Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
Comcast's (CMCSA +0.72%) recent announcement shocked Roku (ROKU 2.27%) investors.
On Wednesday, the nation's biggest cable provider (and more to the point, its biggest provider of internet-only service over its cables) announced that it will begin distributing free Xfinity Flex streaming media devices to its internet-only subscribers. In so doing, Comcast will eliminate the $5 monthly fee for renting the device currently being charged to its customers, and also give internet-only customers access to a library of "more than 10,000 free movies and TV shows" streamable through Flex.
The device will also facilitate streaming popular services such as Netflix, Amazon Prime, and HBO, as well as Comcast's own upcoming Peacock service.
Roku investors didn't like this development, subtracting 14% from the company's market capitalization the day the news broke. After a brief rebound Thursday, Roku stock is taking another dive today -- down another 19% in afternoon trading. You can thank Pivotal Research for that.
Image source: Roku.
A Pivotal sell rating
This morning, Pivotal Research initiated coverage of Roku stock with a "sell" rating.
The analyst prefers Comcast stock over Roku, you see, rating the former buy but the latter sell. Moreover, Pivotal believes that the "potential" for "outsized subscriber growth and ARPU opportunities that" have made Roku such a great growth stock these last couple of years is "materially reduced post the CMCSA move."
But while Pivotal may favor Comcast over Roku in this contest, it's not just Comcast that has the analyst feeling pessimistic about Roku. "Comcast's recent moves with its free Xfinity Flex product" are "likely to be copied by other distributors" as rival cable concerns like Charter, Cox, and Altice move to imitate Comcast's strike at Roku. Over time, Pivotal anticipates that Roku will face "dramatically more competition" from these cable providers offering free equipment to lock folks into subscribing to their internet services, and this could "drive the cost of OTT devices to zero" -- drying up the $325-million-a-year revenue stream that Roku currently derives from hardware sales.
What it means to investors
Granted, that may not seem like such a big deal at first glance. After all, according to data from S&P Global Market Intelligence, hardware sales only generate a gross profit margin of about 11% for Roku. The bulk of the company's gross profit comes not from the sale of Roku Ultras, Roku Expresses, and Roku Sticks, but from the sale of software and services that are enabled by these devices.
And yet, that's the key point right there:
Unless Roku puts a piece of Roku hardware into a customer's living room, how is it to place ads in front of said consumer's eyeballs? How will it collect data on the consumer's viewing habits? How will it sell ad space and data to its corporate customers? Roku's hardware, it turns out, is the sine qua non to its entire streaming ecosystem.
And by disrupting this link in the Roku value-creation chain, Comcast puts the entire chain at risk. This, in essence, is why Pivotal Research believes that Roku is worth only $60 a share (the stock closed at $133.76 yesterday).
Caveats and provisos
So is Pivotal Research right about that?
The analyst argues that Roku stock is "dramatically overvalued" today, and I have to admit that with shares still selling for more than 16 times sales, the company's valuation makes me a little bit nervous, too. That being said, it's worth pointing out that Comcast's success -- and Roku's demise -- are far from foregone conclusions.
Before abandoning all hope in Roku, it's worth remembering: Comcast only just announced its free Xfinity Flex offer two days ago. At present, there's zero evidence that customers will take it up on its offer, or even if they do, that they won't do more than put their free Comcast devices on a shelf to collect dust, sitting around as a backup device to plug in if and when the customer's current Roku ever goes on the fritz.
Consider: Roku owns 39% of the streaming media player market in the U.S. -- 41 million installed devices and Roku-enabled TVs already established in customer living rooms. These are devices that customers are already familiar with, comfortable with, used to. Even at $0 per unit MSRP, there's going to be a substantial switching cost involved if Comcast wants to get its subscribers to switch out one OTT device for another.
Moreover, while the $0 purchase price Comcast is offering sounds like a pretty good deal, objectively speaking, it's really not all that much cheaper than the $30 that a Roku Express will set you back. And if you want to stream video via the Xfinity Flex on more than one television (the average U.S. household has 2.3 televisions), you'll have to rent the second one from Comcast...for $60 a year.
When dealing with cable companies, the devil is always in the fine print. Considering that, perhaps Roku investors shouldn't be panicking just yet?
