Roku: TV Push Could Boost Revenue, Margins
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Summary:
- Roku, Inc. announced that it will roll out Roku-branded smart TVs.
- The company doesn’t earn a fee for licensing its OS to TV manufacturers.
- Selling TVs directly should increase revenues and improve margins of the Player business.
Justin Sullivan
Roku Inc.’s (NASDAQ:ROKU) decision to sell its own-labeled TVs should be a clear positive for the stock, given it will likely add incremental revenue and improve margins at the Player business segment.
What We Know About Roku’s Decision to Sell TVs
The company announced the launch of Roku Select and Roku Plus Series TVs. These Roku-branded HD and 4K TVs are the first ever to be both designed and made by Roku. The company will offer 11 models ranging from 24-inch to 75-inch-TVs. They will be available in Spring of 2023 at prices ranging from $119 to $999.
The company didn’t announce its manufacturing partner, but said it is not producing the units with any of its existing brand license partners for TVs.
While the announcement lacked a lot of details, especially since the product launch is quite soon, it offered enough information to show investors it will have a positive impact on profitability.
How Roku Makes Money
Streaming players are loss leaders for Roku. The company’s strategy is to sell smart TVs and streaming devices at a low price to acquire as many customers as possible, so that it can monetize their data in its platform business. This strategy makes sense given there is some switching costs to buying a TV (Its easier for a customer to switch between streaming services than to change TVs). That enables Roku to sell its hardware cheaply, in order to gain share on the software side.
In the first three quarters of 2022, the company made $269 million in player sales from 5.3 million new accounts, or $50.75 per device. There is an upward bias in this number given there could be some old accounts that bought new devices as well. The company lost $3.3 on each device it sold during the period. That’s just the gross profit, so without any operating expenses. But it made a gross profit of $13.3 per account on the platform side, easily covering the loss selling streaming devices.
The deterioration in the business came on the operating expenses side. Roku spent $540.9 million to acquire the 5.3 million customers it did in the first three-quarters of 2022. In the same period of 2021, the company added 5.2 million accounts while spending only $292.3 million on sales and marketing. Similar expense increases in R&D and G&A also took place in the first three quarters of 2022, and selling Roku-branded TVs can help digest those increases in the future.
How Selling TVs Will Help Roku Boost Revenue, Margins
Roku makes no money from licensing OS (Roku regulatory filling)
Roku does not recognize any revenue from licensing its operating system to TV manufacturers. This explains why its player revenue per net account added is closer to the price of streaming devices than it is to TVs. Roku also states that it incurs expenses in connection with these commercial agreements, bringing the operating margins on the player business down even more.
Selling Roku-branded TVs, on the other hand, enables the company to recognize revenue for TV sales and in the process enhance the margins of its player business. The lowest-priced Roku TV will sell for more than double the $50.75 recognized in player revenue per net account added. It will also, probably, sell at a positive gross margin, compared to the negative/flat gross margin the company currently sells players for.
I believe the positive impact of selling TVs compared to licensing the OS isn’t currently priced into the stock. This is evident from the lack of upgrades after the announcement, even though the stock was down 82% in 2022. Just to illustrate the impact of selling TVs, assume the first three quarters of 2024 will see Roku add a similar 5.3 million accounts like it did in 2022, but that all these accounts would be Roku-branded TVs. At the lowest-priced TV ($119), the company would recognize $630.7 million in revenue from the Player segment only. That is more than double the $269 million they recognized in the same period of 2022. The gross profits on these sales would be $63 million at a gross margin of 10%, compared to the loss of $54.5 million it incurred in the first three quarters of 2022.
While it’s difficult to anticipate the sales numbers of Roku-branded TVs, it is clear that their introduction to the sales mix will boost revenues and margins in some respect. And that, in turn, will increase the likelihood of the company beating consensus estimates, given this change in strategy is yet to be highlighted by analysts.
Risks
Roku isn’t producing its branded TV sets with any of its TV partners, and it’s unclear how they would react to Roku’s decision. The company tried to stress in the statement that it will remain committed to its TV partners, saying that:
Roku-branded TVs will enable further innovation around the TV experience, and all innovations will be made available to the full Roku TV program, including current and future OEM partners.
It is still unclear if that will be convincing to the company’s OEM partners, especially that it will be more profitable for Roku to focus on producing its own TVs. A decision by OEM partners to switch their OS to other competitors like Google for example could negatively impact Roku’s revenues.
The other risk is that, while Roku is selling its TVs at comparable prices to other TV manufacturers, some execution risks could mean the company fails to produce it at a similar gross margin profile, and that would lead to lower profitability than expected.
Conclusion
Roku’s stock is a buy because the company’s decision to sell its own brand of TVs will likely boost revenues and margins. The company doesn’t receive a fee for licensing its operating system to TV manufacturers, and selling its own TV will finally help it recognize some revenue for TV sales. Roku has also relied on its streaming devices as loss leaders to take share in its more lucrative platform business. Selling its own TVs will see it consistently recognize positive gross margins on that side of the business, especially as the portion of its own-branded TVs grows as a percent of the total player sales. The positive impact Roku-branded TVs will have on revenue and margins appears currently not priced in Roku stock given analysts are yet to highlight the change in strategy. This means that the company could beat consensus estimates once it starts selling those TVs starting spring 2023. The risk is that Roku’s TV manufacturing partners could view this move as a competitive threat and start switching to competing OS products.
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.