Roku (NASDAQ:ROKU) is best known for the small set-top boxes and streaming sticks it produces, but the company has its eyes set on a much bigger prize than being another box that sits on a shelf. In fact, Roku's ultimate goal is to become an embedded part of most TVs by licensing its TV operating system to manufacturers.
"Our fundamental thesis that all TV manufacturers will license an OS has not changed," CEO Anthony Wood said on the company's second-quarter earnings call.
Half of new Roku accounts came from licensed sources in the first quarter. That number fell below 50% as player sales outperformed in the second quarter, but management reiterated long-term expectations that the majority of new users will come from sources like Roku TVs. If Roku's thesis is correct, the company's player business may eventually disappear entirely.
So, what's stopping Roku from getting its software on TVs? Manufacturers are still working on their own homegrown operating systems, and they're very slow to change.
Winning over manufacturers
Roku has struck multiple deals with manufacturers including TCL, Insignia, Philips, Sharp, Hitachi, RCA, Hisense, Element, and Sanyo. That said, most of them offer some smart TVs with Roku's software and others with their own software.
Wood said it might take time for manufacturers to realize it's more efficient and effective to just sell Roku TVs. Indeed, Roku TVs accounted for 25% of smart TV sales in the first half of 2018. Management estimates Samsung (NASDAQOTH: SSNLF) took another 25%. That leaves just 50% of the market for non-Samsung manufacturers' homegrown smart TV platforms.
The pitch to manufacturers is that they're wasting resources building software when their expertise lies in hardware. TCL took the plunge a few years ago, going all in on Roku TV, and it's grown from the No. 14 television manufacturer in the U.S. in 2014 to the No. 3 brand today.
Overcoming the inertia of manufacturers has been a challenge for Roku, but it's seen great success with companies that license its operating system. Over time, Roku should be able to take a larger share of its partners' sales, and ultimately take a larger share of total smart TV sales.
What about Samsung?
Management has practically admitted Samsung is the only competitor that has the scale and resources to support its own television operating system. In effect, it wants to be the Android to Samsung's iOS.
That may be why Roku chose Samsung smart TVs as the first platform for it to extend the Roku Channel to outside of its own devices and OS. Roku has since expanded the service to the web.
The Roku Channel, despite being less than a year old, is a core product for Roku. It's an ad-supported video channel that includes content Roku licensed itself alongside content from partners looking to reach a broader audience. Roku is able to use its data to sell targeted advertisements against that content, and it shares revenue with partners.
The extension of the Roku Channel to Samsung TVs is like Google making a YouTube app for iOS. It's all about reaching as wide an audience as possible.
So, while Roku doesn't think it will ever take 100% of the smart TV market, it does think it can at least have a presence on 100% of smart TVs. The biggest challenge it currently faces is convincing most manufacturers that it's better for them to license Roku's software instead of building their own, differentiating their products through better hardware. And there's a lot of intertia built up in the television industry.
For now, investors should pay attention to announcements about licensing deals. And they should also look for quarterly updates on Roku's estimated share of the smart TV market. The percentage of new accounts coming from licensed sources versus player devices is a secondary metric to consider, but keep in mind player sales can be lumpy and tied to third-party promotions not entirely within Roku's control.