• Brett Schafer

Deep Dive: Roku

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Show Notes

(Ryan) What they do: Roku is a leading TV streaming platform. It’s an end-to-end solution for connected TV. So users can buy a Roku TV (which is manufactured by TCL) or they can buy a Roku stick and plug it into an existing TV’s HDMI port. Both of these are ways of accessing the Roku operating system. This is an iPhone-like layout on the TV that allows users to select OTT media apps. Disney+, Netflix, ESPN, YouTube, Prime Video, and thousands of other apps to choose from.

So it does generate revenue by selling this low-cost hardware, but it generates the bulk of its operating income by what it categorizes as platform revenue. This includes a lot of different digital services. So advertising sales and related services, subscription and transaction revenue sharing agreements, the sale of premium subscription services, the sale of branded channel buttons on the remote, and licensing arrangements with service operators.

The advertising side gets complicated and they aren’t super transparent about it. But here’s how I understand it (thanks Dhaval). If you run an ad-supported channel on Roku (CBS, ABC, there’s tons) you can choose between two types of ad servicing systems, inventory split or the Roku Sales Representation Program. Either way, Roku gets a share of the ad spend.

(Ryan) History: Roku was founded in 2002 by Anthony Wood after his company ReplayTV was acquired by SONICBlue. Wood actually invented the DVR. And Roku is Japanese for number 6, since it was the 6th company he started.

But Roku early on became a part of Netflix since Netflix didn’t want to build its own media player. Anthony Wood was named a VP at Netflix, but eventually he spun it out and Netflix gave them early funding of $6M. The company went public in 2017 and has made several acquisitions along the way including some DSPs and acquiring Quibi’s content for $100M.

Other notable moments from their history would be content disputes. So several companies have held out putting their app on Roku likely over revenue share agreements. Including HBO Max and Google with YouTube TV getting pulled from Roku’s app store. Each of these disputes got resolved and eventually the content providers were put back on the platform. Without knowing how the contracts were resolved it feels like a testament to the value of Roku’s platform.

(Brett) Industry/Landscape/Competition:

  1. Roku estimates TV advertising market to be $70 billion. So that’s what they are going after

  2. Global Smart TV market is estimated to be around $200 billion, clearly a rapid growing and large industry

  3. I put the competitors in two buckets and maybe we can discuss any others

  4. Other video advertisers. Mainly YouTube, linear, Facebook, and TikTok

  5. Non-advertising video services. Netflix, HBO Max, Disney+. These may give small take rates to Roku, but the industry is only so big and if tens of billions are flowing to these players each year it is not flowing to Roku. Will be interesting to see how these relationships develop over the next decade

(Brad) Management and Ownership:

There are very few bigger names in the CTV space than (Jeff G & Reed Hastings) Anthony Wood

– VP of CTV at Netflix

– Invested and shipped the first DVR (now owned by DirecTV) as the founder of ReplayTV

– Founder & Board Chairman of BrightSign digital signage company

– Founded several other companies in the media/ad space

CFO Steve Louden

– Former Expedia Treasurer and VP

– Advisory Board Member at Silicon Valley Bank

– Manager & Analyst at Walt Disney

– Consultant at McKinsey

– Harvard B School

Ownership – the data sources are pretty off here based on the dual class share structure

Class B shares = 10 votes per class A share

While it looks like Wood owns nothing if you look at Yahoo or Koyfin or anywhere else

Wood owns 13% of the outstanding class A & B shares but over 50% of Roku’s voting power

Tells us there are 62 beneficial owners (so institutions, directors, insiders etc.) & 22 beneficial owners of the class B shares

Ownership – the data sources are pretty off here based on the duel class share structure

Class B shares = 10 votes per class A share

While it looks like Wood owns nothing if you look at Yahoo or Koyfin or anywhere else

Wood owns 13% of the outstanding class A & B shares but over 50% of Roku’s voting power

Tells us there are 62 beneficial owners (so institutions, directors, insiders etc.) & 22 beneficial owners of the class B shares

Sources have roughly 70% of shares (not voting power) owned by institutions

(Brett) Valuation:

  1. Market cap of $58.3 billion, ticker ROKU

  2. EV closer to $56.5 billion

  3. Trailing EV/S of 27.8

  4. Trailing EV/GP of 54.4

  5. Trailing EV/OCF of 285.2

  6. A little over 10 million in RSUs and options outstanding, compared to current share count of 132 million

(Ryan) Earnings:

  1. TTM revenue of $2.03B, up 63% YoY

  2. $994M in TTM Gross Profit, up 86% YoY

  3. Gross margin of 49%, up from 32% 3 years ago

  4. $198M in TTM OCF

  5. They are pouring money into opex.

  6. Spent $40M in capex in the last 12 months. Plus ~$400M in R&D. They are certainly investing heavily.

(Brad) Balance sheet and liquidity:

