In a year including some notably disappointing IPOs, Roku (NASDAQ:ROKU) appears to be the rare exception. After pricing its initial public price at $14 per share, good for a $1.3 billion valuation, shares have ran up to approximately $50 per share, providing early investors with a near 250% return in less than two months.
The impetus for Roku's recent leg up was the third-quarter earnings report. Colleague Erik Volkman provides more detail, but the company handily beat analyst estimates of $110.5 million in revenue with an adjusted EPS loss of $0.28 by reporting $124.8 million on the top line and a narrower adjusted EPS loss of $0.10. In response, shares exploded during the post-announcement trading session, climbing 55%.
While it's too late for new investors to experience those 250% gains, it's prudent to ask if the stock is still undervalued or if Roku's rally has gone too far?
The numbers were better than advertised
The numbers are even better than they appear. Management has stated, in no uncertain terms, it feels platform revenue is its key to growth. However, as of the third quarter of 2016, 73% of the company's revenue came from its player division, hardware, with the rest coming from the platform division.
In the recently reported quarter, those numbers were much closer to parity with player revenue coming in at 54% of total revenue and platform taking 46%. And that's due to tremendous growth from the division: Versus total revenue growth of 40% year over year, platform revenue grew 137%. That's good news for investors because platform revenue has a 77% gross profit margin profile while player reported a gross margin of 8% this quarter.
Roku appears to be using a razor and blade model
Gross-margin growth provides more insight into the company's strategy. On a year-over-year basis, Roku produced $3.3 million less in gross profit from its player division, a decrease of 38%. However, platform profit increased by $27.1 million, an increase of 156%. Overall, the company increased its gross margin by 92% on a year-over-year basis.
It's apparent that Roku is transitioning to a razor and blade model by selling hardware near or at cost to drive platform revenue. During the conference call, CFO Steve Louden said, "We're happy to make the trade-off of player revenue growth for faster account growth as we view this as an attractive account acquisition path and we believe our low-cost leadership in the industry is a competitive advantage."
The hits keep coming
Earlier I said the third quarter powered the recent leg up -- consider that partially true. Roku stock jumped another 28% two days later because the company announced it had inked a licensing deal with Philips to include its operating system on Philips' line of smart TVs and announced a discount on the Roku Streaming Stick for the holidays.
While the timing seems odd in light of the recent conference call, a time when many executives announce partnerships and future sales strategies, it does show a management team focused on increasing the customers on its platform.
Too far too fast?
Roku's last week obscures the fact that the company had traded lower than its first-day closing before this earnings announcement. Colleague Evan Niu argues the tremendous run the company has recently experienced is partially due to a short squeeze. While I'm not 100% sold on this theory, it does partially explain why management announced the Philips deal days after its earnings report -- to extend the length of its stock rally.
Roku is an interesting story, but it's important to look at the company's fundamentals. Although the company is doing an admirable job growing gross profit, the company still isn't close to turning a real profit. The company expects to report adjusted EBITDA between a $6 million loss to breakeven next quarter. While I like what management is doing, I'm waiting on the sidelines until the company guides for profitability.