Every major media company is pouring billions of dollars into developing a streaming service, producing content, and attracting customers. While these companies fight tooth and nail to capture consumers' mindshare, they're happy to partner with Roku (NASDAQ: Roku), a leading streaming platform that is helping them reach millions of households. Roku shares have taken a beating with the broader pullback in tech stocks and the supply chain issues, but its business fundamentals and future opportunity remain strong for three key reasons.
Tailwinds of shifting advertising dollars
Audiences are steadily abandoning traditional cable and satellite TV in favor of streaming. And advertisers are following the lead, shifting their spending from traditional TV to "connected TV," which includes streaming services, platforms, and connected devices. According to eMarketer, advertising revenue for the connected TV segment in the US is projected to more than double from $14 billion in 2021 to $29.5 billion in 2024.
Image source: Getty Images.
Roku makes a big chunk of its money by showing advertisements to viewers. Also, anytime a viewer subscribes to a streaming service such as Netflix or Disney+ via Roku's platform, Roku takes a percentage of the price the user paid. And streaming companies pay Roku for premium placement on the home screen.
Roku has reaped the rewards of shifting advertising dollars to streaming, growing its ad-driven platform revenue over 70% annually for four consecutive years. Platform revenue has eclipsed Roku's revenue from selling streaming hardware over the years, representing a massive 82% of the total revenue in 2021.
A leading streaming platform
For over 60 million households, Roku has become a central gateway to entertainment, offering a convenient way to aggregate and access all major streaming content. With its end-to-end ecosystem of Roku TV and streaming devices, Roku operating system, Roku channel, and its advertising platform, the company has established a leadership position in the industry. Unlike many of its competitors who repurposed their cellphone or computer operating systems to stream content on TV, Roku purpose-built a software platform ground up for TVs, and the company believes its platform to be the best in the industry.
More and more consumers are paying for the convenience that Roku offers. And once customers buy a Roku TV or Roku streaming player, there is very little incentive for them to move away from it.
Image source: Company Earnings Release
In 2021, the Roku operating system (OS) remained the No. 1 selling Smart TV OS in the U.S., representing more than 1 in 3 Smart TVs sold.
In addition to more people adopting Roku's products, viewers are spending more time streaming on Roku's platform. Viewers watched streaming content on Roku's platform for 3.6 hours a day on average in the fourth quarter of 2021, up from 3.5 hours a day in the third quarter of 2021 and 3.4 hours pre-COVID in the fourth quarter of 2019. According to the company's assessment, Roku's 2021 total viewing hour growth of 25% year over year "significantly outperformed the broader industry."
Competitive advantages translating to robust performance
Growing subscribers and engagement on Roku's platform validate the superiority of Roku's product. And as more viewers join Roku's platform, there is a greater incentive for TV manufacturers, content providers, and advertisers to partner with Roku. Broader availability of the Roku platform and more content, in turn, attract even more users, creating a virtuous business cycle.
As a result, Roku has consistently improved its average revenue per user (ARPU), another promising sign of the resilience of its business. The company increased its average revenue per user (ARPU) in 2021 by a whopping 43%, its highest rate of growth in the past five years.
Image source: Company Earnings Release
Advertisers find partnership with Roku incredibly valuable, because Roku's platform generates an enormous amount of user data. The company leverages this data with artificial intelligence to empower advertisers to serve up relevant ads targeting specific segments of consumers, delivering a bigger bang for the buck for advertisers. As advertisers continue to shift to streaming, Roku's platform becomes a go-to destination for them.
Growing users, engagement, and monetization have increased Roku's total revenue by over 50% for three consecutive years.
Image source: Company Earnings Release
Can Roku continue to grow?
Analysts are worried that Roku won't be able to keep up with the surge in revenue growth it experienced during the second half of 2020 and the first half of 2021. Roku's year-over-year revenue growth slowed down from 79% and 81% in the first two quarters of 2021 to 51% and 33% in the final two quarters of 2021. The company is projecting 35% revenue growth for 2022, which is also lower than the past four years.
Roku's sales growth is slowing partly because of the pull-forward of the demand in 2020 during the COVID-19 pandemic, and partly due to the supply chain constraints that are leading to lower than anticipated TV sales. Supply chain issues are impacting advertising revenue, as certain sectors of the economy such as automobiles and consumer packaged goods are pulling back on their ad spending. Also, TV manufacturers are expecting to sell fewer TVs in 2022 than their pre-pandemic levels, as supply chain constraints seem likely to persist. However, the company views all these factors as temporary, and expects Roku to keep its industry-leading position.
The company also plans to focus aggressively on customer acquisition by keeping the prices of its streaming devices unchanged, absorbing the higher component and logistical costs. This strategy will likely keep demand steady for Roku's devices, but will result in lower margins until supply chain issues normalize.
Roku is also investing in its international growth beyond North America. According to Statista, Roku had about 6.4% share of the global market in 2020, and there is certainly a long runway for the company to grow. However, the international market is highly fragmented, with a ton of competitors fighting for a piece of the streaming market pie. Although Roku is in a great position to replicate its US formula globally, it'll need flawless execution to win a worldwide audience.
Finally, Roku's recently introduced exclusive channel, offering original and licensed content, can be a strong growth driver for the company. However, producing and licensing content is expensive. If the Roku channel doesn't grow user engagement and in turn advertising revenue, it could dilute the company's profits.
A measured approach for investors
Roku has produced positive free cash flow for two consecutive years now, and the company turned profitable on GAAP basis in 2021. But Roku's profitability and share price may struggle in the near-term as supply chain issues and related inflation may persist.
Roku is still a leading streaming platform with distinct competitive advantages, and has a long runway in front of it. Roku's founder Anthony Wood has successfully led the company, and is focused on long-term success. Employees give Wood highly a 90% approval rating, and give Roku 4.3 stars out of five on survey website Glassdoor.com. The current pullback in Roku's share price, which brings its price-to-sales valuation to a three-year low, is a good opportunity for patient long-term investors to open a small position in this great business.
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