Roku Inc (NASDAQ:ROKU) has quickly become one of 2017’s superstar IPOs. ROKU stock IPOed at $14 per share and immediately traded up into the 20s.
After a month of trading sideways, ROKU stock has again launched higher following a strong earnings report. ROKU stock subsequently traded as high as $48 and is now sitting around the $40 mark. That’s a double for anyone who bought prior to earnings, and a triple for anyone fortunate enough to have purchased at the IPO price.
Now, though, the question is whether this run is sustainable. Roku is dominating its market. Its earnings report surprised observers in multiple ways. That said, the company still loses money. Bears are getting excited about ROKU stock thinking a big breakdown is on the way. Let’s examine the arguments.
ROKU Stock Cons
Huge Price Runup: There is a reason ROKU stock IPOed for just $14 per share recently. The company has been in business for 15 years and never generated a profit. And the company lost money again this quarter, even with the blowout revenue numbers.
And Roku had an edge on many of its start-up peers. Netflix, Inc. (NASDAQ:NFLX) has long partnered with Roku. Yet, even a star backer hasn’t been enough to lift Roku to profitability. Yes, they’re having a hot streak now, but the stock has already tripled to reflect it. If Roku isn’t taken over, there’s a good chance its stock will come back to earth sooner or later.
Consumers Are Fickle: It’s worth remembering what happened to TiVo Corp (NASDAQ:TIVO). I may be showing my age here, but I remember Tivo stock running up 10x during the 1990s tech bubble. The company launched the first successful digital video recorder. Success seemed assured and the stock went from the teens to $120.
The stock collapsed with the rest of the dot.coms. It would have one more surge in 2009-11 on its patent portfolio and hopes of a buyout. But that all went away, and TIVO stock has been a dud, falling 70% since its 2011 peak. Tivo is still in business today. In fact, it has a decent competitive product to Roku even now. But the buzz is long gone. The company never generated consistent profits, and when consumers moved on, the stock plunged. I expect a similar fate for Roku unless it receives a takeover bid.
Dual-Class Share Structure: Snap Inc (NYSE:SNAP) raised eyebrows earlier this year with its IPO where its newly-issued shares came with no voting rights whatsoever. The makers of the S&P 500 index, in an unprecedented move, excluded SNAP stock from the benchmark in response.
Roku hasn’t gone quite that far. However, its dual-class structure is pretty close. Post-Roku IPO, the public got A-class shares that have just 2% of the voting interest in Roku. The pre-existing owners still control 98% of the company with their superior B-class shares. It’s generally a disreputable move when insiders sell stock with minimal voting rights.
ROKU Stock Pros
However, there’s a key difference. Companies like GoPro and Fitbit dominate minor niches. The vast majority of the population rarely or never engages in extreme sports, which limits the demand for action cameras. Similarly, Fitbit’s market is modest since most people are rather lazy about their health, and even people who buy one Fitbit product don’t seem too keen on getting another one later. Roku, by contrast, is on the right side of human behavior. People love watching TV, and the largest digital media player companies will always have plenty of mass market appeal.
Hardware Sales Miss the Point: ROKU stock short-sellers have been pointing to the company’s inability to sell more hardware. The previous quarter of 2017 showed an outright decline in hardware revenues versus 2016. And this most recently reported quarter showed just single-digit growth in hardware revenues. This supposedly signifies that consumers aren’t buying what Roku is selling.
But the bears are wrong. Roku is making a strategic play to take market share and make more platform revenues. For this most recent quarter, hardware sales only grew 4%. But platform revenues grew 137%. One more such quarter, and the company will make more off platform than it does on hardware from a revenue perspective.
Here’s what has happened. Roku is blowing out its inventory, selling a lot of previous-gen devices at big discounts. This hits gross margin on hardware but gets more devices in households. Once installed, the platform revenues generate 80% gross profit margins. Given that platform revenues are high-margin and recurring, this is absolutely the correct strategic choice. The bears are totally wrong on this point.
Buyout Target With High Short Interest: As the market leader in its space, Roku is a valuable target for various large tech companies. Roku is ahead of the offerings from Amazon.com, Inc. (NASDAQ:AMZN), Alphabet Inc (NASDAQ:GOOGL) (NASDAQ:GOOG), and Apple Inc. (NASDAQ:AAPL).
Even though Roku is extremely expensive on a sales basis and loses money, it’d be a cheap takeover target for any of those three in the bigger picture. Roku is hot with consumers now, and under the ownership of a tech giant, it could become significantly profitable and far more powerful. With 27% of ROKU stock sold short, bears think this stock is heading for a collapse. A buyout offer would crush these skeptics.
Bottom Line on ROKU Stock
So is ROKU stock a new technology winner or a flash-in-the-pan? To Roku’s credit, it currently leads a key market segment and is ahead of credible competition from many of the world’s leading tech firms.
That said, it’s far from clear that Roku has the firepower to maintain this advantage. And even atop the competitive heap at the moment, it still can’t turn a profit. Throw in a ugly two-class share structure, and ROKU stock is an easy avoid. That said, there is plenty of reason to think a competitor will try to buy Roku. I wouldn’t sleep well if I were short the stock either.
At the time of this writing, the author held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.