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Countering Morgan Stanley, Needham Is Now the Biggest Roku Bull

By Evan Niu, CFA – Dec 4, 2019 at 2:00AM

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Needham analyst Laura Martin thinks Roku shares are heading to $200.

Shares of Roku (ROKU -5.06%) tanked on Monday after Morgan Stanley said it was time to sell, citing concerns around valuation and slowing growth. Needham countered that downgrade on Tuesday with a major upgrade, with analyst Laura Martin boosting her price target from $150 to $200 -- the highest on Wall Street -- and reiterating a buy rating. That's nearly twice the $110 price target that Morgan Stanley slapped on the stock.

Here's why Needham thinks Morgan Stanley is wrong about Roku.

Apple TV+ displayed on a Roku TV

Apple TV+ is available on Roku. Image source: Roku.

Roku will be a "winning aggregator"

Martin argues that the launch of high-profile subscription video-on-demand (SVOD) services -- including those recently introduced by Apple and Disney, as well as others on the horizon from Comcast and AT&T -- will reduce the overall risk that Roku faces.

"In 2020, Roku's key upside valuation driver will be accelerating subscription SVOD revenues, which lowers investment risk, we believe," the analyst wrote in a research note to investors. "Additionally, Disney+, Apple+, Peacock/[Comcast] and HBOMax/AT&T should accelerate customer acquisition spending, and Roku is a key beneficiary owing to its installed base of 32 [million] US connected-TV homes."

Needham compares Roku to other content aggregator platforms like Alphabet's YouTube or Apple's iOS, suggesting that Roku will ultimately become the "winning aggregator of TV and films" in the same way that YouTube is the dominant tech platform for user-generated videos. Leading platforms enjoy "winner take most economics, walled garden data advantages, scale economics and enormous barriers to entry," according to Martin.

It's worth noting that Roku is new to selling premium subscriptions; the company only started offering third-party subscriptions in January. Roku has been coy about sharing many granular details around the growing premium subscription business but does note that premium subscriptions carry lower gross margin than other parts of the platform segment. Still, that revenue is incrementally additive in terms of gross profit dollars, even if those sales dilute gross margin percentage a little.

Martin is also bullish on Roku's recent acquisition of ad tech platform DataXu, which is expected to bolster the core advertising business that represents the bulk of Roku's platform segment. Improving the company's ad products will help improve targeting and relevance, allowing Roku to grab more and more of the ad budgets that are already shifting from linear TV toward over-the-top (OTT) services.

As Roku cements itself as the largest streaming TV platform in the U.S., it could wield greater negotiating leverage and extract more favorable revenue-sharing terms. The analyst adds, "Any OTT service trying to get new subscribers (or viewers to watch their free content) must spend more ad dollars on Roku or risk ignoring 40% of connected TV homes that their competitors are reaching."

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Evan Niu, CFA owns shares of Apple and Walt Disney. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Apple, Roku, and Walt Disney. The Motley Fool recommends Comcast and recommends the following options: long January 2021 $60 calls on Walt Disney and short January 2020 $130 calls on Walt Disney. The Motley Fool has a disclosure policy.

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