Late last week, Roku (NASDAQ:ROKU) announced it had come to an agreement with Quibi, the failed short-form streaming platform, to exclusively host its content on the Roku Channel. Being the operating system for internet-connected TVs (CTVs), it probably came as a bit of a surprise that Roku was being so aggressive buying up content.

But is it the right move for the business going forward? Let's investigate. 

Roku's current business model

To give context around why Roku would buy Quibi's catalog of shows, investors need to understand the company's business strategy. Roku sells USB sticks and media players that enable TVs to connect to its operating system (OS), and partners with manufacturers to sell TVs with its OS pre-loaded. Equipment sales make up the player revenue segment of Roku's earnings reports. Last quarter, player revenue was $132.4 million, up 62% year over year, and it made up 29.3% of Roku's overall revenue.

Two people watching TV.

Image source: Getty Images.

The other 70.7% of Roku's business, and the segment that investors should be following the closest, is platform revenue. This is money the company brings in through ads, revenue sharing with streaming services, and anything else associated with the use of the TV OS itself. Last quarter, platform revenue grew 78% year over year to $319.2 million. 

But if we look further down the income statement, we see that while player revenue makes up a sizable portion of Roku's sales, it only makes up a small part of its gross profit. Last quarter, the segment only brought in $20 million in gross profit (a 15% gross margin) versus $195 million in gross profit (a 73% gross margin) for the platform segment. This shows that Roku is almost treating its hardware as a loss-leader, with the goal of making most of its money through advertising. 

So far, this strategy has worked swimmingly. The company just announced it had 51.2 million active accounts at the end of 2020, up 14 million from 2019, and an estimated 58.7 billion streaming hours last year, up 55% year over year. Roku's active accounts are slightly ahead of Amazon Fire TV's 50 million active users. It looks like it has become a two-company race to see who will lead the CTV OS space, at least in America.

But can Quibi's content catalog, or buying other video content, help Roku achieve its platform ambitions?

Is buying content the right strategy for Roku?

One of Roku's strategies for advertising is to grow the Roku Channel, its ad-supported streaming service that is free for anyone to use. Quibi's content will be housed on the Roku Channel alongside the 40,000 free movies and 150 free TV feeds already available on the service. 

In the press release announcing the Quibi content acquisition, Roku mentioned that an estimated 61.8 million people now have access to the Roku Channel. Why is this important? Since the majority of streaming services are ad-free (think Netflix, Amazon Prime Video, AT&T's HBOMax, etc.), Roku likely thought it would need to grow the ad-supported market on its own. A big part of this will be through the Roku Channel. Look for the company to continue buying cheap or second-tier content to help improve the value proposition of the service. There's no need to build an internal studio that spends billions of dollars a year on premium content (let's leave that for Netflix), but it still will need to find some sort of content to convince users to watch.

Overall, while the Quibi acquisition looks strange at first, it fits right in line with Roku's plan to grow the ad-supported streaming video market. With close to 62 million people now using the Roku Channel on a regular basis, the company has the scale to make buying content like Quibi's worth it. This, in turn, should allow Roku to grow its advertising revenue for years to come.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.