How to Value Roku

11/22/2017 6:00 am EST

Focus: STOCKS

Tyler Laundon

Editor, Cabot Small-Cap Confidential

Roku (ROKU) makes those small streaming players that connect to your TV; it has seen its stock rise by 180% since it went public at $14 on September 27th, notes Tyler Laundon, editor of Cabot Small-Cap Confidential.

Call it cord-cutting, streaming, or over-the-air (OTA) TV, it doesn’t matter. The point is that there is a strengthening wind at the back of companies that offer TV services that are delivered via the internet.

Most people recognize Roku as the company that makes the streaming devices that plug in to a TV. In the early days, people bought them to turn their dumb TVs into smart TVs, so they could access streaming apps.

Roku still sells a range of these streaming devices, but it also sells much smaller streaming sticks, and has partnered with TV manufacturers to provide its Roku TV operating system on a number of their TV models.

It’s worth mentioning that the company’s stated strategy for the Player segment isn’t to drive revenue growth, but to drive the number of active accounts. And Roku appears to be exectuting the strategy well through price discounting; active accounts grew by 48% in Q3, and now total 11.3 million users.

The Platform segment generates revenue through three vehicles: (1) advertising, typically on free channels like The Roku Channel, (2) content distribution services, including streaming services like its two new offerings, DirecTV Now and Hulu Live, and (3) audience development, which means Roku tracks what users watch (if they opt-in) and then sells the data.


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Platform revenue was up an impressive 137% in Q3, illustrating that, so far, Roku’s business model is working. The 48% growth in active accounts drove another critical metric, streaming hours, up by 58% to 3.8 billion hours. More streaming hours means more users exposed to ads, and more data collected, which helps drive Platform revenue.

It all boiled down to adjusted EPS of a loss of $0.10 in Q3, which was $0.19 better than expected. Based on the company’s annual revenue growth trajectory of just under 30%, and blended profit margin profile, Roku could be profitable in 2020.

The business model appears to be working and growth is impressive. But the stock seems like a risky bet right now. Roku recently traded near $20. After reporting earnings, it traded as high as $48, a better-than 100% increase. Trading volume is high, there is a battle going on between longs and shorts, and the stock is incredibly volatile.

Its blended business model means that, based on Q3 results, it’s 73% a hardware and software company (based on Player segment revenue) and 27% an online-media company (based on Platform segment revenue). If you base your analysis off Q3 gross profit, it’s closer to 33% a hardware company, and 67% an online-media company.

Roku should probably be valued at about 40% hardware/software and 60% online-media to balance its revenue and gross profit profile. That assumption means it should trade with a 2019 EV/Sales multiple near 3.5. If we assume 2019 revenue of $840 million, then we get to a price target near $25.

You can make whatever assumptions you want, of course, and this peer-based analysis is far from perfect. But it’s a starting point, and it suggests Roku stock isn’t a great buy at today’s price of just below $40.

If you have the discipline to average in over several months to help moderate the risk of buying during a speculative spike in value, your chances of generating a decent return are probably better.

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