We sent out the ROKU notes below on September 27th but are providing a few UPDATES here:
- "Splitting the difference" turned out to be about right - it suggested $20/share and that's where ROKU settled the first day of trading. Since then it's moved up a bit more to $23. There are some reasons to be cautious.
- An author we follow on Seeking Alpha wrote an intriguing post about "The Postage Scale Problem" which probes whether some of the success of Roku has come from the ability to illegally stream content via "private channels." Roku had to shut this down and replace it with their own "Roku Channel" which hasn't gone over so well. It's not clear how this will impact their business but it's an underappreciated facet of the story.
- Finally, Ben Thompson at Stratechery revisits the Roku backstory (it was once part of Netflix and Reed Hastings decided to spin it off rather than launch it.) Ben notes that in many ways "a bet on Roku is a bet against Netflix." His content is subscription only but highly recommended.
My own reflection of Roku is that their story is really one about better digital advertising. Despite the early success and total domination of Google for search advertising - general digital advertising remains is a shambles of missed opportunity. For some reason serving relevant and effective digital ads is much harder than anyone imagined.
Roku has chosen an exciting time for their IPO - not in terms of the market which remains good but because they are at a crossroads in their business. If you have been to a Best Buy or bought a new TV lately you have probably heard of Roku. Their "box" allows your TV to access content on the internet or "Over The Top" AKA "OTT." OTT content can be accessed without going through a traditional cable TV set-top box or dare I say it, an antenna.
It's clear that OTT is a thing now. Music has gone that way as well thanks to Pandora (P), Spotify and Apple (AAPL). Video programming has taken a bit longer (the content payload is much bigger) but it's definitely here. Much of "TV" has become "non-linear" which is a way of saying we watch what we want, when we want to. It's less about "appointment TV" and more about choice and flexibility.
Unfortunately OTT also brings complexity and at times, so-so performance. The business model is also still evolving. Netflix (NFLX) started it and the content providers followed with their own subscriptions - I have a bunch including HBO, the NFL, and Tennis Channel. (Sadly when you add all these up it starts to look like that "high" monthly cable bill all over again.)
Most of the OTT growth so far has been in subscriptions. The new kid on the block is "free" content that has advertising. At first glance, this seems a little insane - part of what makes OTT worth it is the lack of advertising. But you can only pay for so many subscriptions before the cost and accounting gets to be too much. So when you feel like watch The Late Show with Stephen Colbert and don't want to subscribe to an "All Access Pass" you can watch it with commercials.
This new OTT advertising-based model is what Roku is about now. Before that Roku was focused on the player which makes up the bulk of their revenues. The current strategy is to focus on the "platform" part of the business which is digital advertising. In 2015 the $320M in revenue was split 84% player/16% platform. In the most recent six months their $200M of revenue has shifted to 58% player/42% platform. Player revenue is declining and platform revenue is growing at close to 100%. This pattern will continue for the next year, dampening total revenue growth but eventually leading to a higher multiple revenue stream.
There is some writing on the wall here for the other "TV" box makers. The Roku "box" has merged into the TV. In many models the Roku technology is already integrated into the set, there is no separate box and it's "free" from a consumer perspective. If Apple, Google, and Amazon want to play in the TV space they may have to give their box away or come up with more reasons for a consumer to want their device. Because Roku is independent they offer the broadest access to different content types - no "Apple TV won't show Amazon Video" and vice versa nonsense to contend with.
Roku is offering 16-18M shares at $12-14 to form a ~$220M IPO. There will be 95M shares outstanding for a market cap of $1.2B which is about 3x current revenue. Although there are no "direct" comparable stocks we'd note that TIVO trades at 3.5x and NFLX is at close to 9x. ROKU looks more like TIVO than they do NFLX though so the multiple should be closer to 3x than 9x.
If we "split the difference" that would put ROKU stock at $20/share.
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