Shares of streaming company Roku (ROKU -3.71%) have been beaten down so severely in this bear market that the stock price is up more than 40% over the past month but is still trading down 85% from its former highs! The company's recent fourth-quarter earnings showed shrinking margins and guided for $700 million in first-quarter revenue, below the $733 million it made in the first quarter two years ago.
So, do Roku's falling revenue and profit margins make the recent share price gain a selling opportunity? I'm not so sure, and I'd caution against rushing out to place that sell order.
Here are three reasons I'm not worried about Roku's long-term prospects.
1. Roku's subscriber growth is strong
Roku's business model depends on growing its account base. For that, there are two segments at work.
The devices segment includes revenue from streaming sticks and other hardware and licensing fees when manufacturers use the company's OS for Roku TVs. This part of Roku's business has negative gross profit margins. Why would it want this? The company wants to grow its platform audience, so it's willing to lose money to get those extra eyeballs. Think of it as customer acquisition costs.
And the platform segment makes revenue primarily by selling ads on ad-supported channels like The Roku Channel and through revenue-sharing agreements. Today, the platform segment is the core business. It contributed all of Roku's gross profit and $2.7 billion of the company's $3.1 billion in total revenue in 2022.
Roku's membership growth could indicate how the business will do in the future as those users are monetized. Fortunately, user growth remains strong: The company added 4.6 million accounts between the third and fourth quarters.
Its 70 million active accounts are a 9.9 million jump from last year. Roku TVs (sets that run on its OS) are now the top-selling OS in the United States, Canada, and Mexico, and Roku is expanding worldwide. There's a lot of room for account growth if Roku can replicate its success in North America.
2. The struggles are industrywide, not just Roku
So why is first-quarter 2023 revenue (guided at $700 million) expected to be below the $733 million it did in 2021 if it has all of these new accounts? Advertisers across the economy are spending less in fear of a potential recession. There's evidence of this across Wall Street. For example, Meta Platforms noted that its ad prices declined 22% year over year in the fourth quarter.
Advertising can be considered a cyclical industry because companies aren't going to spend on promoting their products and services if they think few people can afford them. Roku barely grew its average revenue per user, squeaking out a 2% year-over-year increase in the fourth quarter, and management's soft first-quarter guidance shows that things could still get worse.
But I'm not worried because advertising spending will probably rebound as the economic picture becomes clearer. According to a chart on the website Statista, ad spending on connected TVs was approximately $18.9 billion in 2022 and could double to $38 billion by 2026. More ad dollars are leaving places like print and traditional cable and heading online, where viewers are.
Roku's strong market share in connected TVs should make it a benefactor from this broader growth over the coming years, despite the soft short-term guidance management issued.
3. A strong balance sheet buys Roku time
Some have criticized the company for its money-losing devices business, its expansion into smart-home gadgets, and investments in streaming content because Roku has become unprofitable. But the company is financially equipped to trade short-term profits for long-term growth. The chart below shows its quarterly cash losses are hovering around $58 million.
ROKU free cash flow (quarterly) data by YCharts.
But when you factor in nearly $2 billion in cash on hand versus a negligible amount of debt, it's clear that Roku can continue on its current path for quite a while before worrying about needing more money. There is at least a decent chance that the business will perform much better when advertising budgets rebound.
Roku is in a seemingly great strategic position within consumer households. Televisions are becoming smarter and larger, with better picture quality.
The company is building an ecosystem around a resilient part of most people's households. That doesn't mean the road won't be bumpy along the way, but it's hard to ignore Roku's long-term potential, especially as it continues growing its audience and remains well-funded.
