Roku's (ROKU -10.29%) been making set-top streaming devices for consumers' living rooms longer than practically anyone else in the market.
Its little streaming box debuted in 2008 when subscription video on demand was still in its infancy. Since then, it's grown to become a leader in the space. It offers set-top boxes and streaming sticks, and it partners with multiple television manufacturers to sell fully integrated smart televisions. The company recently forayed into offering consumers its own branded television lineup too.
But if you think Roku's making money from the sales of its streaming hardware, you're missing the bigger picture for this company and why it's one of the best ways to invest in streaming media.
Here's the real secret sauce behind Roku's business.
Image source: Getty Images.
Roku doesn't really make any money until you start using its products
Over the 12 months ended in Sept. 2023, Roku sold $471 million worth of streaming sticks, set-top players, branded smart TVs, and other devices. But the cost to manufacture those devices came out to $538 million. That's right, Roku is losing money on the average device sold, and that's before accounting for all the administrative, marketing, and research and development expenses it incurs.
So, why would Roku willingly sell its devices at a loss? The simple answer is that it makes up for it when buyers actually start using their devices.
When Roku filed its IPO prospectus with the Securities and Exchange Commission (SEC) ahead of its market debut, it provided a detailed overview of its business. Under the section describing its products, first on the list wasn't its smart TVs or streaming players, it was advertising. Roku's advertising business, which includes video ads, audience development for streaming services, and brand sponsorships, is the backbone of its platform.
And the platform generated $2.9 billion of revenue for Roku in the same 12 months it sold $471 million worth of devices. Not only that, but the platform segment generated a gross profit margin of over 50%, more than making up for the losses on the streaming device sales.
Roku says its 75.8 million users each generated an average of $41.03 through its platform business over the last 12 months. That's actually down from its peak in the second quarter of 2022 when it generated $44.01 per user. And that's due to a pullback in video advertising during a period of economic uncertainty and less spending on audience development by streaming services amid a push for profits and the strikes for both actors and writers.
What makes Roku one of the best investments in streaming
By selling its devices so inexpensively, Roku has built a massive user base. As I mentioned above, it now counts 75.8 million users around the world.
More importantly, consumers not only buy its devices, but they also use those devices a lot. The average user spent over 3 hours and 50 minutes per day streaming content on their Roku devices during the third quarter of last year.
That's a powerful position for Roku. It controls the means of distribution for all the major streaming services. If a streaming service wants to be available in every living room, it needs to negotiate with Roku, and the company has become an increasingly tough negotiator as its audience has grown.
As a result, Roku's able to extract better and better terms for revenue and advertising sharing with streaming services. Additionally, it's able to command higher ad prices for the video ads it places in those streaming services.
There are few other companies in its position. Apple benefits from a similar platform business, where businesses have to pay to access its 2 billion iOS users. That's led it to generate a whopping $85 billion in services sales over the last 12 months. Apple is an example of just how lucrative being the platform owner can be.
While Roku probably won't reach the same level of ubiquity as Apple devices, it's worth pointing out it already generates about the same revenue per user from its platform business as Apple. That speaks to the execution level of Roku's management. As the business continues to scale, gains further negotiating power with advertisers and streaming services, and leverages its operational expenses, it has the potential to become massively profitable.
After a major sell-off of the stock in 2021 and 2022, Roku saw its shares recover in 2023 with a 125% gain. But with shares still trading at just 3.6 times sales, the stock appears undervalued. It's a great way to invest in the secular growth of streaming without having to pick a specific winner among competing media companies.
