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Is the Honeymoon Over for Roku?

By Mac Greer - Feb 24, 2018 at 5:42PM

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After doubling since its IPO late last year, Roku is down big on this quarter’s earnings, and its plans from here on out aren’t inspiring much confidence.

In today's episode of the Market Foolery podcast, host Mac Greer talks with contributors Jason Moser from Million Dollar Portfolio and David Kretzmann from Hidden Gems Canada about four very different company reports and the stories behind them.

Roku (ROKU 7.11%) is down big on earnings, and its long-term growth strategy isn't all that impressive. Wayfair (W 10.53%) is down big on earnings, too, but the e-commerce furniture store has a few potential bright spots tucked up its sleeve. (STMP) is up big on a great fourth quarter and a solid growth runway for the future. Meanwhile, Pandora (P) was selling off, and the music streaming company's future could hardly look grimmer. Click play to find out more.

A full transcript follows the video.

This video was recorded on Feb. 22, 2018. 

Mac Greer: It's Thursday, Feb. 22. Welcome to Market Foolery. I'm Mac Greer. Joining me in studio, we have Jason Moser from Motley Fool Million Dollar Portfolio and David Kretzmann from Hidden Gems Canada. Gentlemen, welcome! How are you feeling?

Jason Moser: Hey! Happy Thursday!

David Kretzmann: Pretty good!

Greer: Jason, happy eighth anniversary! You started at The Motley Fool eight years ago?

Moser: Yes, actually today. My eighth-year Fooliversary here. Thank you for saying that, Mac.

Greer: And has it felt like eight years? Has it felt more like seven and a half years, nine years?

Moser: This is the longest I've ever worked at one particular place. And I say it and I really do mean it that I enjoy being able to come to work every day. It doesn't really feel a whole heck of a lot like work. So, for me, I can only hope for eight more just like this.

Greer: Well, we are lucky to have you.

Kretzmann: Absolutely.

Moser: That's nice of you to say, thanks.

Greer: On today's show, we're going to talk some Wayfair, we're going to talk I don't know about that name. I'm going to ask you about it.

Kretzmann: We'll talk about it.

Greer: And Pandora. But I want to begin with Roku, one of my favorite names, the streaming device maker. Shares of Roku down big on earnings. David, this is a stock that has more than doubled since the IPO back in September. Is the honeymoon finally over here?

Kretzmann: I don't know. That's the million-dollar question here. I think there's reason to not be completely pessimistic about Roku.

Greer: [laughs] OK. That's the type of strong statement I love.

Moser: He's hedging his bets. [laughs] 

Kretzmann: Initially, when the company went public last year, I was definitely more in the pessimistic camp. But looking at what management was saying for this quarter and their outlook for the year, I was thinking, maybe there's a way they can compete in this space. Because obviously, when you're talking about this whole streaming platform space or these streaming devices, you're talking about Roku, which is that neutral stand-alone device. They're agnostic whether you're trying to stream stuff from YouTube or Netflix or Hulu. But then, they're going up against Apple (AAPL 0.11%), Google, and Amazon (AMZN 2.57%), literally the biggest tech giants out there. So, as far as competitors go, that's a steep climb. 

But really, what Roku is trying to do is become the distribution platform for streaming. And some of the metrics look really good. Their number of active accounts were up 44% to over 19 million. Those are people who either have the devices or have Roku on their smart TV. The number of hours that were streamed increased 55% to 4.3 billion. So, they are seeing more users and more engagement on that platform. 

But again, I think the ultimate question there is, can they really build up enough of a platform business or an advertising business? They're not really trying to make money on the devices that they sell, but they're trying to become the operating system for streaming platforms. That's a tall order, but they are seeing some progress. That's something to watch. But like I said, I'm not as pessimistic as I was, but it's such a tall order to compete against those giants.

Greer: When you talk about this space, Roku was really a pioneer, a bit of a first-mover, right?

Kretzmann: Yeah.

