Roku: Must Better Monetizing Households To Boost Growth

Summary:

• I appreciate Roku’s strong financial stability, particularly its substantial cash reserves.
• I question whether its valuation justifies the slowing revenue growth rates projected for 2025.
• I recognize the competitive challenges Roku faces in a crowded streaming ecosystem.
• I see potential in better monetizing its vast household reach and leveraging its cash for acquisitions.

Investment Thesis

The core of Roku‘s (NASDAQ:ROKU) bull thesis is that its balance sheet holds no debt, and more than 20% of its market cap is made up of cash.

However, beyond this aspect, I don’t find this stock cheap. On top of that, I believe that in 2025, without the US elections to provide a boost to its ad revenue growth rates, Roku’s revenue growth rates will decelerate.

Consequently, as I look ahead, I question whether investors will find its stock a bargain when they are asked to pay 33x forward free cash flows for a business delivering no more than 15% topline growth in 2025?

Altogether, I find myself on the fence on this stock. It could work out, but it may just as easily not work out. Its outlook is too mixed for me.

Rapid Recap

In my previous analysis, back in September, I said:

I believe that the bulk of Roku’s investment thesis can be summed up as two considerations. At one point, the stock was higher, therefore many investors believe it now to be undervalued. Also, close to 20% of its market cap is made up of cash. That’s as far as the bull case goes in my opinion.

Meanwhile, investors have to come up against the thorny issue, that the business isn’t priced cheaply. Particularly when we consider that its growth rates are meek.

Altogether, I believe that investors would do well to look elsewhere for more compelling bargain opportunities.

Since I made that statement, the stock has underperformed a very strong bull market, where small and midcaps have been strong performers.

Even though I confidently believe that there are much better investment opportunities elsewhere, I fail to rate this stock a sell, given its rock-solid financial footing. Thus, it remains a neutral rating from me.

Roku’s Near-Term Prospects

Roku offers streaming entertainment for households with its user-friendly operating system, making it the most popular TV OS in the U.S., Canada, and Mexico for over five years.

By integrating services like live sports, subscription management, and curated zones, Roku seeks to enhance engagement for users.

Roku’s streaming hours continue to rise, with increased engagement globally, while initiatives like deeper integrations with ad platforms and subscription services are accelerating revenue growth, see the table that follows.

That being said, Roku operates in a highly competitive streaming ecosystem alongside major players like Amazon (AMZN) Fire TV and Apple (AAPL) TV. What’s more, households already find themselves being served by a plethora of streaming services. Therefore, there are arguably already near-saturation levels of competing services.

With that balanced background in mind, let’s now discuss its fundamentals.

Revenue Growth Rates Will Moderate in 2025

There’s good news and bad news. The good news is that Roku still has substantial topline growth. That is very much supportive of the bull thesis.

The bad news is that next year’s comparables will be tough, which probably translates into Roku growing at 15% CAGR and no more, which will mean a deceleration from 2024. On top of that, recall that in 2025 there will be no election-advertising tailwinds.

Accordingly, I don’t believe that investors will be too inclined to pay too high a multiple for a business with decelerating revenue growth rates, particularly one that faces tremendous competition from other streaming platforms.

With that in mind, let’s now discuss its valuation.

ROKU Stock Valuation – 33x Next Year’s Free Cash Flow

As an Inflection investor, I recognize, as I’ve done for a long time, that the bull case for Roku is supported by its steel-like balance sheet. More specifically, more than 20% of its market cap is made up of cash and cash equivalents.

Indeed, it’s difficult to be too bearish on ROKU when the business holds so much cash! I believe that cash on a balance sheet is like oxygen. You don’t really care to think about it most of the time. Apart from when you need it. And when you need it, you really need it. And on that front, ROKU fares very well.

That being said, consider this. In the best-case scenario, Roku is going to finish 2024 with approximately $200 million of free cash flow. Now, let’s make a bold assumption that in 2025, Roku’s free cash flow resumes its climb higher so that its free cash flow is up 50% y/y to $300 million.

Hopefully, you’ll think about this $300 million figure with some unease! Your first question should be, how will Roku’s free cash flow climb 50% y/y on the back of approximately 15% topline growth?

Nevertheless, let’s just go with the bull case. This would put the stock priced at 33x forward free cash flow. For my part, I don’t find this a particularly enticing valuation. And personally, I am assured that I can find better stock opportunities elsewhere.

Risk Factors to the Bearish Thesis

I’ve already noted this several times. The main reason why I’m not outright bearish on this stock is its high cash sum on its balance sheet. If Roku can prudently deploy its cash balance towards a bolt-on acquisition, this could significantly reignite its bull case forward.

Also, Roku is close to reaching 90 million households. That’s a massive reach. If Roku was able to better monetize those households, either through more advanced programmatic advertising or conceivably through commerce opportunities, this could significantly unlock higher revenue growth rates, which would immediately make its stock worthwhile considering.

The Bottom Line

As I reflect on Roku’s current position, I find myself cautiously neutral. Its substantial cash reserves and robust financial footing make it a resilient company, but the valuation and moderate growth projections leave much to be desired.

While I see potential for strategic improvements and monetization, I remain hesitant to call this stock a compelling investment at present.

I recommend that you look elsewhere.

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Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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