Roku’s Stock: Decline In The Cards As Covid-19 Hits Ad Spend?

by Trefis Team
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Roku Inc stock (NASDAQ: ROKU) lost more than 53% of its value – dropping from $137 in January 2020 to $64 in March 2020, due to the Covid-19 outbreak and the resultant lockdown, which led to expectations of economic slowdown and lower consumer spending power. This was followed by the multi-billion-dollar Fed stimulus announcement which provided a floor to the stock price as it recovered from April onward and currently stands at $156 per share. With the stock about 14% above its level at the beginning of 2020 and 25% higher than its price a year ago, is the market exuberant or is the price rise warranted? We believe that the stock price has risen beyond its near-term potential and will likely decline by around 8% from here.

Where Is Roku’s Stock Headed?

Trefis estimates Roku’s valuation to be around $143 per share, a little over 8% lower than its current market price. The trigger is the uncertainty about the future outlook for the company and the recent surge in the Covid positive cases in the US. The company’s management has also failed to provide any guidance for Q3 and full year 2020. The current crisis has had a mixed impact on the company, with streaming hours increasing significantly due to home confinement of people, but advertisers have decreased spending due to the current pandemic hitting their finances.

This was evident from the recently released Q2 2020 results for the company. Roku’s revenues jumped 42% y-o-y to $356 million in Q2 2020. Growth was primarily driven by a 46% increase in the company’s platform revenue, which includes revenue mainly derived from Roku’s share of ads and subscriptions on its platform. Platform revenue benefited from an acceleration in streaming hours as people were confined at home and spent more time in front of the TV. Streaming hours on the Roku platform soared 65% year over year to 14.6 billion during the quarter. But Roku’s business isn’t just about selling streaming devices, but also includes advertising on its TV operating system and the Roku Channel. Though advertising revenue also increased on y-o-y basis, it was driven by the acquisition of Dataxu Inc, a demand-side platform (DSP) company that enables marketers to plan and buy video advertising campaigns. Additionally, profitability dropped during the quarter, with earnings coming in at -$0.35/share in Q2 2020 compared to -$0.08/share in Q2 2019.

So despite Q2 2020 seeing growth in revenue, the lack of visibility for the remaining months of 2020 is a major concern for the company, as the management is not able to arrive at an outlook for the company. Also, the recent surge in Covid positive cases in the US could prove to be an impediment in the path of the company’s healthy growth, as re-imposition of lockdowns will lead to further uncertainty. Though the company is seeing impressive growth in streaming hours, another Covid wave and lockdown could put its advertising revenue at risk, as Roku’s ad platform primarily has considerable exposure to brand advertising spend and its reliance on verticals like casual dining, travel, and tourism, which are most affected by the current crisis and are pulling back on ad spend. Additionally, though partnering with Disney+ has been mutually beneficial for Walt Disney as well as Roku, three new streaming services – HBO Max, Peacock, and Quibi – are not yet available on Roku.

For the full year 2020, total revenue is expected to be close to $1.5 billion and once lockdowns are lifted, revenue is expected to rise to around $1.9 billion in FY2021. But Roku is likely to make losses in both the years, with its margins in 2020 and 2021 remaining below its 2019 level. With share count increasing only marginally, revenue per share (RPS) is expected to rise over 60% by 2021. Despite the rise in revenue, the P/S multiple is projected to fall, thus wiping out the gains in RPS. The drop in P/S multiple is likely to be the effect of the uncertainty surrounding the pick up in ad business, as Roku’s management has stated that the total advertising spending is not likely to return to pre-Covid levels until sometime in 2021. Revival of the ad business (which currently depends on abatement of the pandemic) is extremely important for Roku as almost 70% of the company’s revenue comes from Ads and Commission, and only the remaining 30% from sale of devices. Thus, number of factors such as (i) rise in covid-positive cases, (ii) no sign of discovery of a vaccine by the end of 2020, (iii) ad business verticals that Roku mainly depends on being severely affected, (iv) Roku not being able to stitch a partnership with newly launched streaming offerings and (v) the company’s profitability deteriorating, could lead to a drop in the P/S multiple. RPS of a little less than $16 and P/S multiple of 9x in 2021 suggests that Roku’s fair value works out to $143, thus reflecting a potential downside of around 8% from its current level.

Take a look at our outlier analysis for Roku, which puts the spotlight on unexpected but possible scenarios and discusses How Roku’s Stock Could Cross $450 and the specifics of Roku stock downside of $30. For further perspective of the streaming world, see how Disney compares with Netflix.

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