Roku: An investment in the future?
Opdateret: 3. maj
Roku's stock price has dropped significantly from its high in July 2021 where it reached $473 to now where it trades just below $115, which is a 75 % drop! Does it mean that you should steer clear of Roku or is it time to buy? In this analysis I will share my thoughts on Roku.
This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
This analysis will be a bit different from what you are used to read in my blog. Roku did their IPO in 2017, meaning I don't have access to the historical numbers dating back longer than that. So instead of using the principles I have learned from my Phil Town workshop, I use the principles I have learned from the GOAT academy. I should also mention that most of the numbers I use in this analysis is from Finbox, which I believe is a great tool to easily get the numbers you need from various companies.
Before I start with the analysis, I should mention that I do not currently own shares in Roku. I have never used their products either, so I don't have any firsthand experience with them. If you would like to see or copy my portfolio, you can read how to access it here. As always, I will try my best to be objective in this analysis.
Roku is an American company that was founded in 2002 but didn't IPO until 2017. Roku is a leading streaming platform in the United States. Mexico and Canada by hours streamed. Their strategy is to be a global streaming platform that connects and benefits the entire TV ecosystem of consumers, content publishers and advertisers. In short, what they do is to connect various streaming services through their platform, which means that their customers can watch TV shows, movies etc. from various streaming services through their platform. However, the customers would need to have a subscription to the streaming service to see it, so they don't get access to everything through Roku, they just make it easier to navigate through their platform. Roku earns their revenue through four different ways: 1. Selling hardware also known as Roku players (it can be a streaming stick, a box etc.). 2. License fee, they offer their operating system to TV makers. 3. Commission by taking a cut from subscriptions (such as HBO max) made through Roku. 4. Advertising, especially through their own TV channel called the Roku Channel, which is a free ad-supported service for every Roku subscriber. While Roku is the leading streaming platform in North America, I don't think they have built a moat just yet. It might be something they built in the future but so far, I don't think their brand is strong enough to have build a brand moat and switching streaming platform isn't complicated enough for them to have a switching moat.
Their CEO is Anthony Wood. He is also the founder of Roku, which is something I like, as founders are usually determined in growing the business. Roku is the sixth company that he founds and has previously been successful in selling some of his other companies such as ReplayTV and iband.com. He also briefly served as Vice President of Internet TV at Netflix in 2007. He is educated from Texas A&M University, where he earned a bachelor's degree in electrical engineering. Anthony Wood invented the DVR (digital video recorder) and is known as a very innovative and creative person. Regarding his management style, he has previously stated that "working in in Roku is like being part of a professional sports team. We put extreme care into recruiting the best people, we pay well in a competitive market, encourage excellent teamwork, and expect everyone to perform at a high level". He also added "we expect you to do a good job, if you don't do a good job, you are going to be fired eventually". A former executive in Roku said the following in working for Roku: "Working at Roku is like being a field goal kicker, where employees are expected to accomplish specific, detailed goals. Some employees thrive under pressure. If they can't, they won't be here long". No doubt that Anthony Wood has high expectations for his employees, and while some disagree with his management style, others will thrive. However, by looking at his results, taking Roku from nothing to the leading streaming platform in North America, suggests that Anthony Wood is a CEO that can move Roku forward.
I believe that Roku doesn't have a moat now but could build one in the future. However, I feel very confident about the management. Later I will do a discounted cash flow model to calculate a price for Roku but before I do so, let us just have a look at some key financial metrics.
Down below we see some key financial metrics Roku over the last three years. The first thing that is worth noting is that 2021 was the year where Roku turned profitable. I like to invest in profitable companies, so it is great to see. Revenue growth is very solid and is above 50 % in each of the years. Gross profit margin is also increasing year over year, which is something that is very encouraging to see. Operating margin became positive in 2021. However, the low operating margin means that they still have high operating costs. It would be nice to see that one increase in the future. Overall, it seems like Roku is trending in the right direction, and hopefully we will see an increased operating margin moving forward. I would say the numbers and the fact that Roku became profitable in 2021 makes me more interested in the company.
