Shares of Roku (NASDAQ:ROKU) tanked yesterday after Morgan Stanley analyst Benjamin Swinburne downgraded the stock from equalweight to underweight, or the equivalent of a sell rating. The analyst also increased his price target from $100 to $110, which may sound counterintuitive but factors in Roku's massive rally this year (the stock has more than quadrupled in 2019).

Here's why Swinburne thinks it's time to bail on the streaming TV platform.

Roku interface displayed on a TV

Image source: Roku.

Roku's valuation has gotten too lofty

While Morgan Stanley acknowledges that Roku is at the epicenter of the shift to video streaming, the firm believes that Roku will face meaningful risks as it grows that investors aren't fully appreciating. Swinburne writes:

Roku continues to execute a sound strategy to capitalize on the shift to streaming. However, we believe there are risks to growth expectations not reflected in current valuation levels. Specifically, we think revenue and gross profit growth slow meaningfully in '20 and the multiple compresses.

As evidence of Roku's lofty valuation, Swinburne points to Roku's platform EV/revenue multiple, which he estimates to be roughly triple Netflix's and almost double the multiples that software-as-a-service (SaaS) companies fetch. SaaS companies enjoy incredibly high valuations since the businesses are built on subscription models and many sell critical enterprise software. It's also common for high-multiple stocks to get punished when growth starts to slow, bringing valuation multiples back down to earth.

The platform segment, which is primarily driven by advertising, will start to see growth decelerate as it becomes larger, in Swinburne's view, which has happened with many other ad-based businesses in the social media sector. In recent years, Roku has utilized a strategy of selling its hardware at razor-thin margins in order to grow the platform segment that enjoys much higher margins.


Gross Margin (Q3 2019)





Data source: SEC filings.

At the same time, Roku has also leaned heavily on partnerships with third-party TV manufacturers such as TCL for active account growth. The analyst argues that Roku will need to keep inking new deals to maintain the growth rate of active accounts, which stood at 32.3 million at the end of the third quarter. The company estimates that Roku TVs accounted for over a third of all smart TVs sold in the U.S. during the first three quarters of 2019.

There's little doubt that Roku stands to benefit from the barrage of video-streaming services that are launching, as it operates an agnostic platform that gets a cut of premium channel subscriptions. Apple and Disney both rolled out their respective services, Apple TV+ and Disney+, last month. There are more major launches on the horizon: Comcast plans to introduce Peacock in April 2020, followed shortly by AT&T's HBO Max in May 2020. But all that future growth is already priced in to Roku stock, according to Swinburne.