Greer: Is there first-mover advantage? Or is that something, we don't really talk first-mover advantages when you're talking about technology and how fluid all these companies are?

Kretzmann: There might be somewhat of an advantage. They are certainly a leading platform. I think that's one of the risks here. There isn't really a switching cost as a user. I think a lot of people will even have multiple streaming devices. So, you might have a Chromecast, you might have a Fire TV Stick and a Roku. As a user, there's not really much of a cost or a disadvantage to switching from one to the other or having multiple platforms there. What Roku is trying to do, they're focusing on smart TV. In 2017, one in five smart TVs sold in the U.S. had Roku pre-installed on the TV. They're talking more about becoming the operating system for that whole home entertainment ecosystem, so, plugging the Roku operating system into smart speakers and different devices that really will be plugged into the living room. 

And they really see themselves as a content distribution platform. One of the stats they threw out in the press release, which, I don't know if I fully agree with this, they're basically saying, if you compare us to traditional cable companies with those 19 million users, we're third behind Comcast and AT&T. Now, the difference is, no one is actually paying a subscription to Roku. But it's interesting to see, as you're seeing this shift with cord cutting, people leaving that traditional cable platform, Roku is certainly on the upswing, and they are a beneficiary as more people are shifting over to streaming. 

But the company still isn't profitable, they're not expecting to be profitable this year. They're really reinvesting in growth. They're cutting the prices on the devices that they are selling, but they see that really as a customer acquisition strategy. Like I said, they're not trying to make money there. Their platform sales are largely made up of advertising dollars, and that's what they see as a primary revenue driver going forward.

Moser: I have to say, I'm sort of in your camp here. I initially was very skeptical when they went public. I feel like I'm a little bit more on the fence now than I was before. I wouldn't go so far as to say I'm actually optimistic or bullish. I think the biggest problem I have is, if that monetization model, I mean, we know it's going from the devices to being the platform. If you're trying to base your monetization on advertising and content, well, it costs a lot of money to bring content to the table. And advertising? I mean, come on, man, seriously? We have a lot of companies out there that already do it really well. And a lot of the streaming offerings that we get now are either sans-advertising, or they give you a cost incentive to pay a little bit more to eliminate advertising from the mix, like Hulu, for example. 

And on the switching cost side, I think an interesting dynamic is, with Roku, there's no switching cost to leave Roku. But, if you have an Amazon Fire TV device or an Apple TV device, there's a little bit more of a switching cost there, because you're already hooked into that ecosystem. I'll use myself as an example. We have Amazon Fire TV, and because I can access all of our pictures and videos in the Amazon Cloud and whatnot there, it makes it very easy, I would never consider switching to a Roku, because I'm already ingrained and enmeshed in that Amazon environment. So, kind of interesting to see switching costs work one way but not the other.

Greer: I'm going to call you cautiously pessimistic.

Moser: Probably the best way to classify me for now, yeah.

Kretzmann: I think that's where we're at. And I agree with you, JaMo. It's hard for me to get really excited about advertising being the primary driving force behind the company. And at least in the next year or so, that's where management sees the bulk of their growth coming from. But, being an advertising business, competing against Apple, Amazon and Google, I hope they can find some way to bring in some sort of a subscription. I could see Roku maybe offering a bundle of their own, where maybe they lump in Netflix, HBO, and Hulu into a streaming bundle that you can purchase for less if you're on the Roku platform, something like that to really give them a little bit more of an edge over the competitors. But as it stands now, I still just wonder how sustainable of an advantage the company really has.

Greer: Guys, let's move on to Wayfair. Shares of the home retailer down big on earnings. Jason, I know that, at least as a consumer, you are a fan of Wayfair. Is that a true statement?

Moser: That is a true statement.

Greer: What about the stock, what do you think?

