Share prices of streaming company Roku (ROKU 0.15%) fell sharply over the past year and are down more than 76% from their 52-week high of $190.50. The ad scatter market has been abysmal, and that led to some poor growth numbers for the business of late.
To help address the issue, the company recently announced a big move that could change its business and make it less dependent on ad revenue. How should investors react to this latest effort?
Roku is going to be making its own TVs
Roku's business centers around its popular streaming sticks that people can use to convert a regular TV into a smart TV that can use apps and easily access multiple streaming platforms, like Netflix or Disney+. Roku even has its own channel that offers free content.
There are already Roku-enabled TVs where third-party manufacturers make the TVs and that have the software built within them. But in a significant shift, the company announced on Jan. 4 that it will launch Roku Select and Roku Plus Series TVs. These will be "the first ever to be both designed and made by Roku." The price range of the TVs will be between $119 and $999, depending on the series and size of the TV, and will be available as early as this spring.
Is this part of a bigger strategy to diversify away from ad revenue?
Last year, Roku also announced the Roku Smart Home -- a line of smart home products including cameras, bulbs, light strips, video doorbells, and smart plugs. Combined with the TV manufacturing move, it looks like part of a broader strategy to become less reliant on ad revenue, which created volatility and uncertainty for Roku and other tech companies in the past year.
Although the ad market will recover once the outlook for the economy improves, it can be difficult to predict when that may be. By making more types of products, Roku can be less reliant on the ad market and have a more diversified revenue stream.
Is this a good move for Roku?
Diversification can be good, but the problem I have with this move can be summed up with just a single chart:
SSNLF Gross Profit Margin (Quarterly) data by YCharts
The top TV makers, Samsung and Sony, have worse gross margins than Roku. Even in its own products business segment, Roku's margins on its players (hardware) have consistently been negative; for the quarter ending Sept. 30, its gross margin on players was negative 19.2%. But on the software side, for its platform, margins are much stronger at just under 56%. Platform revenue of $670.4 million for the period accounted for the vast majority (88%) of the company's sales, and that's why the overall gross margin for the business is strong. But if Roku transitions more toward hardware, those margins could deteriorate quickly.
Ideally, I'd like to see Roku focus more on the software side where margins are stronger, rather than go deeper into hardware. Plus, if Roku's TVs have to compete for limited space in stores against Samsung, Sony, and other manufacturers, it may need to be more aggressive on price, resulting in even worse margins.
I wouldn't buy Roku after this move
Previously, I was bullish on Roku. But after seeing the company pivot toward hardware with smart home products and now its own TVs, my concern is what its margins will look like when all is said and done.
Roku struggled with profitability even prior to the softness in the ad market. Looking ahead, I'm more concerned that profits will be even less likely in the future. I was hesitant about Roku's stock before this move, and now, I'm less confident the growth stock will be able to turn things around this year.
At this stage, investors are better off taking a wait-and-see approach and assessing how the business performs in light of its recent changes before making an investment decision.