Balance Sheet and Liquidity

– roughly 2 billion in cash vs. 1.1 billion Quarter over quarter

o pocketed $989 million from a at the market equity offerings

o Another half billion in receivables (just $100 million in payables)

o $125 million in goodwill & just $80 million left in intangibles on the balance sheet so that shouldn’t be too alarming

– Essentially 0 current debt so 0 current interest expense

– $628 million in long term debt & another $300 million in lease liabilities

– Another couple hundred million in revolvers

o drew down $70 million recently at LIBOR + 1.75% so strong balance sheet for sure

(Ad)

Anecdotal Evidence:

  1. (Ryan) Been a Roku user for 4 years now. It’s pretty much the go-to college TV since it’s one of the lowest cost providers. And there is a bit of a lock-in for me at least. Navigation is so intuitive, that fire stick, or chromecast, or Apple TV feel a little more frustrating/messy.

  2. (Brett) I’ve been a doubter on the Roku Channel, still am on the long-term economics. But I did watch a movie on it this week. Getting people to utilize Roku’s search bar could help with this

  3. (Brad)– Had it in undergrad and sort of regretted getting it over basic cable as we couldn’t watch the sports we were all gambling on

Future growth opportunities:

  1. (Ryan) The OTT media push. Not necessarily something they can control. But this has been a pretty obvious trend in recent years and content spend should continue to grow. And now you’re seeing just how valuable Roku’s real estate is to the content providers. AppleTV+ just paid to have its button added to new Roku remotes. Apparently it’s about $1 per customer for this advertisement.

  2. (Brett) Acquired this Old House, a home improvement show, for $100 mil. Going on the Roku Channel. This is a part of their originals strategy to get the demand going for advertising on the Roku Channel

  3. (Brad) – I think the DataXu acquisition is very compelling. I own The Trade Desk which features mouthwatering unit economics & growth so this makes a lot of sense to me to try to internalize some of their programmatic ad outsourcing. This should be a strong margin & growth tailwind going forward

Highlights and lowlights:

  1. (Ryan) Highlights: I’d put Anthony Wood in my top 4 or 5 CEO’s in the world currently. He’s a big reason this industry exists and when you listen to interviews from him in 2016-2017 everything he talked about came to fruition. 38% of smart TVs sold in the US are Roku TVs. Seeing similar dominance in Canada. Lowlights: Being the end-to-end provider leads to concerns over monopolistic power. Same issues that Apple experiences. A 20% take-rate for subscriptions or VOD purchases is an area where they are going to see pushback especially if the Roku Channel becomes a major player.

  2. (Brett) Highlights: All around quality business and the market leader, great margins and long runway for reinvestment, management has a track record of making the right moves at the right time. Lowlights: Worried about where ad dollars flow, and the share dilution is a headwind. Overall any lowlights are only minimal, lots of respect for the business Roku has built

  3. (Brad) GPM expansion. To me competition is the big lowlight here with Google handing out free youtube TVs and all of the richest companies in the World going after a piece of this lucrative space. They ay be a victim of their own success which has been undeniably remarkable

Bull Case:

  1. (Ryan) Control over the eyeballs grants negotiating leverage and ad placement pricing power, ultimately boosting ARPU. The cord cutting trend and OTT push persists. And some of these avenues for optionality become big hits. I could see a tech giant type of path.

  2. (Brett) I think you have to expect ARPU to hit at least $100, and likely $150 – $200 for the current share price to be viable. I don’t think that is impossible, but not a certainty from here. Probably at least 150 million active accounts too

  3. (Brad) Companies like Apple (so Amazon and Google) continue to work with Roku and this becomes a de-facto streaming device similarly to Spotify overcoming all of the Apple Music concerns thus far

Bear Case:

  1. (Ryan) Poorly adopted internationally. The market gets more crowded in both content and hardware (although their market share has only grown despite about as much competition as possible) and the Roku Channel capex produces crappy returns. 

  2. (Brett) decline in ad-supported traditional TV. The dominance of YouTube/Facebook/Instagram/TikTok video ads continues. Maybe it is less zero-sum than I think, but these trends have got to be on investors minds.

  3. (Brad) Promotions like free YouTube TVs make people more aware of how similar some of these products are & Roku has to begin competing more on price & leaning on software/ad revenues

Our Sunday Deep Dives are sponsored by Potential Multibaggers. Looking for stocks that have the potential to go up 10x over 10 years? Check-out Potential Multibaggers on Seeking Alpha or on Twitter @FromValue

Disclosure: The authors and podcast guests are not financial advisors. Brett Schafer and Ryan Henderson are portfolio managers at Arch Capital. Clients of Arch Capital may hold securities discussed on this podcast.

#Roku

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