There's no denying that connected-TV company Roku (ROKU -10.29%) served up some pleasant surprises in its recent third-quarter report. Chief among them is revenue.
The top line of $912 million is 20% better than the year-ago comparison, and markedly better than expectations of $855.2 million. Revenue guidance of $955 million for the quarter now underway is also above analysts' consensus forecast of $952 million.
Shares surged following the news, further driven by CEO Anthony Wood's positive take: "We had a solid rebound in video ads in Q3 and we expect the YoY [year over year] growth rate of video ads in Q4 to be similar."
Still, a deeper dive into last quarter's fiscal metrics raises questions more investors should be asking. These include whether Roku's operating expenses (including one-time charges) have permanently been reduced, and why per-user revenue remains subdued if ad spending is on the mend. Let's dive in.
Roku's costs are rising in step with revenue
All in all, the third quarter was a pretty good one for Roku. Its home-grown smart TVs seem to be gaining traction, pushing quarterly revenue to its best-ever levels. Hitting the fourth quarter's sales target of $955 million would mark another new record.
This growth isn't coming cheap, though, and contrary to some headlines, revenue growth isn't reaccelerating, at least not in the grand scheme of things. While up year over year, last quarter's player (device/TV) revenue of $125 million is subpar. The company is still losing money on its manufacturing devices after a couple of brief blips into the black.
All of the real revenue growth of late has come from growing platform (advertising) sales. But even this revenue's resulting gross profit has been tapering since its late-2021 peak. These aren't the gross profit trajectories you'd expect to see from any organization that's growing its scale.
Data source: Roku Inc. Chart by author. Figures are in millions.
And it gets worse. Despite cost-cutting measures put into place beginning early this year, operating costs (which further reduce gross profits) like marketing, payroll, research and development, and administration jumped to record levels during the third quarter, outpacing revenue's race to new records. The next graphic puts this spending surge in perspective.
Data source: Roku Inc. Chart by author. Figures are in millions.
The image above comes with a critical footnote: Roku booked exaggerated operating expenses stemming from its headcount reductions. It also suffered a massive asset impairment charge. Taking these unusual and one-time costs out of the mix, the company actually reported positive earnings before interest, taxes, depreciation, and amortization (EBITDA) of $43.4 million. That's not overwhelming, but it's something to build on.
This footnote comes with its own footnote, however. That is, it's also still not clear if Roku can grow (or even maintain) its third-quarter EBITDA levels as the business is operating right now. Despite looking for record revenue of $955 million for the quarter currently underway, the company anticipates adjusted EBITDA shrinking to only $10 million. Clearly, Roku sees its costs remaining relatively elevated for at least one more quarter.
Active accounts can't grow at this pace forever
Underscoring this concern is the prospect that advertising spending may not be growing as robustly as Roku's management suggests. So the bulk of the company's third-quarter revenue growth once again came from the sheer expansion of its active user base rather than advertisers' willingness to spend more to connect with the same number of consumers.
This point bears out in the company's recent average revenue per user (or ARPU) data. Last quarter's ARPU of $41.03 is more or less in line with the lackluster ARPU levels seen in the previous three quarters, all of which were well down from Q3 2022's peak of $44.01. Even more surprising is how this tepid per-user ad spending is being seen at a time when the economy is supposed to be shrugging off the lingering impact of the COVID-19 pandemic.
Data source: Roku Inc. Chart by author. Active account figures are in millions.
It's not necessarily the end of the world. As Roku also noted in its quarterly report, it's now serving a record 75.8 million regular Roku accounts, up 2.3 million from the second quarter's count and 10.4 million higher than year-ago levels. Revenue growth is good no matter how it's made.
This isn't exactly how any company wants its top line to grow, however. It's far better to improve the monetization potential of each and every customer as time marches on, since there will come a time when there are no users left to add to your active account tally. Roku isn't bumping into that headwind just yet, but the prospect is on the radar.
Streaming market research outfit Hub Research reports that 74% of U.S. homes already own an internet-connected television, while Leichtman Research Group says 88% of households in the United States own at least one device like a streaming box or game console allowing them to access streaming apps.
Many of them may well add another such device in the foreseeable future. On the flip side, many of them likely already own several such devices, and won't need another one anytime soon. Headwinds are brewing overseas, where Roku's reach is minimal and streaming mania is far more muted compared to the U.S.
Then there's the overarching question that must be asked: Is it possible that the "solid rebound in video ads" which Roku's CEO says he's seeing is benefiting rivals more than it's boosting Roku's advertising business?
Never say never. Well-established YouTube's ad revenue was up 12% last quarter. Netflix reports 15 million people are now signed up for its ad-supported streaming service just a year after launching it. That's enough scale to start pulling some would-be advertising dollars away from Roku's platform. It's also enough scale to further aggravate the existing price war raging among all ad-supported streaming services.
Now what?
Roku could still find a path to sustainable profitability. It can probably find more costs to cut without undermining its own growth. The company might start gaining more traction outside of the United States, too. The fourth-quarter results due three months from now will shed considerably more light on its situation. After all, it's a quarter that's usually a healthy one thanks to holiday gift-giving, testing the new, streamlined operation.
After the stock's one-day 30% surge following the release of its third-quarter numbers, however, there's now far too much risk baked in to buy it now. That's because there are still too many unanswered questions. Interested investors may want to steer clear for at least another quarter before jumping to any long-term conclusions.
