What ROKU’s Valuation Implies (at ~$150/share)
Nowadays there's rarely a discussion Roku without someone touting the $70bn connected TV advertising market. Below are some quick numbers to show that opportunity is already priced in.
Nowadays there's rarely a discussion Roku without someone touting the $70bn connected TV advertising market. Below are some quick numbers to show that opportunity is already priced in.
Let’s go through the Upside case first.
- $70bn TV advertising spend in US. Let’s say it grows into $75bn in a few years.
- Assume a high % of that will be advertising funded (notwithstanding the current trend of content being subscription based and ad free). Assume ROKU end with 40% of the market and take 30% of ad spend as its revenue.
- That’s $9bn revenue for ROKU. Assume EBIT margin 20% and you get to $1.8bn of EBIT, or 10x EV/EBIT.
- That sounds cheap. But keep in mind that 1) $1.8bn EBIT is assuming a fully penetrated US TAM (so low growth from there on); it will take years to reach and success is by no means assured. 2) Also, this is before time value discounting. 3) I'm not factoring share dilutions which will make enterprise value go up.
So even the Upside case above has little upside. I actually believe both the Base case and Downside scenarios are more likely. Competitors are all upping their game in the CTV space, and I think Roku will end with no more than 1/3 market share (switching cost is low in my opinion since all these players have offer similar content). Take rate of ad inventory will probably have to come down with competition.
The base case and downside scenarios imply 16x or even 30x eventual EBIT, at TAM (again, this is with no time value discounting).
This is U.S. market only. So ROKU has no upside at those valuations - IF it only monetizes from U.S. AVOD.
Where Is the Upside?
But of course, Roku is more than just U.S. based advertising. First, there is international advertising. Second, don't forget SVOD!
The company is actively making progress in international. Here I can't help but think Roku will be disadvantaged because Apple, Amazon, and Google all have far greater name recognition. There’s also the inevitable rise of local/national champions that will contend with U.S. players. Analysts have been asking about international expansion, but management simply have not disclosed much.
More importantly, investors of Roku have to look beyond advertising dollars and into its strategic value in the value chain.
More importantly, investors of Roku have to look beyond advertising dollars and into its strategic value in the value chain.
There is a streaming war right now and players like Netflix, Disney, Amazon, Apple, HBO...etc are fiercely fighting over the key battle ground of being customer facing modules.
As this article by @EntStrategyGuy (a "must follow" on Twitter) points out, whoever controls access to consumers gets to extract tremendous value from other parts of the value chain.
"To see this in action, consider the traditional cable offered HBO. For the privilege of distributing HBO to subscribers, of the $15 or so dollars each month paid by subscribers, the cable company kept half. Half!"The question is what is the consumer's first stop for watching content? That is the strategic choke point, or what @EntStrategyGuy calls the "key terrain". The answer is no longer cable TV or Netflix. Nor will it be independent apps like Disney+ or HBO Max.
The "key terrain" is controlled by Amazon Fire TV, Roku, Android TV, and Apple TV.
Currently, Roku converts that strategic value into monetary gains through revenue sharing agreements with subscription video on demand (SVOD) providers. Ultimately though, we have to think about Roku's value as an acquisition target.
Going back to that article by @EntStrategyGuy, he lists Comcast, Disney, and AT&T as "potential bundlers" - and all three could use Roku to fill out their value proposition.
Comcast, Disney & AT&T – Potential Bundlers
These are all companies who could offer psuedo-bundles. Disney has a bundled price with Hulu, ESPN+ and Disney+. The challenge is it doesn’t have one experience to offer for other streamers, like its own Hulu Live TV offers HBO and Showtime, but no Disney+. (Seriously, why haven’t they started selling this yet?) We need to monitor Hulu here for them to become a true DVBs. The other Disney issue is a lack of device or operating system to leverage. (Roku could be the play here.)
Comcast is much better positioned with their “Flex” box, and integrations with Amazon Prime and Netflix. I’m not sure they sell subscriptions, but that could be added for other streamers fairly easily I’d assume. They already have the infrastructure to do these sales. (Also, I’ve seen speculation that Roku could help Comcast’s technology base and ad-sales.)
AT&T, like Disney, is a wildcard. They’ve launched a vMVPD, and control wireless customers but not devices and don’t have an operating system. But they’re thinking about this. If they weren’t so cash strapped, Roku would be an obvious play here. (Turns out, buying Roku would help lots of streamers stand against Apple and Amazon.)
There you have it. The much hyped $70bn U.S. AVOD market is not enough to justify Roku's stock price. For investors to get more upside, Roku will have to execute on international advertising, as well as monetize its value to SVOD streaming providers - including its potential as an acquisition target.
