Roku (NASDAQ:ROKU) saw revenue grow a whopping 73% year over year in the third quarter of 2020, a stark acceleration from the second quarter when the COVID-19 pandemic hurt ad sales for its platform business. Roku's platform business accounted for over 70% of its revenue in the third quarter, and it'll account for the bulk of Roku's revenue growth going forward.
Investors should expect its platform business' revenue acceleration to continue because of the following three factors: ad spend shifting to streaming, Roku's growing ad inventory, and progress in its international expansion plans.
TV ad budgets aren't what they used to be
After delaying the TV upfront event -- where marketers commit to spend on primetime TV commercials -- the industry saw a significant decline in ad sales during the big event. Commitments fell 15% to 20%, which would result in a shortfall of around $3 billion to $4 billion compared to last year's upfronts.
It's worth pointing out that advertisers had already started to pull back on TV ad spending, cutting their previous upfront commitments this summer through a rarely used clause. When factoring in that previous cut, upfront sales are about flat. That said, advertisers could cut back further on their upfront commitments if the COVID-19 pandemic conditions don't improve as expected.
For the most part, those ad budgets aren't just disappearing into thin air -- they're moving to digital platforms like Roku. Roku and other digital platforms offer better audience targeting and measurement, which are extremely valuable in times with limited visibility into market conditions. And Roku's management notes that when advertisers shift their ad budgets to streaming, they don't usually shift back toward traditional TV. (The same goes for viewers.)
A growing ad inventory
There are several factors providing Roku with more ads to sell to marketers.
First of all is the overall growth in engagement among its audience. Streaming hours increased 54% year over year in the third quarter. Average engagement among its users has consistently climbed from quarter to quarter. Increased cord-cutting and a growing number of streaming options will only serve to continue that trend for years to come.
Second, a greater percentage of viewing takes place in The Roku Channel. Roku says viewing time for its ad-supported service climbed more than twice as fast as its overall platform. What's more, there's still a lot of room for The Roku Channel to grow its audience, as it still hasn't penetrated half of Roku's user base.
Finally, Roku has a strengthening position in negotiations with media companies to take a larger share of ad inventory in ad-supported streaming services. It has the largest, most engaged user base of connected-TV platforms in the United States, which makes it increasingly valuable as a distribution partner. Roku has recently exercised its position in recent negotiations for some notable streaming services, and it appears to be winning concessions it's been unable to in the past. For example, its negotiations with Comcast to distribute Peacock included a provision to add NBC News to The Roku Channel.
Roku's still in the early stages of international expansion
Roku's international strategy follows the same three phases that made it successful in America: build scale, grow engagement, and then monetize. Roku's currently in the early stages in most markets, but it's making progress in some of its earlier international markets including Canada and the U.K. Both of those markets hold the promise of significant ad revenue as Roku ramps up engagement.
In Canada, Roku already claims it holds the top spot for smart TV sales. It's also increasing visibility in the U.K, launching The Roku Channel in the country earlier this year. As Roku makes progress on its roadmap in those countries, it should see a strong uptick in revenue growth, supporting continued growth in its larger domestic market.
Meanwhile, Roku continues to expand to new markets. It's making progress in Brazil, where it launched in January. It also struck several deals in continental Europe about a year ago that hold lots of promise.
The platform is still small
The above three factors should lead to continued acceleration in platform revenue, which accounts for the vast majority of Roku's total. Over the last 12 months, Roku's platform business generated $1.06 billion in revenue. That's just a tiny fraction of the global streaming market, which itself is growing quickly and expected to reach about $150 billion by 2026. As the trends continue to favor Roku, it should be able to produce strong growth for investors.