Roku: Leaping Past Estimates Should Be More Difficult In 2024
Contributor since 2023 / 3072 Followers
Summary:
- Roku stock continues to benefit from the company leaping past the lowballed guidance it issued at the start of the year.
- Roku’s high household penetration in the US and lower ARPU in international markets may pose challenges for future growth.
- With the evolving streaming market, where ROKU will fit in the coming years is an unknown.
Giuliano Benzin
Back in April, I wrote that while the numbers and trends for Roku (NASDAQ:ROKU) looked poor, I thought the company had lowballed its 2023 guidance. More recently, in September, I said while the company continues to leap past easy estimates, that this won’t last forever, and that the stocked looked pricey even based on outer year numbers. Let’s catch up on the name, which reported earnings last month.
Company Profile
As a reminder, ROKU is a TV streaming company. It sells its own streaming devices, while its operating system (“OS”) is also used by several third-party TV makers. The company has also sells its own Roku-powered TVs as well as other home electronic devices, such as sound bars, video cameras, light bulbs, and video doorbells.
That said, ROKU’s primary business is its platform business, where it generates revenue from advertising and content distribution service. The company operates the Roku Channel, which is an ad-supported streaming service. It also has an ad buying platform called OneView. Meanwhile, the company also has revenue-sharing agreements where it receives a percentage of the sale when consumers sign-up for subscriptions on its platform, while for ad-supported streaming services, it typically receives a portion of the ad inventory spots.
Stock Soars on Earnings Again
ROKU stock has continued to benefit from the low bar it set when it offered its initial 2023 guidance. After an over 25% just following its earnings last quarter, the stock saw a 31% jump the next session after it reported its Q3 results last month.
The streaming company easily topped analyst revenue estimates by $56.3 million, or over 6.5%, to come in at $912.0 million. Adjusted EBITDA of $43.4 million, meanwhile, was much better than its guidance calling for a loss of -$50 million. The company had $91.3 million in stock comp expense in the quarter that was not reflected in adjusted EBITDA.
In Q3, the company saw its device revenue rise 33% to $125.2 million. Device gross margins were -7.5%, but that was an 830 basis point improvement over the prior year. It was also a 950 basis point improvement from Q2, when it had -17.0% gross margins.
ROKU’s platform numbers, meanwhile, were a mixed bag. Revenue rose 18% to $786.8 million, while ARPU dropped -7% year over year to $41.03. ARPU rose less than 1% sequentially from $40.67.
Gross margins dipped -760 basis year over year and were down -510 basis points sequentially to 48.1%. The company said the Roku Channel had a $62 million restructuring charge related to the removal of select licensed and produced content. Excluding that one-time item, gross margins would have been 56%.
Active accounts rose by 2.3 million sequentially to 75.8 million. The company said in the U.S. it was approaching being active in half of U.S. broadband households. The company said ROKU Channel streaming hours were up 50% year over year.
The company also talked up the progress it was making in international markets, particularly in Latin America. It noted it was the #1 TV OS in Mexico now.
On the cost side, meanwhile, ROKU’s sales and marketing expenses rose 48% year over year to $307.7 million. G&A expenses climbed 48% to $128.7 million, while R&D expenses climbed 36% to $282.2 million.
Turning to the balance sheet, ROKU ended Q3 with $2.0 billion in cash and no debt.
It has generated $239.5 million in operating cash flow this year. Its stock based comp expenses has been $277.4 million year to date.
On its Q3 call, ROKU guided for Q4 revenue of $955 million, a gross profit of $405 million (margins of 42.4%), and adjusted EBITDA of $10 million.
In a letter to shareholders, CEO Anthony Wood wrote:
“We had a solid rebound in video ads in Q3 and we expect the YoY growth rate of video ads in Q4 to be similar. However, we remain cautious amid an uncertain macro environment and an uneven ad market recovery. Additionally, we will face difficult YoY growth rate comparisons in content distribution and M&E which will challenge the YoY growth rate of platform revenue in Q4. That said, we have significant scale and engagement, and we expect to grow ad share. We will continue to operate our business with discipline to defend margins, with a focus on driving positive free cash flow over time. While we have made the difficult decision to reduce headcount, we will invest in high ROI initiatives to maintain our competitive position. … We remain committed to positive Adjusted EBITDA for full year 2024, with continued improvements after that.”
Setting a low bar and continually jumping over it throughout the year has been a big boon to ROKU’s stock. This was once again the case this quarter. Positively, the company is starting to see its platform revenue growth re-accelerate despite lower ARPU and a slowdown in the Media & Entertainment sector, which has been a high-margin growth driver for the company in the past. After being down -1% in Q1 and up 11% in Q2, revenue growth accelerated to 18% in Q3.
Growth is being driven by new users, but with the company being in about 50% of U.S. broadband households, saturation could begin to set in. That would put ROKU in about 63 million U.S. households. That compares to 77.3 U.S. and Canada paid memberships for Netflix (NFLX), and Canada likely represents around 7 million of those paid memberships. International is an opportunity, but would likely come with much lower ARPU, as is the case with most advertising based models.
And while the shift from linear TV to streaming TV continues, many streaming companies are struggling to add users and find the right model. Ad-based tiers are being added and bundling has even started being introduced. It almost seems like the direction of streaming is headed back more to the linear TV model in many aspects. The streaming landscape is evolving, so we’ll have to see where ROKU eventually fits in.
Valuation
Valuing ROKU isn’t easy, as the company currently isn’t profitable, although it has been in the past. The current consensus for the full-year 2023 is for ROKU to generate negative EBITDA of -$37.8 million, which is a huge improvement from earlier this year. The company also recorded nearly $277.4 million in stock-based compensation so far in 2023, which is a real expense that gets excluded in the EBITDA calculation. Stock comp was down nearly -8% in Q3 but up 8.5% year to date.
If you want to go out to 2027, the analyst estimate is for the company to generate EBITDA of nearly $674.6 million. That places a value of the company at 18.5x 2027 numbers. However, stock-based comp of say $400 million could wipe much of that away. Including stock comp, it would trade at a whopping 45x multiple, which isn’t cheap. Analysts are still looking for ROKU to be able generate mid-teens revenue growth in 3-4 years, but that could be difficult given its household penetration levels in the U.S. and the lower ARPU that international markets generate.
I’ll use 2027 adjusted EBITDA, but bump the share count up to 160 million given its high stock comp that consistently has increased its shares outstanding. This seems like a reasonable amount to assume where shares outstanding will be in 2027. Place a 20-30x multiple on that, and you get a $85-$139 valuation in 3-4 years.
Conclusion
The decision by ROKU management to kitchen sink guidance at the start of the year has been a big benefit to shareholders this year. However, that’s a difficult play to run for two years in a row, and investors will likely need to see some nice guidance for next year after the stock’s strong run and hefty valuation.
While there have been signs of advertisers returning, the M&E segment that ROKU relies on should remain challenging, while macro uncertainty next year could play a role in marketing budgets next year. At the same time, I would expect ROKU’s U.S. active account growth to start to slow given its high penetration.
At current levels, the risk/reward of ROKU skews slightly negative in my view. As such I remain “neutral” on the name.
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.
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