The largest development in entertainment over the last decade-plus has been the transition from traditional formats like cable television or movie theaters to internet-enabled services. A growing share of audiences is watching TV and movies today through internet-connected televisions, otherwise known as CTV. Advertising budgets are following those eyeballs to new platforms with industry analysts expecting CTV advertising to grow almost 15% in 2023 compared to 2022.
YouTube -- owned by technology giant Alphabet (GOOG 0.74%) (GOOGL 0.55%) -- is one of the companies trying to grow its revenue from this advertising transition, and it has recently made some new announcements to win a larger chunk of the CTV market. Roku (ROKU 0.15%), one of the largest CTV operating systems in the world, has been a beneficiary of the internet-connected transition but is now coming under increasing pressure from these large technology competitors like YouTube.
Does Roku have what it takes to defend itself from this coming onslaught of new offerings from YouTube? Let's take a look.
YouTube's expansion plans
Over the last year or so, YouTube has added multiple products to its platform and signed a huge contract to help it expand outside of its core do-it-yourself videos. These include a test for accessing free ad-supported streaming channels directly from the YouTube application, a hub for free advertising-supported TV shows and movies, and the ability to subscribe to paid streaming channels like Starz and Paramount+ in a dedicated hub. It also just signed a deal with the National Football League (NFL) for NFL Sunday Ticket, a contract that will cost YouTube $2 billion a year but bring the popular sports service to the YouTube and YouTube TV applications.
These moves serve two purposes. One, YouTube wants as much video content available on its services as possible that it can serve up to users, increasing viewing hours and therefore the number of advertising slots it can sell. Second, it wants people to think of YouTube as their central hub for CTV viewing, making it the first application they look for when turning on their televisions. This is leading YouTube to become a bigger competitor to its platform partners like Roku.
Why this could hurt Roku
Roku has a simple business model. It sells CTV hardware at cost to undercut the competition. Once consumers are tapped into its platform, the company then makes money through advertisements, promotions, and revenue-sharing agreements. It even has its own free ad-supported streaming channel called the Roku Channel, which is one of the most popular services for Roku users. Revenue growth is fueled by the growth of active accounts, hours watched on Roku devices, and engagement with the Roku Channel.
These recent moves by YouTube could threaten Roku's advertising ambitions. For one, if people start accessing free streaming channels through YouTube instead of directly through the Roku home screen, Roku will earn less or possibly zero dollars from its advertising-sharing agreements. As well, if people start their video searches from the YouTube app instead of on Roku's search bar, that could hurt viewership for the Roku Channel, which has been one of Roku's key growth drivers over the past few years.
There is a growing pool of advertising dollars spent on CTV each year. But if more and more of this spending goes to YouTube, that is going to be bad for Roku's ambitions as a leading CTV platform.
Does this mean you should sell Roku stock?
Even though Roku is getting competitive pressure from one of the largest companies in the world, I don't necessarily think it means you should sell your shares.
Roku has been in competition with technology giants like Apple and Amazon ever since its inception. This has not stopped it from growing with the company recently hitting 70 million active accounts and growing streaming hours by 23% year over year in the fourth quarter. YouTube could pose a threat if it continues to take market share, but the CTV opportunity has proven large enough that there are multiple winners, and Roku has proven it can still lead a pack of larger competitors.
Data by YCharts.
The stock also trades at a relative bargain as of this writing. With a trailing price-to-sales ratio (P/S) of just 2.3, Roku's stock has a sales multiple below the market average (and its own historical levels), which could be a steal considering the company's track record of growth and the overall growth of the CTV advertising industry. Investors will expect the business to eventually reach profitability (it had a net income of negative $237 million over the last 12 months), but there's no need to sell your shares today because of some new competition, even from a huge name like YouTube.
