For the fourth straight quarter, Roku's (ROKU 2.94%) player segment, which includes revenue from sales of its popular media sticks, posted a negative gross margin. To blame are the usual suspects, like supply-chain issues and inflation, which are causing higher input costs that aren't being passed on to customers.
While this situation might cause investors to sour on the stock, which is down 58% in 2022, management is making the correct decision by not raising prices. Contrary to what many observers might think, Roku's hardware business is not the company's bread and butter.
Let's take a closer look.
Roku's goal is to add more users
In the quarter that ended March 31, Roku lost $15.1 million by selling its media devices, which users can plug into their TVs for access to the company's streaming platform. And the leadership team, led by founder and CEO Anthony Wood, sees supply-chain and inflation disruptions continuing for the foreseeable future. In fact, the environment is so difficult right now that industry-wide TV unit sales in the U.S. are below pre-pandemic levels in 2019.
However, I view this as a temporary problem that really isn't a big deal in the grand scheme of things. Roku wants to add as many users as possible, so if it has to lose money in the short term to attract customers, so be it. Hardware only represented 11.8% of total revenue in Q1, down from 63.6% five years ago in Q1 2017.
The real crown jewel of Roku's business is the platform segment, which includes revenue from advertising and subscription agreements. It grew sales 39% year over year, and carried a gross margin of 58.7% in the most recent quarter. Five years ago, the platform segment accounted for 36.4% of the business. Today, that figure is 88.2%.
Image source: Getty Images.
Roku's objective is to sign up as many active accounts as it can, which the company is able to monetize continuously going forward. If a viewer signs up for a streaming service through Roku, the business gets a cut. Additionally, if someone watches an ad-supported streaming option on Roku, the business receives compensation.
This is why Netflix's recent announcement to introduce a cheaper, ad-based subscription tier could be a major win for Roku. Roku has more than 61 million active accounts that streamed 20.9 billion hours of content in the first three months of 2022. Once Netflix adds the lower-cost option to the mix, Roku's ability to monetize its user base will soar because it now has a lucrative opportunity to generate revenue from Netflix viewers.
I do believe that supply-chain challenges and inflationary pressures will eventually normalize, and as a result, Roku will stop losing money on its hardware sales. But I think continuing to sell these products at the lowest prices possible is the correct strategy. Roku wants to grow its base of active accounts as quickly as possible. The real value comes over time by monetizing these users through its superior advertising platform.
At a current price-to-sales ratio of just 4.7, I think Roku is a screaming buy right now.
