Roku (ROKU 0.15%) stock surged Wednesday on employee rumors of a potential acquisition by Netflix (NFLX -3.92%). The reports seemed to gain steam when "Roku abruptly closed the trading window for all employees, prohibiting them from selling any of their vested stock at a time when they should normally be able to do so," according to a report by Business Insider, citing "people familiar with the matter."
Netflix and Roku declined to comment on the rumors and there could be other reasons to restrict trading, but it raises the intriguing possibility that Roku's digital advertising prowess could be just the thing that Netflix needs to reignite its waning subscriber growth.
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Pain as a catalyst for change
After years of strong subscriber gains, Netflix suddenly reversed course in the first quarter, a hangover from its pandemic-fueled growth spurt. And to say Netflix investors were discouraged by its financial report would be an understatement. The stock went down in flames, losing 35% of its value in a single day following the earnings release, as the streaming giant reported its first subscriber loss in more than a decade. Management added fuel to the fire, saying in addition to the 200,000 subscribers it shed during the first quarter, it expected to lose another 2 million in Q2.
The media landscape has undergone a rapid transformation in recent years, which has caused streaming executives to reconsider some long-held beliefs. Indeed, after its disastrous results -- and following years of denials -- Netflix CEO Reed Hastings finally acknowledged the need for an ad-supported tier, which could come as early as the end of this year. That shift in strategy highlights a key strength of Roku's and why it would be a perfect match for Netflix.
The cure for what ails you
Roku is much more than the company's namesake set-top box. It's also the leading aggregator of both paid and ad-supported streaming services, with more than 10,000 streaming channels gathered in one place. This industry-leading position has helped Roku attract more than 61 million active household accounts. This in turn gives the company bargaining power with streaming services supported by advertising, charging a 30% cut of all the ad space that appears on its platform. It then uses a treasure trove of viewer data to inform its targeted advertising. This ad revenue helped Roku's platform segment generate $647 million in the first quarter, up 39% year over year.
Hasting said on the conference call, "I've been against the complexity of advertising and a big fan of the simplicity of subscription." Roku's experience in digital advertising would help to solve the "complexity" problem and provide Netflix with a new avenue for subscriber growth and an additional revenue stream fueled by a lower-priced, ad-supported tier -- with Roku doing the heavy lifting.
Does such a deal make sense?
There are other reasons to believe that now would be the perfect time for such a pairing. Roku stock declined 80% from its November high as of market close on Tuesday, bringing its price-to-sales ratio down near 4, a level not seen in more than three years. That puts its market cap at less then $13 billion, making an acquisition much more palatable for Netflix, particularly in an all-stock transaction.
Roku investors would likely require at least a 30% premium to approve such a deal, but it would still cost Netflix less than $17 billion, a bargain for a company that generated revenue of $2.77 billion last year, while being consistently profitable and generating strong operating cash flow.
It's worth noting that the Roku device was actually developed at Netflix in 2007, before being spun off. At the time, Hastings feared that he would alienate the company's partners, who were including the ubiquitous, red "Netflix" buttons on their remotes in the early days of streaming, helping the company become the dominant force in the space it popularized.
Netflix stock is down 70% from its recent high, as investors wonder if the company's best days are in the rearview mirror. Management also appears to be considering all options in formulating a plan to reignite its subscriber growth. It appears that now would be the perfect time for Netflix to welcome home its prodigal child, Roku.
