Roku's (ROKU 0.15%) stock sank 18% during after-hours trading on Nov. 2 following the release of its third-quarter earnings report. The streaming platform and device maker's revenue rose 12% year-over-year to $761 million, which beat analysts' estimates by $68 million. It posted a net loss of $122 million, compared to a net profit of $69 million a year earlier -- but, that came out to a net loss of $0.88 per share, which cleared the consensus forecast by $0.41.
Roku passed Wall Street's low bar, but a closer look at its growth metrics and guidance reveals some glaring weaknesses. Should investors still buy Roku's stock as it languishes near its lowest levels in nearly four years?
Image source: Getty Images.
Another quarter of decelerating growth
Roku experienced a major growth spurt during the pandemic, which prompted people to stay at home and watch more streaming videos. But its sales of streaming devices declined as those lockdown measures ended. On top of that, growth of Roku's higher-margin software platform -- which generates the bulk of its revenue by selling integrated ads on Roku devices and third-party hardware -- also cooled off, as macro headwinds prompted companies to purchase fewer ads.
At first glance, Roku's third quarter numbers don't look too bad. Its active accounts grew 16% year over year to 65.4 million in the third quarter, an acceleration from 14% growth in the second quarter. Total streaming hours grew 21% to 21.9 billion, accelerating from its 19% growth in the previous quarter. However, its average revenue per user (ARPU) rose a mere 10% to $44.25, a significant slowdown from the 21% growth reported last quarter.
That lessened ARPU growth can be attributed to the aforementioned headwinds facing the digital advertising market and broader economy. But it also caused a slowdown of Roku's revenue growth: Platform revenue, which accounted for 88% of the company's top line, brought in $670.4 million in the third quarter, up by 15% year over year but down sequentially from Q2's $673.2 million. Player revenue reported only $91 million, a decline of 7% growth compared to the year-ago quarter. All in all, Roku's third quarter revenue rose just 12% year over year, to $761.4 million. But that's a drop from the second quarter's $764.4 million in revenue.
Roku expects this pain to persist as its player and platform businesses simultaneously slow down. Roku predicts fourth quarter revenue will reach $800 million. While that's a significant sequential increase, it would represent a 7.5% decline compared to the fourth quarter of 2021, when revenue hit $865.3 million. Management expects net loss to more than double sequentially to $245 million. That gloomy forecast indicates that Roku's business will endure much more pain over the next few quarters.
Will Roku's business ever recover?
Roku's platform gross margin declined sequentially and year over year to 55.8% in the third quarter, reflecting the company's waning pricing power in the shriveling advertising market. It's been trying to lock in more viewers and advertisers with its ad-supported Roku Channel, but that streaming service faces intense competition for ad dollars from other ad-supported services like Comcast's Peacock, Disney+ (DIS 0.18%), and even Netflix (NFLX -3.92%).
Roku's player gross margin also remained negative for the sixth consecutive quarter. That was caused by its limited pricing power in the streaming device market, which has been saturated with other formidable competitors like Amazon (AMZN -1.64%) and Apple (AAPL 1.27%), as well as the ongoing supply chain shortages and supply chain disruptions.
Rather than pass those costs onto the consumer and potentially cede its market share to competitors, Roku has been absorbing those costs and incurring losses for the past three quarters. That loss-leading strategy might have worked if its platform business were healthier, but it could be difficult to sustain as its advertising business slows down.
Faced with these challenges, it isn't surprising that Roku turned unprofitable and has posted widening losses since the start of fiscal 2022. Adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization), which generously excludes its stock-based compensation and other one-time expenses, also turned red over the past two quarters.
Roku's stock is still a falling knife
Roku's stock might look cheap at just two times next year's sales, but it faces too many challenges. Its platform business was once its core profit engine, but it's stalling out in this rough market for advertising companies. At the same time, it needs to ramp up its spending on new content for the Roku Channel to widen its moat against Netflix, Disney, Amazon, and other formidable competitors in the streaming market. That's all bad news for its near-term margins.
Roku's hardware business will also continue to struggle as it competes against tech giants like Amazon and Apple -- which can afford to rack up losses on their devices to support the expansion of their digital ecosystems. In short, I believe Roku will remain a falling knife until the macro headwinds dissipate and its advertising business shows a few flickers of life again.
