The pandemic has accelerated the development of all sorts of business trends and technology. Two of them are digital advertising and connected TV (CTV).
Laying at the intersection of digital ads and CTV are Roku (ROKU 6.58%) and Magnite (MGNI 1.40%). Neither stock did particularly well the first half of 2020, but both have been reinvigorated the last few months. The stocks are sporting positive year-to-date gains as of this writing, but one stands out as the better buy right now.
The future of entertainment is already here
CTV, programming delivered to consumers via the internet, is a high-growth industry, but various methods of monetizing CTV have been disrupted by the pandemic. Magnite and Roku illustrate the lopsided course ads and subscriptions have taken.
Magnite is a "sell-side" advertising technologist. Publishers use its platform to make money on their content, listing ad slots for buy-side advertising intermediaries to peruse on behalf of their customers. For example, if a TV show publisher decides to make a 30-second ad available during a commercial break, the company could list it with Magnite to make that slot available for purchase from an advertiser. As a sell-side service for CTV and other digital outlets, Magnite is the largest independent name in the industry -- a product of a merger between Rubicon Project and Telaria earlier this year.
Roku, like other large media platforms, has a hand in both sides of the advertising market. Its platform (the largest CTV company around as measured by total viewing time) operates on behalf of both publishers and advertisers (the sell-side and the buy-side, respectively). Additionally, the company typically sells its TV streaming devices at or below the cost of manufacture, foregoing those dollars in order to get a cut of premium TV subscriptions and other one-time sales through the Roku Channel.
Given the economic environment of 2020, Roku is the winner here. Magnite remains in growth mode as well with all of the extra screen time that has been occurring due to shelter-in-place and social distancing, but its one-sided platform was dented early in the year when many advertisers hit the pause button during the height of the economic lockdown. Revenue through the first six months of 2020 increased "only" 12% year over year to $78.6 million.
Meanwhile, Roku's dual platform for both sides of the ad transaction served it well, and subscription and other TV-related transactions have soared. Roku revenue increased 48% through the first half of the year to $676.8 million.
Working in Magnite's favor, though, is the fact that management reported CTV-specific ad growth was some 50% higher than a year ago at the start of the third quarter. It remains to be seen how business overall will fare as non-CTV ads were flat year over year at the start of the summer months, but a general pickup in economic activity and migration to digital ads bodes well for Magnite going forward.
Growth now, profit later
Neither Magnite nor Roku currently operate with the intent of maximizing profitability. Rather, both operate at a loss in order to capitalize on the growing CTV and digital ad market. Over the last 12 months, Magnite reported negative free cash flow of $16.7 million, and Roku reported negative free cash flow of $45.8 million.
Given the losses both companies are racking up, balance sheet strength becomes important. And in this regard, Magnite and Roku are doing just fine. At the end of June, Magnite had just over $107 million in cash and equivalents and zero debt, good for about two quarters' worth of operating expenses (when excluding non-cash stock-based compensation and depreciation expenses) using second quarter numbers. Roku had $886 million in cash and equivalents and just $97 million in debt, leaving a net cash balance that covers about a year's worth of cash operating expenses based on second-quarter results.
With momentum on its side and a solid balance sheet, I like Roku long term in the CTV race. It has built a strong position in the future of television and is far along in its monetization strategy. However, shares are up almost 70% this year with most of the run coming since July. Roku trades for over 20 times trailing 12-month sales.
Thus, I'm leaning toward Magnite at the moment. Its stock is up only 6% year to date as of this writing and is valued at just six times trailing 12-month sales. It also generated gross profit on services rendered of 62% over the last year to Roku's 42%, making its revenue more valuable than Roku's. As a result, Magnite looks undervalued right now -- especially if it rekindles double-digit percentage growth as was seemingly implied during the last quarterly update. I'm considering a purchase.