Today brings us another “black box” teaser pitch — we see similar themes across investment teases, and the “black box” is popular… a presentation with some pundit holding up a mysterious box sand saying, “thar be gold!”
This time around, it’s Hilary Kramer pitching us as she tries to recruit subscribers to her GameChangers service ($149/yr)… this is what the email said when it popped up for me starting a couple days ago:
“What’s inside this small box is the greatest Game Changer I’ve ever seen….
“Nothing compares. Even the world’s biggest, most powerful businesses can’t compete with it…
“Amazon gave up on trying to develop its own competitive tech, acknowledging it couldn’t catch up.
“Apple threw in the towel and agreed to use its tech….
“When’s the last time you heard a smaller company standing up to both Amazon and Apple, and winning?”
Sounds compelling, right? It is a pretty innocuous looking box, I guess it could be anything, but let’s dig into Kramer’s clues and see what it is she’s talking about.
The “611% gains” she talks about are historic, that’s what the stock did in nine months for early investors, we’re told. We don’t know when… but she also does say that it has already returned 62.8% in its rebound since the COVID-19 collapse… so that’s enough to get us to click through from the email into her big ol’ presentation to see what details might be dropped in her push to sell the newsletter.
This is how the presentation starts…
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“… what’s inside this black box can already be found in 40 million homes.
“It’s being built into 1 out of every 3 new smart TVs sold.
“At last count, 30,000 of them are being sold each day.
“And every one of them makes money every hour it is used.”
Oh, so there we go… we’ve got our answer. But don’t worry, we’ll check the rest of the clues just to make sure… and to get an idea of what Kramer’s reasoning might be.
We get some clues about how much revenue the company generates per user…
“… this perfect business generates $2.30 per home for the company.
“With 40 million homes in America, that’s $86 million.
“Every single day.”
And we get more detail on that past 611% surge — apparently it was from December 2018 to September 2019, so still pretty fresh. And while it dropped with the coronavirus news in March, it has roared back to where it was earlier in the year. Kramer says that this is because the business is actually a beneficiary of the coronavirus lockdown…
While many companies are losing millions or going out of business completely, this one is making millions more a day… because of the pandemic.
The company has something to do with video streaming — not unlike our look at Limelight Networks yesterday — so are you getting closer to guessing the answer? Here’s what she says…
“As the streaming wars heat up, some channels will win and some will lose.
“Yet with the company I’m talking about, it doesn’t matter which company’s content wins, like Disney’s with Marvel and Pixar…
“Or which independent channels thrive, like HBO or ESPN… and it doesn’t matter whose platform they use, like Sling or even Apple TV…
“That’s because, to come to your living room TV, it has to go through what’s in this black box.
“And our company is the only one that makes it.”
But it’s not really those “black boxes” that they’re profiting from, according to the ad:
“… it doesn’t even make money from the device.
“It practically gives them away at cost in order to get it into households.
“That’s because the real money-making business of this company is online advertising… and the black box gives it a virtual monopoly on it.”
She forecasts them tripling its user base just in the US, generating $400 million in profit per quarter, and supporting a $30 billion valuation — which she says is 3X where the company is now, so it’s roughly a $10 billion stock.
OK, fine, we’ll take you out of your misery now… this is, of course, good ol’ Roku (ROKU), the provider of those little “black box” streaming devices that allow you to serve up over the top (OTT) and streaming TV content directly to your TV.
I don’t know why Kramer teases this as being “the only one that makes” these black boxes — they’re not even the only one who makes Roku-branded stuff, a lot of their revenue comes from licensing out the Roku operating system to makers of Smart TVs, and there are dozens of other “black boxes” that you can use to stream Netflix, Hulu, AppleTV, Amazon Prime or whatever other video service to your television. Roku is the leader, I’d argue, partly because they’re the only large streaming equipment maker that doesn’t have a dog in the Amazon/Netflix/Apple fight so can be perceived as offering a level playing field (they don’t favor one provider over another, or block major providers like Amazon blocked YouTube for a while), but it doesn’t have anything close to a monopoly… and some of their competitors, like Google with its Chromecast and Amazon with its Fire TV Stick, are huge and very deep-pocketed. Apple and Amazon have not abandoned the “streaming device” business.
