented Subscriptions:
Previously, viewing data and ratings on SVOD (subscription video on demand) such as Netflix (NFLX), Hulu Plus, and Amazon Prime and other OTT content was not disclosed even by Nielsen (NLSN). However, in a recent interview, Nielsen COO Steve Hasker revealed four previously undisclosed statistics about SVOD such as 89.5% of SVOD content is primarily viewed on the television glass whereas 11.5% is viewed on smartphones and tablets.
Of this time, 80% is spent on catalog programming whereas 20% is spent on original content. Meanwhile, as competition increases, the costs for original programming are escalating with Netflix spending $8 billion in 2018 in order to remain competitive for a small piece of the pie (20% of how time is spent). Meanwhile, Roku has held firm on not creating original programming and the statistics support this. The costs for original programming are likely to escalate as HBO, Showtime, and now Apple will continue to compete for this space.
In addition, subscribers pay for quite a few premium $8+ subscription channels, which will eventually lead to subscription fatigue – not to mention mitigate the reason cord-cutters leave pay TV services – which is to lower costs. For a subscriber with YouTube TV ($40) and three premium channels ($24-26), they are paying $65+ per month. This pricing will meet resistance by cord cutters and ad-supported video on demand (AVOD) will be the answer.
Most importantly, original programming will consolidate or bundle (like it has on cable) and Roku is the perfect middleman to do this.
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4. Global Potential:
This point ties into the previous two points where agnosticism in hardware and operating system along with building out a free, ad-supported channel will help Roku crush global expansion – especially in the emerging markets. The low price point for both the hardware and free content is desirable for global adoption, plus the 5,000 channels that Roku offers caters to differences in cultural viewing preferences. Most recently, Roku has announced offering the Roku Channel on the web in the United States which will serve people who do not have a set top box or television. Don’t be surprised if their next move is to take this web channel global. For instance, while India has roughly 180 million television sets, the country has nearly 300 million smartphones which a global Roku Channel could potentially reach.
Bottom line is that Roku has shown competitive vigor by maintaining the lead as the top streaming media player in the United States claiming 37% of devices with nearly 40 million U.S. customers use Roku once per month. It’s only a matter of time until they take this success to the billions of people overseas who can’t afford pay TV or want to reduce pay TV costs.
5. Purely OTT Play:
In reference to the first point, there is an opportunity to capitalize due to massive pay TV subscriber losses such as last month when Charter (CHTR) lost 12% of market cap after reporting 112,000 subscriber losses and Comcast reported a loss of 98,000 in video users compared to a gain of 41,000 one year ago in Q1 2017.
This bloodbath from attrition will continue to accelerate through 2025 when even TV networks are expected to experience a 41% revenue loss. Roku is a very desirable purely OTT mid-cap choice with 22 million users and a $5.75 billion market cap that narrows in on this staggering market trend. Compare this to Charter Communications, which has a $69 billion market cap and only 16 million users.
Conclusion:
In the next 2-5 years, Roku stock will outpace competitors globally as it continues to be the cheapest, agnostic option with the most channels. Its executive team is experienced in OTT media and advertising, and the platform revenue will redefine how investors see this razor/razor blade opportunity (device player that locks in licensing fees and advertising). The free channel especially is attractive setting it apart from the overabundance of paid, subscription channels. In addition, live TV will be an attractive space for Roku with the company already recently partnered with ABC News, People TV, and Cheddar.
Any information or analysis contained herein and published or referenced elsewhere should be appropriately credited to Beth Kindig of beth.technologybeth.technology
Summary: Despite knee jerk volatility, Roku will become a large cap stock in OTT (over-the-top) within 2-5 years. While Pay TV operators continue to bleed subscribers, Roku has the best business model to capitalize on these losses compared to highly fragmented OTT and SVOD competitors. In addition, Roku has maintained competitive vigor as the number one streaming device in the United States while remaining vendor agnostic. Going global will cement this position.
Roku (ROKU) stock prices have fluctuated wildly from being one of the hottest stocks in 2017 with a 400% return from the IPO price of $14 to a high in December of $56. From there, the streaming device maker saw shares drop 42% where it’s been range-bound at $31-$34 per share. That is, except when Amazon (AMZN) announced a fairly irrelevant partnership with a dying brick-and-mortar Best Buy (BBY) resulting in an 11.8% drop.
Or, the announcement of Roku offering access to ESPN+, which bumped the shares up 12%. While some are still confused on Roku’s value proposition, one thing is for certain, Roku’s stock is volatile and will continue to test investors’ technological depth on how exactly a hardware company plans to stay profitable … except, Roku is not a hardware company. Wall Street just (mistakenly) thinks it is.
This article originally appeared May 8th on Seeking Alpha.
Ahead of earnings this week, KeyBanc placed a $42 price target on the stock at about 27% above current levels of the shares. Notably, many short sellers lost the gamble when the lock-up expired six months after the IPO date in March with false expectations the market would be flooded with shares. The stock has seen about an 11% decline since March from the price of $39 – not the crash short investors were hoping for. Meanwhile, Roku’s short interest has dropped 38% since its peak from 10 million shares shorted at the end of March to 6.2 million shares shorted by mid-April.
Roku’s stock will continue to be volatile as the company expects to continue losing money in 2018 aiming to operate “at, or near, break-even on an operating cash flow basis.” Yet bulls continue to focus on the huge upside potential as the number one streaming device in the United States with $90 million in revenue coming from the ad-supported platform.
