Roku's Flexing Its Ability to Compete Like Amazon or Google

Roku is sacrificing profits on its streaming players for account growth, and it's worth every penny.

Adam Levy
Adam Levy
Feb 23, 2019 at 12:02PM
Consumer Goods

Roku's (NASDAQ:ROKU) fourth-quarter results emphasize an ongoing trend at the company: Roku's gross margin on its player sales is shrinking, while active account growth is accelerating. Roku's player gross margin was just 2.4% in the fourth quarter, but active accounts surged by 3.3 million during the period.

The fourth quarter is seasonally strong for Roku account additions, and it's also the time of year when it puts on sales for its devices, but declining player gross margin and increasing account growth is something that's been a trend for the last two years.

The growth of Roku's platform business has gotten it to a point where it can sell its devices practically at cost just like its competitors -- Amazon (NASDAQ:AMZN) and Alphabet's (NASDAQ:GOOG) (NASDAQ:GOOGL) Google.

A Roku player remote on a table next to popcorn

Image source: Roku.

Making it a fair fight

In Roku's quarterly financial filings with the SEC, it warns investors that Amazon and Google "have the financial resources to subsidize the cost of their streaming devices in order to promote their other products and services making it harder for us to acquire new users and increase hours streamed."

Amazon sells its Fire TV devices in order to sell more Prime subscriptions. Making a small, one-time profit on a streaming device is nothing compared to the value Amazon generates from getting someone to sign up for Prime. Prime members spend more than twice as much on Amazon's marketplace compared to non-Prime members. Amazon has found members who stream Prime Video are more likely to renew their subscriptions, and Fire TV devices encourage streaming.

Likewise, Google sells its Chromecast devices in order to encourage more YouTube streaming. Google says streaming on televisions is one of the biggest sources of growth for YouTube. Google may also benefit from seeing what content users are streaming on their televisions, whether it's on YouTube or another device. It could feed that data into its ad targeting to make ads across its network more relevant.

The growth of Roku's platform business, which the company expects to account for two-thirds of revenue next year, enables Roku to take less in profit on its streaming hardware and maximize its long-term potential.

How much long-term potential is left?

An important question for investors to ask is, how much potential is there for Roku to grow active accounts? The company boasted that its U.S. active account base is big enough for it to be considered the second-largest pay-TV company in its fourth-quarter letter to shareholders.

Even with over 27 million active accounts, Roku management says it still sees plenty of room to grow in the U.S. Considering Netflix has over twice as many active U.S. accounts, and it's still growing at a steady pace, there's certainly still an opportunity. Additionally, just 27% of U.S. consumers who use streaming video services streamed via a Roku player as of last summer, according to a William Blair survey.


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However, Roku sees an even bigger opportunity to grow internationally. In fact, Roku has made international growth one of its prime areas of investment for 2019. That said, management doesn't expect international markets to contribute significant growth in accounts this year as it's only just laying the groundwork for growth. It expects its investments to start showing up as account growth in 2020 and beyond.

Roku seems content to keep the margins on its player sales low even as it invests in international distribution. While it saw EBITDA grow to nearly $33 million in 2018 from a loss of $3 million in 2017, its outlook for 2019 is for break-even EBITDA. High-margin platform revenue from the U.S. account base ought to help keep the overall operating margin of Roku's business near break-even as it invests for long-term account growth.

Check out the latest Roku earnings call transcript.