Don’t get me wrong, I really like Roku and have built up a meaningful position in the stock since I started buying on March 2… but it doesn’t have a monopoly. In fact, the reason it first caught my eye was because of that huge drop last fall, which was itself caused by another chink in that monopoly idea when Comcast announced that they would be giving away streaming boxes for free. The actual equipment to provide streaming video is pretty well commoditized, with several big players making high-quality products available quite cheap — Roku leads, and arguably has the best devices, but they are far from alone in the marketplace.
Roku’s primary source of revenue is selling devices and licensing their Roku operating system for Smart TVs, and that did surge higher when people were stuck at home, but their primary source of profit is advertising — mostly the ads they insert into free content for some of the lower-profile streaming services that are ad-supported, like IMDB, but also promotional income from advertising on the Roku homepage (so when Disney+ launched, for example, they paid up to “own” the Roku home screen to get higher visibility and hopefully more signups). They don’t have a monopoly on streaming advertising, either, but the fact that they built a large installed base of Roku TVs and streaming devices means that they have a huge audience, and huge audiences attract advertisers.
Oh, and I have no idea what Kramer is talking about with that “$2.30 per user, every single day” tease — one of the major metrics we use in assessing Roku’s progress is indeed average revenue per user (ARPU), and that has grown nicely — but it’s nowhere near $2.30 per day. It was $13.80 for the year in 2017, rose to $23.10 in 2019, and the “trailing twelve months” number as of Q1 was up to $24.35. It could easily be in the $26-28 range for all of 2020 if things go well, but $2.30 per month is a more rational target than $2.30 per day. They do have more than 40 million active accounts now, with a 10% jump in the first quarter, so it adds up nicely.
I’ve been adding pretty steadily to my Roku position over the past few months, spending as much as $127 and as little as $74 to buy shares during a volatile period, but this is the latest note that I shared with the Irregulars on this one, back on May 22:
5/22/20: And for Roku (ROKU) this week brought another dip in the share price with a patent fight announced over some of their remote control technologies — I have no idea whether that will lead anywhere or not, but my guess is that the worst case scenario is a relatively minor licensing fee if they lose the fight next year.
The more immediately substantive impact seemed to come from an analyst downgrade today, which was premised on concern about Roku’s partnership with its biggest TV licensing partner, TCL (Roku has taken the leading market share in smart TVs in the US mostly by licensing their operating system to a few big manufacturers who levered the Roku brand to break into the US market). The analyst at Stephens, Kyle Evans, issued a big downgrade that’s mostly related to that TCL relationship, cutting their price target from $155 to $105 because they see international expansion being slower than expected, believe expectations are too high for their OneView ad business (acquired from Dataxu), and worry that TCL is easing out of the relationship because ROKU is taking the lion’s share of the profit. Here’s a quote from the StreetInsider summary:
“We are downgrading ROKU from OW/V to EW/V, largely on continued TCL concerns. These aren’t new fears to us or ROKU shareholders, we don’t have any new/incremental information on this key partnership and the agreement has clearly been mutually beneficial from a market share perspective, but we believe ROKU has benefited tremendously from TCL’s heavy lifting, TCL still isn’t participating meaningfully in ROKU’s downstream advertising/commerce economics and we have gradually grown more concerned with the duration/magnitude of what we believe is ROKU overearning vs. its most important partner.”
That TCL partnership has been under some scrutiny in the past, and there’s a good article about it here from February if you’d like to read up on the history and how Roku took the market share lead in Smart TV operating systems.
It strikes me as odd to shift your opinion that severely in the absence of new data, particularly when Roku remains in an accelerated revenue growth mode right now (and those TCL Roku TV’s remain the “best sellers” on Amazon), but, of course, these are jumpy days and people change their mind all the time (myself included). I haven’t changed my mind on Roku, I still think they are building on that large market share base in Smart TVs and will benefit greatly from the competition between new streaming services for many years. Competition with giants like Google and Amazon is obviously challenging, and if Apple or Amazon comes out with a branded TV at low cost that builds on the proprietary video streaming operating systems from those companies, ROKU shares will probably fall sharply… but for now, Roku is the leader and is probably a more comforting partner for many streaming services because they’re open to all and don’t prioritize one streamer over the others like Apple or Amazon probably would. So, given the continuing growth and the still reasonable valuation, I’m happy to keep nibbling.
