One of the most exciting companies in the streaming revolution is Roku (ROKU 0.65%). Roku is the market leader in streaming TV operating systems, taking a portion of every streaming subscription and ad shown on its platform. Given that we are still in the early-to-middle innings of the streaming transition, that's a pretty good spot to be.
And yet, the stock has plunged a stunning 86% from its all-time high set back in 2021, culminating in last quarter's disappointing earnings report.
But is the huge sell-off an opportunity? I found four silver linings within the recent report that offer shareholders lots of hope for the future.
1. Roku outgrew other digital advertisers last quarter
When looking at Roku, I tend to ignore its player hardware sales since those are sold at cost or a loss and instead focus on platform revenue, which encompasses subscriptions and ad sales. Since the platform segment generates all the profits, that's the real value driver.
Platform revenue decelerated more than expected last quarter to just 26% growth, down markedly from the 39% growth in the first quarter and 49% growth in the fourth quarter of 2021. And while management doesn't break out platform revenue in its guidance, it did guide for total revenue to decline sequentially next quarter.
And yet, when looking at the whole digital advertising sector, Roku was a relative outperformer. Its 26% revenue growth was better than most large digital ad platforms, trouncing the struggling social media stocks, and even outgrowing the more defensive Google (GOOG 1.27%) (GOOGL 1.36%) Search and Amazon (AMZN) ad revenue last quarter.
True, Google and Amazon are operating at much higher revenue levels. But Roku's relative outperformance still seems to show ad dollars are flowing to streaming ads over other formats as times get tight.
Roku's revenue was also affected by an accounting markdown. Under accounting rule 606, whenever there is a large change in the business climate for good or ill, Roku needs to adjust the value of its customer contracts up or down. Last quarter, since the operating environment deteriorated across the board, Roku had to make a 606 accounting adjustment down, making revenue look even worse. Despite this, Roku's platform revenue still outperformed its peers.
2. When ad spend comes back, it should return with a vengeance
The worse-than-expected slowdown is partly because Roku's advertising over-indexes to the scatter market. TV ad buyers generally buy a mix of upfront ads at the beginning of a period, then also buy unused inventory closer to the actual day that a show airs. This second type of buying is the "scatter" market.
Unsurprisingly, when times are uncertain, advertisers can immediately pull back on scatter ad spending, leaving that inventory unused or sold for a lower CPM. That's what happened in the second quarter when rampant inflation and talk of recession scared businesses into pulling back.
Yet when businesses get a handle on their operating environment, those dollars should come roaring back. Additionally, the upcoming midterm elections should bolster political advertising this fall. Management also believes difficult economic times lead advertisers to abandon long-term habits and relationships and move to higher-return options, which management believes will spur an exodus of ad dollars from linear TV to streaming.
On the conference call with analysts, CEO Anthony Wood predicted, "this reminds us of when advertisers paused spend during the 2008 recession, but it became a catalyst that accelerated the shift of ad spend from print publishing to digital." With advertisers only forecast to spend 22% of TV ad budgets on streaming, even though 18- to 49-year-olds spent over half of their viewing on streaming versus linear TV last quarter, the opportunity is certainly there.
3. Player margins should eventually improve
Amid supply chain constraints, Roku's hardware gross margins have gone from close to breakeven a year ago to negative 24% in the recent quarter. While Roku's component and supply chain costs have gone up, management hasn't raised prices for consumers. Ultimately, Roku sees greater longer-term value in acquiring customers, which is probably correct. One wouldn't want to turn down long-term subscription and ad revenue by raising the price of a streaming device today.
However, when supply chains normalize, which is admittedly taking longer than normal to do, Roku should be able to recoup those margins and get closer to selling its players at cost.
4. Roku has plenty of cash, and the stock seems cheap
Back when growth stocks were booming in the heyday of early 2021, management had the foresight to raise money at very attractive prices. In March 2021, Roku sold $1 billion worth of stock when its share price was $379.26. That's looking awfully smart, as the stock price is now at a lowly $68.
With a $9.4 billion market cap and $7.4 billion enterprise value due to its $2 billion in net cash, Roku's stock is looking pretty reasonable at these levels. Over the past four quarters, Roku's platform revenue totaled over $2.6 billion, so the stock trades for about 3.6 times platform revenue and just 2.9 times platform revenue on an enterprise value basis.
That's a very reasonable valuation if Roku can eventually reaccelerate growth and get back to the profitability it enjoyed last year. While near-term risks remain, Roku's stock is starting to look like a good value among the beaten-down growth stocks.