Moser: I've always been a fan of the stock from the perspective of, it's one of those Rule Breaker type ideas where I felt like they have a lot of opportunity. The one counter to that is, I've always tried to basically frame it thusly: instead of buying Wayfair stock, convince me why I shouldn't just buy a share of Amazon. If you can tell me why I should buy Wayfair and not Amazon, then we have something there. I come back to, I feel like I would rather just own Amazon. And that's still where I am today, but that's not to say I don't think Wayfair has a lot of potential. As a consumer, I think it's working great. They're doing something very well there, and they've really produced an optimal shopping environment for online home shopping. 

This was a good quarter from a lot of perspectives, but it's tough to keep the momentum going in your stock price when the market has bid this thing up beyond all expectations based on a business that's still unprofitable. And we really don't have a clear idea as to when they're actually going to hit profitability. And guidance here in the near-term suggests that they may actually be a little bit below expectations here, at least in quarter one or quarter two. I think that's really what the market is taking them to task today on, is what they said in that call. But, what we care about with Wayfair primarily is top line growth and repeat customers. And on both fronts there, we saw a lot of signs of success.

Kretzmann: Yeah. I'd say, the growing numbers of repeat orders and the overall growing number of users, and also the average size of the orders, continues to bump up. A lot of the metrics moving in the right direction. There's obviously the overarching question mark, when does a company hit profitability when they're going up against Amazon, Walmart (WMT -0.61%) is rolling out more of their online furniture shopping. So, they're going up against big competitors. Target is another one. 

But one of the things I do like about Wayfair, when we talk about a leadership team, this is a leadership team I really admire. The two co-founders still own close to 30% of the shares. They have sold off some of their shares over the past year, but they still own a sizable stake. And when you look at the incentive structure with the compensation there, Wayfair is really unique as far as tech or online companies go. The base salaries for the founders are both at $80,000 a year, and the bulk of executive pay is actually paid out in restricted stock units that vest over a five-year period. And the directors on the board aren't paid any cash for showing up. They're actually compensated with restricted stock units that vest over three years. So, again, that's something very different than you'll see at any of the Silicon Valley tech giants. And to me, that reinforces that this leadership team is focused on the long-term. They're not going to try to artificially juice short-term numbers, because they're being compensated on the value of the company over a three-year or five-year period. So that does set them apart a bit. And the fact that the two co-founders still own a healthy stake and are still involved in leadership for the company, that gives me a little bit more confidence.

Greer: Jason, you mentioned Amazon. I want to talk about another potential competitor, Walmart. Walmart announcing on Thursday that it's revamping part of its website to better highlight its furniture and home offerings. How much of a threat is Walmart to Wayfair?

Moser: It's definitely one to keep an eye on. Walmart is a big company with vast financial resources and a tremendous distribution network. And I saw that headline, and Walmart looking to make more ways into furniture, and I thought to myself, how are they going to do that? Acquiring Wayfair seems to me probably the easiest solution to that. 

But, I think any time you have a business like Walmart looking to gain share in any space, you have to take that seriously. It's a big company, it's a good company. Amazon obviously is going to keep on doing what they're doing. I think Wayfair has done a very good job over the years, though, building an optimal shopping experience for the home. I will reiterate that, as a consumer, I think it's far better than Amazon when it comes to shopping for items in the home. 

And I think the market continues to give the business a little bit of a pass, kind of like it does with Amazon, because they can see at least some similarities there. They're investing everything they're making back into building this business out. It's a good idea. They do a good job, obviously, bringing customers back for more. And there's an international component to it, as well. International revenue was up over 100% for the quarter, closing in on $600 million now. So, this is a business that's growing very quickly, and it has a lot of promise. I think the stock was just well beyond any sort of fundamental valuation there. A pullback seems right, particularly given the guidance in the call.

Greer: Five years from now, is Wayfair still a stand-alone company?

Moser: I really didn't even think they'd make it public, to be honest with you. I thought Amazon would have bought it before they went public. But now that they are where they are, I really do think these guys want to try to make it on their own. So, I tend to think, if they are acquired, they are going to command the price. I'd like to see them independent.

Greer: Guys, getting a big stamp of approval from investors -- I blew the line. I was so proud of the line and I blew it. God, I couldn't resist. Let's try that again. You can leave this in, Dan. getting a big stamp of approval from investors.