So there you have it… another pitch for Roku, and it’s still a stock I like, though it’s now back to a $15 billion market cap (and still well below the highs of last year), and the news yesterday that they’ll be serving up the Peloton channel seemed to give the shares a quick lift (they’re not connecting to Peloton bikes, just serving up Peloton’s channel of non-equipment fitness content for Peloton subscribers — and, of course, offering to sell Peloton content to Roku owners through RokuPay, presumably for a commission).
If you’re looking at valuation, ROKU at 10X sales stands out as looking pretty inexpensive compared to the “cloud” superstars who trade at 20-30X sales (they’re not taking their foot off the gas with their expansion plans, they’re pouring more into growth, so they aren’t likely to turn a profit in the next couple years… which is why I look at sales, not nonexistent earnings), but because of Roku’s two-part business we should probably be careful about looking at what those sales are.
Anywhere from 25-40% of ROKU revenue in any given quarter is from player sales, and that’s a very low margin business (12% gross margin, when other costs come in they lose money in selling the players and TVs), so it’s that “Platform revenue”, mostly advertising, that generates the attention and the big growth — and the much higher 56% gross margins. Platform revenue over the past year grew at a blistering 73% pace, player revenue only 22%. Right now, the trailing revenue for the Platform segment is about $840 million… so if you ignore the break-even player business and focus on Roku as a high-margin, high growth advertising and services business, it’s valued at 18X sales. Still cheaper than some of the similarly fast-growing cloud stocks, and I’d argue it’s still appealing because that growth has been accelerating in the past couple quarters, not tailing off as is usually the case with growth stocks… but it’s not as dramatically cheaper as it first appears.
They won’t report until early August, so it will be a month or so before we know whether the recent trend of accelerating revenue continues — there’s certainly some chance that advertising revenue will dip this year, and that’s a reasonable thing to worry about (travel and restaurant companies aren’t advertising much right now, for example, nor are new blockbuster Hollywood releases), but the market seems quite confident in looking past a likely lull in advertising growth, and it’s also possible that the general weakness could provide a small boost to Roku’s still relatively small ad business. The caution of big ad executives during this recession could slow down their commitment to things like traditional TV, where they typically commit to big ad packages during the “upfront” period, and shift that spending to the “easy on, easy off” streaming TV segment to reach a lot of the same people with more flexibility.
Here’s a quick summary of an analyst note from Briefing.com from a couple weeks ago that touches on most of those points, this seems to be the thinking that’s driving the shares higher these days:
“Negative impacts on ROKU from COVID-19 likely worst felt in 2Q2020 — Needham (117.32)
“Analyst Laura Martin stays Buy rated with a $150 tgt on ROKU noting, ‘We estimate that COVID-19’s negative impacts on Roku will be worst in 2Q20, improving as 2020 wears on and improving in 2021-2022 compared with our pre-COVID expectations. Our channel checks indicate that hours streamed will be strong again in 2Q20 (up 46% y/y), and we expect y/y active accounts growth (at 39% y/y) to be stronger than in 1Q20 (up 37% y/y). However, continued weakness in large digital ad categories such as autos, entertainment, and travel should slow Roku’s y/y ad revs growth to up 38% y/y in 2Q, vs up 108% in 1Q. Longerterm, eMarketer now projects that brands will not commit up to $7B in the Upfront TV market, which would make these ad dollars available to Roku in 4Q20-3Q21. Therefore, we lower our 2020 revenue estimate but raise our 2021 forecast for Roku.'”
(Incidentally, Briefing.com is my favorite source for this kind of rapid info about stocks I follow, collecting and summarizing rumors, news items and analyst notes — they don’t pay me to say that, but I’m happy to pay for the service).
And, of course, I expect that the competition among the streaming titans will be good for Roku as HBO Max and Peacock and all the other newbies try to shoulder aside Hulu or Disney+, possibly increasing their marketing spend on Roku to recruit more subscribers. There’s no monopoly, and there’s no guarantee that Roku will keep its market share, but they’re the leading independent in the space now and I don’t see anybody else catching up. I’ll be watching, and will let our Irregulars, my favorite people, know if I change my mind… but for now, Roku still looks to me like it’s very well-positioned.
Disclosure: Of the companies mentioned above, I own shares of Amazon, Google parent Alphabet, Roku and Apple. I will not trade in any covered stock for at least three days after publication, per Stock Gumshoe’s trading rules.