As of 2020, streaming services boasted approximately 191 million active U.S. subscriptions . Streaming platform Roku's (ROKU +3.86%) slick interface provides viewers access to these services -- but it's now evolving, bringing its own Roku Channel to the forefront. In this new game of chess between Roku and its content partners, investors need to know the risks involved, as well as the potential rewards ahead.
Neutrality and the rise of Roku
Today, Roku's platform commands roughly 38% market share of TVs in the United States. In its earlier days, Roku focused on delivering an interface for streaming services through its streaming sticks, or by getting television brands to adopt its smart TV operating system.
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Roku's interface was simple, giving consumers an all-in-one means to watch Netflix, Hulu, and other favorite streaming services. For content providers, Roku provided a turnkey distribution model. Roku was solely a distribution platform for streaming services, posing no competitive threats for its streaming-service partners.
As Roku's market share has climbed, its growing status as a major "gatekeeper" to streaming audiences has given Roku leverage over those very same content providers. In recent years, Roku has gotten into negotiation battles with AT&T over HBO Max, Comcast over Peacock, and most recently, Google over YouTube TV.
While the dispute with Google is ongoing, AT&T and Comcast eventually caved and struck deals to gain access to Roku's platform. The narrative has slowly shifted from Roku needing content partners to content producers needing Roku's audience. Even Apple has quietly sought help for its own streaming service, buying a button on Roku's TV remote.
The Roku channel is the future
Roku's rise to prominence has resulted in more than 25,000 content creators having apps hosted on Roku's platform. These apps give viewers access to free TV shows, movies, and streaming audio, but Roku's platform is only the access point, with consumers traveling into specific apps to consume content.
Roku Channel is bringing content straight to consumers as a streaming service that viewers access directly from Roku. Instead of traveling between apps on a Roku TV, Roku Channel holds its content "in-house" and functions as a TV channel guide.
Roku Channel gives viewers access to numerous shows, movies, news, and sports -- all for free in exchange for viewing ads. Roku Channel has grown to include hundreds of free "channels," and users can also integrate premium subscriptions (such as Showtime) into it for convenience. Roku Channel effectively draws eyeballs from its hosted apps on its platform to its own "in-house" content source.
The Roku Channel makes ad technology an increasingly important part of Roku's overall business. In addition to Roku Channel, Roku has acquired demand-side ad platform dataxu in 2019, as well as Nielsen's Advanced Video Advertising Unit earlier this year.
The Roku Channel itself is Roku's fastest-growing segment. Roku doesn't break out its advertising revenues, lumping it into its "Platform" segment instead. Still, management does credit ad-tech for driving platform revenue growth of 101% year over year in Q1 2021.
In Q1, The Roku Channel reached an estimated 70 million households, more than double its 2020 reach. The Roku Channel reaches beyond Roku's streaming sticks and Roku-powered TVs. It is also accessible on its own mobile app, web browsers, and smart Samsung and Amazon Fire TVs. Roku Channel's extended reach propelled the streaming service to grow twice as fast as Roku's actual TV platform in Q1.With total Platform revenues making up 80% of revenue for Roku, Roku's business has become software-focused; the remaining sales come from selling streaming devices and other hardware.
Upping the ante with original content
This year, Roku has pivoted into original content. It acquired content rights for approximately 75 shows from failed short-form video creator Quibi for an estimated $100 million. It also acquired This Old House for undisclosed terms, giving Roku rights to more than 1,500 episodes of the home improvement series. This content is being woven into the Roku Channel as "Roku Originals." Roku doesn't have the free cash flow yet to drive content creation continuously, but it has $2 billion on its balance sheet after an equity raise in March of this year.
By formally launching original content, Roku has removed the veil of neutrality that made it attractive to content creators in the first place. Roku is "upping the ante" by potentially alienating its content partners. Roku's decision to compete with other streaming services could backfire if those partners start leaving its platform, and Roku begins losing market share to competitors such as Google (Chrome Cast) or Amazon (Fire TV).
Roku was a big winner during the pandemic. Active accounts grew 35% year over year to 53 million in Q1 2021 -- but rose just 5% from the previous quarter. Still, Roku maintaining its surging user count from the pandemic could be indicative of the platform's stickiness, as well as more evidence that streaming is here to stay. Roku may feel like this growing user base gives it more freedom to compete against the services it carries, since they'll still need access to all those Roku viewers.
Roku still must tread carefully around its largest partners, but because Roku Channel makes money from ads instead of subscription fees like Netflix and Disney, it seems that Roku Channel is more complementary than competitive to those paid services.
Roku may have felt that staying neutral could only take its growth so far. Investors will need to continue monitoring user growth to ensure its leverage in the streaming space. But if it does, the Roku Channel could eventually take Roku to new heights.