Kretzmann: Absolutely.

Greer: Who writes this stuff? Shares up big on earnings. David, there's more to this business than just stamps. We were talking before the show. I've always been hung up on that name, and, is it just about stamps, and selling stamps that the government sells to them, and what's going on here. And lo and behold, you say, it's not just stamps.

Kretzmann: The name, fully, up front, it's repulsive. It brings you back to the .com era. The company was started in the late '90s, so it really did start as a .com lovechild, and it was the first PC postage vendor. Essentially, USPS acknowledged that they're not very good at reaching small businesses, home offices, so they're essentially going to outsource or offload that aspect of the market to to really focus on reaching those smaller players while the USPS could focus on its bread and butter, the larger clients. 

For almost a couple of decades, that was all did. But over the past few years, they've really tried to branch out beyond the USPS, bringing solutions that reach multiple carriers like UPS, FedEx, DHL, and then integrating with a variety of marketplaces, whether it's Amazon, eBayShopify, essentially having a platform where you can aggregate all the orders from these multiple marketplaces and websites into one place, and then find the optimal shipping carrier for each order. 

Over the past few years, they've acquired four other companies. ShipStation is probably the most noteworthy one of those. Over that time period, the average revenue per user for has increased quite a bit. Their churn rate has dropped as they've, again, shifted to these higher-volume shippers. They're serving warehouses and fulfillment centers and e-commerce companies. Those companies tend to spend more, they need a more advanced platform, and they also stick around longer, so they have a lower churn rate. As a subscription business, those are really nice dynamics. 

And that continued in this latest fourth quarter. Revenue was up 25%, earnings up 38%, average revenue per user up 16%. And they're serving about 735,000 customers, primarily in the U.S. now. They're starting to branch out a little bit internationally, testing the waters there. But all in all, this has turned into much more than just a niche business in bed with USPS, which was a decent business, but it was small, it wasn't growing very quickly. And management essentially recognized the enormous tailwind in that opportunity with e-commerce. So, has been a beneficiary of that, especially with these latest acquisitions. The breadth of their offerings really makes them a big beneficiary of e-commerce.

Greer: Let's go back to the name, because I am hung up on the name. This week, we saw Priceline change its name to Booking Holdings to more accurately reflect Priceline's booking business, a big part of the business. So, my question for you, should stick with its name?

Kretzmann: For now, I think it's actually been a boon to long-term Foolish investors to have the name be, because so many people get hung up on that. Short sellers will constantly attack that legacy platform. They get so hung up on that, that it has poor reviews, that it's a weak business model, it's a dying business, who sends mail, who needs stamps, anyway? But in the meantime, they have these four other brands that are really catering to this huge boom in e-commerce, and these are vital solutions. So, I kind of like the fact that it's kind of a distraction, sort of similar to people who might have overlooked Priceline. Like we were talking about before the show --

Greer: Like me, I was just thinking, Priceline and William Shatner and name your own price, and, why would I want to own this stock? And I kind of missed the whole booking business.

Moser:, I think you change the name to something like Postage and Such. "Hey, we have stamps and more."

Greer: I like that. And such.

Kretzmann: I'd say, for now, leave it. Maybe three or five years from now, after the stock has tripled, then maybe you switch the name.

Greer: Guys, let's wrap up with a little Pandora. Shares of the music service down big on earnings.

Moser: [laughs] A much littler Pandora today. Hey-o!

Kretzmann: Golly.

Greer: Much smaller. Jason, it's really hard to talk Pandora without also talking Spotify and Apple Music and Amazon. What's the Pandora story now? What's the secret sauce?

Moser: Yeah, I don't mean to make light of Pandora's drop today for any investors who are feeling the pinch, but you shouldn't have been invested in Pandora in the first place, so let's just get that out of the way.

Greer: Tough love.

Kretzmann: Tough but true.

