Looking at the Nasdaq wreckage, the question isn’t which mid-cap tech stock is growing faster than its current valuation implies but which one has the most room to rebound. We’re going with Roku (ROKU), which we view as the gatekeeper to the streaming resolution, suggests John Freund, contributing editor to Todd Shaver's Bull Market Report.
We believe that the company’s ongoing shift from hardware to services will turn the stock around. The Roku devices have evolved give consumers a low-cost entry into one of the fastest-growing advertising ecosystems around, effectively replacing commercial television for the “cord cutting” audience.
Start with the operating system, which is being packaged on more and more smart TVs from third-party manufacturers. Since 2014, the company has gone from a standing start to seeing its technology incorporated into 25% of all smart TVs now on the market. Amazon (AMZN) can’t fight that. Nobody else can even try.
Notice that Roku-enabled TVs naturally replace sales of the Roku device. That’s part of the overall strategy. After all, devices come and go, but once your technology is embedded in the screen itself, your commercial presence is literally hardwired into the living room.
As management notes, 10% of all U.S. households no longer subscribe to even basic cable television service even though those households still have an average of three TVs apiece. Replacing the traditional cable box and getting onto future generations of the TV itself is the future.
Millennials are now the biggest demographic group. Many are unreachable to conventional advertisers — except via the Roku interface, which streams the company’s authorized messaging to the screen.
With $70 billion in TV advertising at stake, Roku can grow its share of the overall media universe as fast as it can sell devices to households who’ve already cut the cable “cord” and now need to find a way to push new shows to their living room screens.
Watch the platform revenue numbers Roku reports. That’s advertising, embedded software and content fees, and it’s already close to 60% of the business, ramping up 75% a year. Gross margin on that side is above 70%, as close to pure profit as it gets even in Silicon Valley. The company could practically stop selling the Roku device altogether and it would barely make a dent in the bottom line.
Purely based on the platform business, we expect Roku to be sustainably profitably within the next year, assuming of course that no Silicon Valley giant hungry for a deeper streaming video presence takes it out at a rich acquisition price. Of course a lot can happen in a year, but if the company gets to that stage shareholders can write their own long-term ticket. This can easily be an $80 stock.
