Description

I believe ROKU will be meaningfully more valuable in coming years and expect a low-to-mid teens IRR from here.

Roku is an advertising video on demand (AVOD) company. It’s a beneficiary of the secular shift from linear TV viewing to on-demand viewing, as more customers cut the cord and go over-the-top (OTT).

The size of the TV ad market, ex-sports, is tens of billions of dollars. Currently, about one third of TV viewing is OTT, but only 3% of that budget has moved over. This is a gap similar to the early days of mobile, when mobile usage was high but ad revenues hadn’t yet shifted to mobile. It worked out well for Facebook. I expect a similar shift to benefit Roku.

From the Q3 2019 conference call:

One might ask, isn’t a preponderance of the 29% of OTT viewing already ad-free (Netflix, for example?) Yes, but I believe this is a static view of advertising. The majority of marketers on Facebook, for example, never bought newspaper or TV ads. So is Facebook “stealing” existing market share, or creating a new market? I believe Roku will have a similar effect. Programmatic, auction-driven advertising with attribution (see the recent Kroger partnership) means the existing TV ad market is probably smaller than it can be OTT because of the superiority of digital advertising.

https://www.adweek.com/tv-video/roku-and-kroger-partner-on-data-play-for-cpg-advertisers/

How does Roku make money? Primarily from advertising, which is programmatic and can be dynamically bid and inserted in-stream. This is called “platform revenue” and has high gross margins (~55-60%).

To onboard those users, Roku sells its Roku sticks and licenses its operating system to TV manufacturers, and does this at close to cost (small gross margins). This hardware business is extremely strategic for Roku. It’s a key part of how they acquire users cheaply. Roku’s operating system is good. More than one in three TVs sold in the US are Roku TVs.

https://www.wsj.com/articles/tech-giants-leave-room-for-roku-in-streaming-video-11565280696

To be clear, ads are NOT inserted in third party content that is subscription-based. That is, Roku does not insert ads in Netflix content. It does insert programmatic ads in other content in partnership with the content providers:

https://www.businessinsider.com/what-is-the-roku-channel

This successful strategy has resulted in more users, more hours spent watching Roku, and more ad dollars. The company currently reaches households with an estimated 100m people.

From Q1 2017 through Q1 2020:

Active accounts 14.4 -> 39.8 million

Streaming hours 3.3 -> 13.2 billion

ARPU ($) per year 10.04 -> 24.35 (on a TTM basis)

The company recently acquired its own advertising platform, dataxu, and has begun offering targeted ads for large advertisers.

https://digiday.com/future-of-tv/dataxu-buy-roku-unveils-big-ad-ambitions/

It’s also expanding internationally:

https://techcrunch.com/2020/01/21/roku-expands-to-brazil-launches-roku-tv-featuring-globoplay-in-partnership-with-aoc/

The proliferation of streaming services (Disney+, HBO Max, Peacock, etc.) is a net positive for Roku because they earn a cut of subscriptions made inside the service and they get more engagement on Roku, some of which spills over to ad-supported content. The company does not reveal the economics behind the subscriptions, but note that Amazon has been very successful in selling subscriptions inside its Fire TV:

https://digiday.com/future-of-tv/video-briefing-amazon-ott-channel-reseller/

I expect the company to continue to grow users and ARPU at a good pace. Platform revenues are around $1.5 billion, and I expect this number could reach $4 billion in five years. 

I expect operating margins to be quite healthy at scale and believe the stock will trade materially higher. I’m happy to answer any questions. 

Catalyst

Growth