Shares of Roku (ROKU -0.13%) opened sharply lower on Friday after a blistering financial update. With at least three Wall Street analysts putting out cautious notes in the week leading up to its grim report, it's not shocking to see an earnings report fail to live up to expectations.
I was hopeful. I was wrong. Roku's plummet to close out the trading week is fair. You don't hose down near-term guidance -- sharply -- and withdraw full-year guidance without getting roughed up. The ad market has softened swiftly, even for Roku's connected TV stronghold that should've held up better than other marketing markets. The weakness on the hardware end that has held back the last few quarters is clearly more than just a supply chain issue. After all, it's fairly easy to get a Roku dongle -- even at a discount -- these days.
Roku is experiencing growth pains. The stock is gnashing two-year lows. I feel it can recover from this, but -- for the sake of full disclosure -- I've been wrong before. I was wrong earlier this week. Let's see why I feel that Roku will recover from this admittedly well-earned, post-earnings sell-off.
Turning up the brightness
Let's start with the second quarter itself. Folks aren't turning away from the industry-leading smart TV operating system. Roku had a record 63.1 million at the end of June, comfortably ahead of the 55.1 million it was entertaining a year earlier and the 61.3 homes it was serving in March.
They're also not spending less time cradling that Roku remote. The 20.7 billion hours streamed during the quarter -- translating into 3.7 hours a day on average -- is 19% higher than viewership levels were a year earlier. The company is faring better than the 14% growth in active accounts and accelerating from the year-over-year pace in the previous quarter.
This is not a problem of engagement. Roku's problem right now is one of monetization. Average revenue per user (ARPU) did manage to increase sequentially (and is up 21% over the past year). The rub is that advertisers across all marketing missive media are cooling their jets alongside the economy's contraction. It was bad in Q2. It has gotten substantially worse this summer, hence the brutal guidance calling for just $700 million in revenue for the current quarter. We're talking about a 3% year-over-year increase and a bitter 8% sequential decline on the top line.
After years of breathtaking growth, Roku is likely to see its first sequential decline in ARPU. It's a brutal blow, but is there anyone who believes the new normal will be anything other than transitory? Inflationary pressures are already starting to recede on many fronts, and the same monetary policy that has slowed the economy should eventually stabilize consumer sentiment.
A prolonged recession is going to hurt Roku. Like many players, Roku has made the most of its perpetually rising ad revenue per user to subsidize its hardware and expand its reach on all fronts. If that metric starts to deteriorate beyond the next quarter or two, Roku is going to have to make some painful decisions that prioritize survival over expansion.
What happens if ARPU starts to recover? As Roku points out, digital TV consumption continues to take market share over legacy platforms. Advertisers are still spending a lot more to reach traditional TV viewers than the more attracting streaming audience. The trend continues to favor Roku's success over the long haul.
Roku is a bellwether for streaming video stocks, and a decline in ARPU is going to sting. But the stinging shouldn't be permanent. I still believe in Roku even if it seems as if I'm preaching to a thinning room of investors.