Why We Cut Our Price Estimate For Roku, But Still Remain Bullish On The Stock

Roku stock (NASDAQ: ROKU) has had a rough couple of months, declining by 50% year-to-date and by over 75%  from its all-time highs. There were multiple factors driving the sell-off. Firstly, investors have been broadly reducing allocation to high multiple growth stocks, amid a rising interest rate environment, and Roku, which traded at over 20x revenues at its peak back in mid-2021, has been particularly badly hit. Roku’s business is seeing growth cool off as the number of people staying at home gradually declines following the easing of Covid-19 restrictions. Roku’s Q4 2021 earnings and outlook were weak, with the company guiding for just about 25% revenue growth for Q1 2022, after growing by over 79% in Q1 2021, as marketers are likely to go easy on advertising spending, on account of supply headwinds and rising inflation hurting the broader economy.

Moreover, Roku’s players business – which sells the company’s streaming devices –  is also in a tough spot, amid tight component supply conditions and shipping constraints across the consumer electronics industry. Roku has opted to insulate its customers from higher costs by keeping prices of its streaming devices the same, and this has resulted in the players division posting deeply negative gross margins (about -31%) in Q4. This trend is likely to persist into 2022 as well. The supply headwinds are also impacting third partly television manufacturers, who install Roku’s operating system on their smart TVs, with sales now apparently trending below pre-Covid levels. The lower number of TVs and players sold also directly impacts Roku’s platform business growth, as fewer new platform users will be added.

We have reduced our price estimate for Roku to $184 per share from over $400 per share previously to account for the slowing growth and the relatively tough near-term outlook for the company’s players’ business. However, our price estimate remains about 60% ahead of the market. There are a couple of reasons, in our view, to remain long on Roku at current levels. The transition from linear TV toward connected TV is a secular trend and Roku remains well positioned in this space, with a growing base of over 60 million active accounts and with its TV operating system installed on more than 1 out of 3 TVs sold in the United States. Roku has been making solid progress in monetizing its users via ads and growing investment in content. The average revenue per user rose by over 40% year-over-year to $41 in Q4 and there’s probably a lot more room for growth given that advertisers apparently spent just about 18% of their U.S. TV ad budgets on connected TVs last year.

Roku’s valuation is also compelling. While the stock now trades at near levels seen prior to the pandemic, the company has actually made considerable progress since then, with its user base growing by over 60% and its monetization improving considerably. In relative terms, the stock trades at just a little over 5x projected revenue currently, compared to over 12x back in 2019. The Trade Desk, another fast-growing digital ad player focused on TV ads currently trades at over 15x revenue. We also believe Roku’s current strategy of compromising the profitability of its players business is the right strategy at this juncture, given that it is essentially a customer acquisition tool, which drives the growth of its much more lucrative platform operations, which has gross margins of over 60%. As the supply chain headwinds following Covid-19 are gradually resolved with hardware supply improving, it’s very likely that Roku stock will see some upside.

See our analysis on Roku Valuation: Expensive or Cheap for more details on what’s driving our price estimate for Roku. Our analysis on Roku Revenue has more details on the company’s business model and key revenue streams.