Looking beyond the knee-jerk volatility, here are the top reasons Roku will be a large cap stock in OTT (over-the-top) within 2-5 years.
1.Blood In The Water:
The peak for pay TV in the United States occurred in 2010/2011 when it began a predictable erosion. The number of pay-tv subscribers fell by 8,000 in 2012 and accelerated to 164,000 subscriber losses in 2014. Last year, the erosion neared deterioration with the top 10 pay TV operators losing a staggering 3 million linear subscribers in 2017 according to Leichtman Research.
Roku is the most synonymous business model with cable and satellite TV providers and can capitalize long-term on this massive subscriber loss by leveraging its advertising, audience development and content distribution services, which make up 89% of gross margins from the platform. In fact, if Roku was a traditional cable company, it would be the third largest distributor of content in the United States behind Comcast (CMCSA) and AT&T (T) with 19 million active subscribers.
2.Vendor Agnostic:
Roku critics cite too much competition for this mid-cap stock to carry the growth needed for long-term gains, especially from Apple (AAPL), Google (NASDAQ:GOOG) (GOOGL) and Amazon who all have a play in the hardware market for OTT video streaming services. However, this weakness is actually Roku’s strength. The Roku operating system, Roku OS 8, is a robust, reliable option for OTT streaming and has attracted partnerships with 1 in 5 smart TVs in the United States.
Meanwhile, operating systems like Samsung’s (OTC:SSNLF) Tizen continue to be plagued with bugs. But by being vendor-agnostic, Roku has still been able to secure a partnership for their free ad-supported channel with competing OSs like Samsung/Tizen. In addition, by remaining agnostic, Roku has maintained a full menu of original programming while corporate spats between Google (YouTube) and Amazon Prime restrict content choices.
Roku has also built a formidable catalog of 5,000 channels that even Google has not even come close to rival. This is where the discussion as to Roku being a hardware company should curtail as the “player” revenue will soon be eclipsed by the platform revenue (platform revenue stood at 45% in Q4 2017). It’s the latter where the company is making its largest investments including OTT advertising measurement tools, launching the free Roku channel, growing licensing fees and partnering for live TV.
3. There’s More To OTT Than Highly Fragmented Subscriptions:
Previously, viewing data and ratings on SVOD (subscription video on demand) such as Netflix (NFLX), Hulu Plus and Amazon Prime and other OTT content was not disclosed even by Nielsen (NLSN). However, in a recent interview, Nielsen COO Steve Hasker revealed four previously undisclosed statistics about SVOD such as 89.5% of SVOD content is primarily viewed on the television glass whereas 11.5% is viewed on smartphones and tablets.
Of this time, 80% is spent on catalog programming whereas 20% is spent on original content. Meanwhile, as competition increases, the costs for original programming are escalating with Netflix spending $8 billion in 2018 in order to remain competitive for a small piece of the pie (20% of how time is spent). Meanwhile, Roku has held firm on not creating original programming and the statistics support this. The costs for original programming are likely to escalate as HBO, Showtime, and now Apple will continue to compete for this space.
In addition, subscribers pay for quite a few premium $8+ subscription channels, which will eventually lead to subscription fatigue – not to mention mitigate the reason cord-cutters leave pay TV services – which is to lower costs. For a subscriber with YouTube TV ($40) and three premium channels ($24-26), they are paying $65+ per month. This pricing will meet resistance by cord cutters and ad-supported video on demand (AVOD) will be the answer.
Most importantly, original programming will consolidate or bundle (like it has on cable) and Roku is the perfect middleman to do this.
4. Global Potential:
This point ties into the previous two points where agnosticism in hardware and operating system along with building out a free, ad-supported channel will help Roku crush global expansion – especially in the emerging markets. The low price point for both the hardware and free content is desirable for global adoption, plus the 5,000 channels that Roku offers caters to differences in cultural viewing preferences.
Roku has shown competitive vigor by maintaining the lead as the top streaming media player in the United States claiming 37% of devices with nearly 40 million U.S. customers use Roku once per month. It’s only a matter of time until they take this success to the billions of people overseas who can’t afford pay TV or want to reduce pay TV costs.
5. Purely OTT Play:
In reference to the first point, there is an opportunity to capitalize due to massive pay TV subscriber losses such as last month when Charter (CHTR) lost 12% of market cap after reporting 112,000 subscriber losses and Comcast reported a loss of 98,000 in video users compared to a gain of 41,000 one year ago in Q1 2017.
This bloodbath from attrition will continue to accelerate through 2025 when even TV networks are expected to experience a 41% revenue loss. Roku is a very desirable purely OTT mid-cap choice with 19 million users and a $3.29 billion market cap that narrows in on this staggering market trend. Compare this to Charter Communications, which has a $65 billion market cap and only 16 million users.
Conclusion:
In the next 2-5 years, Roku will outpace competitors globally as it continues to be the cheapest, agnostic option with the most channels. Its executive team is experienced in OTT media and advertising, and the platform revenue will redefine how investors see this razor/razor blade opportunity (device player that locks in licensing fees and advertising). The free channel especially is attractive setting it apart from the over-abundance of paid, subscription channels. In addition, live TV will be an attractive space for Roku with the company already recently partnered with ABC News, People TV and Cheddar.