Before we continue to the discounted cashflow model, I would like to investigate the risks and potential of Roku. The largest risk in my opinion is the lack of moat. With no moat nothing protects Roku for losing customers in a competitive market. I would be more confident in investing in Roku if I could clearly point at a moat. Roku has the potential to develop a moat moving forward though, more about that in the next paragraph about the potential. Dilution of shares. Obviously, investors don't like dilution of shares, as it decreases your ownership of the company. The dilution is not alarming, but Roku has gone from approximately 98m shares outstanding in 2017 to 134m shares outstanding in 2021. Hopefully, it will stop now as Roku has turned profitable. Supply chain shortages, material prices and freight prices. In the letter to shareholders, Roku wrote that supply chain shortages hurt TV sales, which in result will affect the revenue for their license fee. Furthermore, material and freight prices affect the margins of the Roku players. Roku has prioritized account acquisitions, hence isolating new customers from the elevated costs in their players business, which resulted in negative player gross margins. Most of the revenue comes from the United States. As mentioned in their annual report, Roku generate a vast majority of their revenue in the United States. They will need to expand internationally as we have seen in Canada and Mexico (Roku is also present in other countries such as Brazil, United Kingdom, and Germany). However, the management has mentioned that they have limited experience marketing, selling, licensing, and supporting, and even more important, monetizing, their devices outside of the United States.
There are also potential for Roku moving forward. Scaling their advertising business. Right now, consumers spend 45 % of their TV time on streaming. However, advertisers have only moved 18 % of their advertising budgets from traditional TV to streaming. Hence, one would think that companies will move more of their advertising spending to streaming. Furthermore, Anthony Wood believes that TV streaming delivers a superior ROI compared to linear TV because of targeting, measurement and optimizing TV streaming can provide over linear TV. Roku has a lot of data of their users, meaning they can target the specific customers with the right commercial, which is something that cannot be done through linear TV. In 2021 the total numbers of advertisers grew by more than 20 %, while Roku retained 95 % of the advertisers that spent more than $1 million in 2020. The Roku operating system. Anthony Wood believes that we will see the same pattern in smart TV software, as we have seen in PC and smart phone operating systems. He explains that to begin with there were lots of different operating systems for both PC's and smart phones. However, now it is pretty much only Windows or Mac OS for PC's and iOS and Android for phones. He predicts the same will happen for smart TVs, and as Roku is already the leading operating system in the United States, while also making progress in other countries, he believes that Roku has a strong position in being one of the few that is left. It they succeed, they will have a strong moat. The Roku channel. The Roku channel has grown has gone from licensing a few low-cost movies to producing the multimillion-dollar originals and is now a top five channel on the Roku platform in the United States. If they can continue to grow the channel, it would generate larger advertising income.
I have now investigated the financials, risks, and potential of Roku. I will now look at the price by doing a discounted cash flow model. To do so I will need some numbers that you can see below. The numbers are the 2021 numbers, which I could find at Finbox. However, the perpetuity growth rate and the discount rate are numbers I have come up with myself. The reason I chose 5 % as perpetuity growth rate is that it is usually a between the historical inflation rate of 2-3% and historical GDP growth of 4-5%. I decided to go with a higher option of 5% due to the market Roku operates in. The chosen discount rate of 12% is because it is usually between 9-12%. I decided to go with the highest one because of the lack of moat and current market conditions. Remember that all the numbers made in these calculations are in millions.
I also need to determine how much EBIT, Depreciation & Amortization and Net Working Capital will evolve over the next couple of years. I decided to use an EBIT growth of 40 % year over year. It might sound like too much for some and too little for others. The median EBIT growth has been 54,8 % a year for the last five years, so I don't think it is unrealistic. I calculated with a growth in Depreciation & Amortization of 30 % a year. It is way lower than the last five years median of 120 % but a number I feel comfortable with. Finally, I decided to grow net working capital by 10 %. It is way lower than the median the last five years of 195 % but there was an outlier in 2018, where it grew by 835 %! I haven't found a smart way to share all my spreadsheet here but once I did my calculations, I found that the intrinsic value of Roku to be $127.
Having investigated Roku, I find the company interesting. I think there are lot of potential, especially if we see more companies increase their advertising budget on streaming. Furthermore, if management is right and we will end up with only a few operating systems for smart TV's, it could be a cash cow moving forward, and result in a very solid moat for the company. Roku will face some short-term headwinds due to supply chain shortages and material and freight costs, but it doesn't concern me long-term. Roku will need to be successful in their international expansion to grow, and so far, it is an unknown. The lack of current moat is also concerning to me. However, I think that Roku could be an interesting company to open a speculative position in, especially if it drops below $100, as it would give you a more than 20 % discount on intrinsic value. I haven't yet decided if I want to open a position in Roku or not if it falls below $100.
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