Moser: I know you'll appreciate this. Mac, I think Pandora is hitting its JCPenney moment where we need to ask the question, does the world really need it? And I think the answer is probably no. When you look at the competition out there, the alternatives, the options, I don't know that the world needs Pandora. It's a fascinating thing to watch, too, because this really was kind of the first mover in this space, wasn't it? 

But, you look at this company's financials, they went public in 2011, and these are some of the worst financials you will ever see. I mean, they cannot get profitable. And I'm not certain they ever will. It was interesting to see the reaction after the release came out yesterday vs. today with the stock tanking. It all goes back to what was in the call, when management decided to hold back on really offering any full-year 2018 guidance, because things aren't quite clear enough for them at this point. They were able to offer some kind of high level quarterly guidance, but the market wanted more. Given that they had some decent numbers in the release for this business, the fact that they can't get more clarity as to how 2018 is going to shake out ... I mean, you read that release and you're thinking, "Man, these guys are setting the table for what should be a really nice year," and then they come out and say, "We can't really offer much beyond what we have right now, and what we have right now doesn't actually look that great." So, to me, you have Spotify, which is the global leader. You have Apple Music, which is really catching hold here domestically. I just don't know that the world needs Pandora.

Greer: Let me try to throw a bull case at you. Sirius XM (SIRI 0.16%) has a stake in Pandora. What about Sirius XM buying all of Pandora?

Moser: And I could actually see a world where that's the case. As a Sirius XM subscriber, I'm a big fan, my wife and I both have it. I think you have it too, right?

Greer: Yep.

Moser: I don't know if you have it, David?

Kretzmann: I don't, no.

Moser: I like it for a lot of reasons. Obviously, I'm a fan of The Howard Stern Show, and that's the primary reason for me.

Greer: 70s on 7.

Moser: The Lithium channel is pretty good. I mean, you have the Grateful Dead, you have the Beatles, you have news, you have everything under one roof there. I could see a point where maybe Sirius XM says, "Look, we feel like there's a lot of equity in the Pandora brand," and it would be a way for them to expand their mobile presence. Because Sirius XM does have a very good mobile app. I think getting, perhaps, that Pandora brand, there could be something to that, given that they already have the contracts inked and they have a lot of the talent and the finances in order there. I think their leadership has been a bit more forward-thinking, perhaps, than Pandora's. So, I could certainly see that being the case one day. But I think, if that does happen, it's probably more of a case where Pandora is a bit of a desperate seller, and I don't know that investors really stand to make out either way.

Greer: So, that should not be the central part of my investment thesis? [laughs] 

Moser: No. There are better ideas out there for new money today, I can tell you that.

Kretzmann: The Sirius XM piece is really the only thing that I could see to be partially optimistic about with Pandora, because Sirius has been a great business over the past several years, and obviously you have the leadership there with John Malone and Liberty Media. So, they are some powerful heavy hitters in the media space. But even that, I don't know if it's enough to save Pandora at this point. 

What was really partially the downfall for Pandora was being so late to the music subscription game. They lagged far behind Spotify and Apple Music with this whole idea that you pay essentially $10 a month and get access to virtually every song out there. They just came out with their offering a year or a year and a half ago. And now, they only have 5.5 million paying subscribers. That compares to 70 million for Spotify, over 30 million for Apple Music last we heard, Amazon, it's been estimated, has about 16 million. So, they're a distant fourth or fifth player in that subscription business. 

They were an early pioneer or first mover with that algorithm-driven ad-supported platform, where you listen and they'll spit out different songs that they think you will like based on your habits. So, that was cool, but that really wasn't a very scalable, profitable business. And now, they're so late to the game with that subscription offering, I just don't see what they offer that's that much differentiated from competitors. And as someone who used to use Pandora a couple of years ago, now I just use Amazon Music. If you're a Prime subscriber, you can subscribe to Amazon Music for $8.

Greer: Love Amazon Music.

