Streaming video has changed the entertainment landscape over the past decade. Companies like Netflix and Amazon, among others, have brought video from the analog world to the digital world. This rise in streaming video has led many households around the globe to buy connected televisions (CTVs), which is shorthand for TVs that are connected to the internet. This has benefited companies like Roku (ROKU 0.57%), one of the leading CTV makers around the world with an estimated market share of 6.4%.
Over the last 12 months, Roku stock is down 65%, potentially creating a buying opportunity for anyone interested in this business. Here are two reasons to buy Roku stock, and one reason to sell.
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1. Large and growing market opportunity
Roku competes in the CTV device market, but its real business lies within its operating system: the Roku TV OS. This is the portal where consumers can access all of their different streaming TV services from one home screen. The company makes money from the Roku TV OS via revenue sharing agreements if consumers sign up for a streaming service through their Roku devices, plus advertisements on the home screen and advertisements run on 3rd-party video services. It also runs its own free, advertising-supported video service called the Roku Channel. These revenue streams get lumped into Roku's platform segment.
CTV has grown steadily in the United States over the past few years. In 2014, only 50% of households had a CTV. In 2021, that number has jumped to 82%. The U.S. market is headed toward maturity, but Roku has its sights set on winning internationally as well. It is making big pushes into Europe and Latin America, which it sees as its next big growth markets after North America.
To provide some context, in the fourth quarter of 2017, Roku had 19.3 million active accounts and 4.3 billion hours streamed on its platform. By the end of last year, it had more than tripled active accounts to 60.1 million and quadrupled streaming hours to 19.5 billion. Investors should expect both of these numbers to continue to tick higher as Roku expands its business around the world.
2. Growth of advertising revenue
As I mentioned above, the majority of Roku's top line doesn't come from device sales but from platform and advertising revenues. Fourth-quarter platform revenue made up 81% of the total. This segment will be the driver of Roku's business long term. Luckily for investors, the segment has grown rapidly over the past few years. In the same four-year period, platform revenue surged from just $85.4 million to $703.6 million.
If platform revenue is to grow in the future, it will come from growth in the advertising-video-on-demand (AVOD) market. These are services like the Roku Channel, PlutoTV, Peacock, and Hulu, video streaming offerings supported by advertising. If more hours are streamed on AVOD, that means more chances for advertisements to play for viewers, which means more opportunities for Roku to earn revenue.
And one reason to sell
Roku is one of the top players in the CTV market, so it's pretty easy to be bullish on its prospects if you believe the industry will continue to grow this decade and beyond. However, there is one reason why Roku might not work out as an investment: the competitive landscape. There are two things that may hold the company back, and they actually don't include direct competitors like the Amazon Fire TV (although that is important for investors to watch as well).
First, a lot of the popular streaming video services like Netflix, HBO Max, and Disney+ do not run advertisements at the moment. This means that, unless someone signs up for the service through their Roku device, the company won't earn revenue when someone watches those channels. Given how popular Netflix is, this could put a ceiling on Roku's revenue potential.
The second big problem is YouTube, the do-it-yourself video service that is wildly popular around the globe. Owned by Alphabet, YouTube generated $8.6 billion in advertising revenue in the fourth quarter. Roku similarly makes no money when people watch YouTube on their CTVs, and given Alphabet's immense power in the market, negotiations have not fallen in Roku's favor when the companies have gotten into contract disputes. If YouTube continues to grow at a torrid pace, that could eat a lot of the video advertising dollars Roku is trying to go after.
The harsh competitive landscape doesn't necessarily mean you should avoid Roku as an investment. There is definitely a world where the stock is much higher 10 years from now. But before you invest, carefully consider the headwinds presented by the dominance of YouTube and ad-free video streaming services and how they'll impact Roku's growth in the coming years.
