The COVID-19 pandemic accelerated several major trends already taking shape in the late 2010s. One of those was a shift to streaming video over linear TV, as nearly every major media company launched a new streaming service and had a captive audience to sell to. One of the biggest beneficiaries of the pandemic period was Roku (ROKU +2.26%), which operates the largest connected TV platform in the world.
Roku's share price more than tripled in value in the six months from mid-August 2020 to mid-February 2021. Shares reached an all-time high in late July that year. But shares dropped precipitously through the end of the year and throughout 2022.
After a strong rebound in 2023, Roku shares looked poised to continue their momentum into 2024. But the market had different ideas. Shares are currently down about 25% year to date and more than 85% from their all-time high.
But right now could be a great opportunity for investors. Roku is posting strong operating results, and its potential is great, especially if you take the long-term view. The ailments of the last few years appear to be mostly behind it.
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The biggest drag on Roku's results
Roku saw strong results in 2020 and 2021 as media companies launched their own streaming services. As the largest streaming platform in the United States (and many other countries), Roku had a lot of leverage over media companies looking to attract a large audience. As a result, it was able to extract favorable terms for revenue sharing, ad-inventory sharing, and ad purchases on its platform.
Moreover, growing competition among streaming services led to higher ad prices for some of its top ad inventory. Platform revenue, which includes its advertising business and revenue sharing, soared 80% in 2021.
Then the Federal Reserve started raising interest rates, investors put pressure on media companies to make streaming profitable, and the industry saw further consolidation.
The competition and ad sales that were driving Roku's incredible success in 2020 and 2021 dried up and led to a massive hangover in 2022. On top of that, high inflation and a shaky economy led to an overall pullback in ad spend, further dampening Roku's results.
Platform revenue grew just 20% that year, and it shrank 1% in the first quarter of 2023. Gross margin also shrank every quarter.
Media and entertainment (M&E) ad spending remains a drag on Roku's results today. But there are signs the worst is now behind it.
NASDAQ: ROKU
Key Data Points
The future looks bright
Despite the setbacks, Roku's still growing its platform revenue at a good pace. During the second quarter, platform sales increased 11%. Management expects 9% year-over-year growth for this segment in the third quarter.
More importantly, gross margin is recovering from its third-quarter 2023 low. Platform gross margin came in at 53.4% last quarter, and management's guidance suggests a similar gross margin next quarter.
In the fourth quarter, management expects platform revenue to accelerate, and it should produce a seasonally strong gross margin as well. Management is also confident platform revenue will accelerate in 2025 as demand recovers and the company expands its ad inventory.
Roku's core user metrics look fantastic. It added 2 million net new users during the quarter, and it saw engagement grow as well. The average Roku household watches four hours of content on its platform every day, up from 3.8 hours a year ago. Roku accounts for 47% of all U.S. streaming time on connected TVs, according to data from Comscore.
That's a huge engaged audience for advertisers, and they've noticed. If you remove M&E ad spending, Roku saw advertising revenue grow faster than the overall ad market and the streaming video ad market in the U.S. last quarter. Investors should expect that trend to continue, more than offsetting the weakness in M&E.
The distant future looks even brighter
The investment thesis for Roku, as CEO Anthony Wood is constantly pointing out, is that all media will eventually move to streaming. If that happens, Roku, with its substantial share of connected TV streaming hours, stands to benefit greatly.
As mentioned earlier, the shift to streaming intensified in 2020 and 2021 as media companies hurried to launch their streaming services and threw a ton of money at them, in part by advertising on Roku's platform. The dust is starting to settle from that frenzy, and media companies are now being forced to justify their spending. But the long-term trend remains intact.
In fact, we've seen more and more deals among media companies to push users to streaming. The next frontier is sports entertainment. Disney, Fox, and Warner Bros. Discovery are planning to launch a streaming joint venture called Venu for their sports offerings. Amazon just bought the rights to certain NBA games.
And even Netflix is getting in on sports streaming with an NFL deal. Sports could be a huge opportunity for Roku, as media companies could spend to drive viewers to their properties in real time, and Roku may be able to leverage its position to take a share of ad inventory within streams.
While Roku's had a rough period, it appears set for a return to form, and the long-term thesis remains intact. At its current share price, it looks like a real bargain for an industry-leading business with excellent growth prospects.
