The future of Roku's (NASDAQ:ROKU) business relies on its ability to grow its advertising revenue. While the company is best known for its streaming devices, Roku makes a lot more profit off its platform business. Advertising accounts for a growing majority of its platform revenue.
Just ahead of its IPO, Roku introduced The Roku Channel, an app exclusive to Roku device users that streams free films and television episodes. Roku combines free content from select partners such as American Classics and Vidmark with its own licensed content from several film and television studios.
The new app is now available on all current-generation Roku devices in the United States. Roku will generate revenue from showing advertisements throughout the videos, splitting the revenue with content partners or keeping all of it for content it licensed.
Is this what all that IPO money is for?
Roku gave a vague boilerplate disclosure for how it plans to use the proceeds from its IPO. Of course, providing more details than necessary only provides competitors with more information that could be used against it.
Roku already has some well-capitalized competitors. In its S-1 fling, Roku names Amazon.com (NASDAQ:AMZN), Alphabet's (NASDAQ:GOOG) (NASDAQ:GOOGL) Google, and Apple (NASDAQ:AAPL) as its competitors. All three have their own video platforms bolstered by their own streaming devices, and they're committing billions of dollars in capital to procuring content.
Roku doesn't have billions to spend on content. And if the budgets of streaming video services such as Amazon Prime Instant Video are any indicator, content is getting more and more expensive. It's going to have to use some of the $219 million it raised in its IPO to buy up content.
Can Roku compete?
Roku is clearly bargain-hunting with its limited budget. You won't find new releases on The Roku Channel. There's no original or exclusive content. But bundling its licensed content with content from other popular free movie services makes it at least worth checking out for some users.
Unlike Amazon, Google, or Apple, Roku won't charge viewers for its premium content. Instead, it's opting to support its content with advertisements.
Roku, however, might be the least equipped of the four competitors to serve targeted advertisements to its users. Amazon and Google have unparalleled targeting data on their users. Apple's user data isn't too shabby either, although management is a bit more reserved about how it uses that data.
That said, there's a $70 billion television advertising industry. And Roku can't have worse targeting capabilities than television. With more people shifting their video watching time from traditional TV to streaming video, Roku is looking to capture a piece of that market with The Roku Channel.
Roku will rely on its 15 million active accounts to develop a viewer base for the app, promoting it in every venue it has available in the channel store -- The Roku Channel is both "Featured" and "New & Notable." That said, while some users might be willing to check out the new channel, it's not clear that Roku's content is good enough to get them to stick around. And if they don't stick around, Roku can't generate any ad revenue off them. It's kind of a chicken-and-egg scenario.
Competing streaming services benefited from less competition when they were first starting out, as well as from large amounts of available capital from other sources within the business. Roku is playing from behind.
Just an experiment for now
The Roku Channel falls into the experimental-product category for me. Now that Roku's a publicly traded company, we'll get quarterly updates from management about how things are going. Look for any commentary on the early days of The Roku Channel and if management expects it to eventually drive meaningful ad revenue at some point.
The Roku Channel has a lot of potential. If management can execute on the idea, it could be a huge revenue driver for the company. The growth of streaming video is a megatrend that Roku already plays a big role in. That said, Apple is looking to execute a similar idea (i.e., monetizing a big user base with a streaming video service), so it has some big competition.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Adam Levy owns shares of Amazon and Apple. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, and Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.