Moser: Or you can get the Prime for free, they have an Echo-only subscription for $3.99. I'm glad you mentioned Amazon, because I find myself more and more, with our Echos in our house, using Amazon Music. And I think that all goes back to the same kind of thing we were talking about in regard to Wayfair, why shouldn't I just buy Amazon, I think with something like Pandora, music is kind of ancillary at this point. It seems like it's something that bigger competitors can offer as a value-add, and that's what Amazon and Apple and Google do. So, instead of buying Pandora, why shouldn't I just buy a share of Amazon or Apple or Google and just move on? And honestly, I think that's the better solution anyway.

Kretzmann: It makes me really want to stay away -- I'll probably, 99% chance, will never touch Spotify once they do go public, because I think, exactly for that reason, as a stand-alone music competitor, I think it's just so difficult to stand out and actually generate any sort of meaningful profit when you're going up against Apple and Amazon, where they can have that be a loss leader or have it sold at cost. So, I don't think Spotify is any more appealing than Pandora today.

Greer: I have two questions for you as we wrap up. The first question: I need a music suggestion.

Kretzmann: JaMo, you go first. I need to think on that.

Moser: I guess everybody out there probably knows I'm a big Widespread Panic fan. I've been following those guys for years. I'm going to give you something a little bit beyond a Panic recommendation today. One of their founding members, Michael Houser, he passed away years ago, but he had an album that was put out shortly after he passed away called Sandbox. You can find that on Spotify, actually, they have it right there on the free model. Michael Houser, Sandbox. It's a very good album, sort of easygoing southern rock, a little bit of country twang in there at times. Good listen.

Kretzmann: I'm currently making my way through Game of Thrones, so I've been listening to the soundtrack quite a bit. I listen to a lot of soundtracks. The Game of Thrones soundtrack is incredibly well done. Two tracks in particular: "You Are No Son of Mine" and "Mhysa" are both really well-done songs. If you're into soundtracks, it's worth a listen.

Moser: What about you, Mac?

Greer: I will throw in Mandolin Orange. They're a folk duo. They have mandolin, guitar, violin, banjo, great vocals. Hey, if that's not enough for you, I can't help you.

Kretzmann: I'm sold.

Greer: If you're into bluegrass, Avett Brothers-esque, it's a North Carolina band. Love them. Mandolin Orange.

Moser: I like that. There's another band I kind of like. Yonder Mountain String Band, if you've ever heard of them. They're great!

Greer: Oh, I love them!

Moser: It's good stuff.

Greer: As we wrap up, you didn't think you were going to get away without me asking my completely arbitrary question.

Moser: [laughs] I love this!

Greer: This is a fun one, this is a desert island question. Here we go. You're on a desert island, and you're confronted with these four stocks, and you have to own one for the next five years: Roku, Wayfair,, and Pandora.

Kretzmann: I'm going to go with, and maybe short Pandora. Is that an option?

Moser: [laughs] Yeah, I'm weighing and Wayfair. I'll go with Wayfair just because I know the business a little bit better and I do think they're onto something. But I like David's, too. Assuming that they change the name.

Greer: Guys, thanks for joining me! Jason, happy eighth Fooliversary!

Moser: Thank you very much!

Greer: As always, people on the show may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's it for this edition of Market Foolery. The show is mixed by Dan Boyd. I'm Mac Greer. Thanks for listening! We'll see you tomorrow!

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Stocks Mentioned

Apple Inc. Stock Quote
Apple Inc.
$140.52 (0.11%) $0.16, Inc. Stock Quote, Inc.
$2,135.50 (2.57%) $53.50
Wal-Mart Stores, Inc. Stock Quote
Wal-Mart Stores, Inc.
$123.37 (-0.61%) $0.76
Sirius XM Holdings Inc. Stock Quote
Sirius XM Holdings Inc.
$6.20 (0.16%) $0.01
Pandora Media, Inc. Stock Quote
Pandora Media, Inc.
P Inc. Stock Quote Inc.
Wayfair Inc. Stock Quote
Wayfair Inc.
$50.30 (10.53%) $4.79
Roku Stock Quote
$84.79 (7.11%) $5.63

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