Well, I’ve been wrong on Roku Inc (NASDAQ:ROKU) so far. The ROKU stock price now has more than tripled from its $14 IPO price just over two months ago, and I’ve missed the rally. In fact, ROKU stock has doubled just since I recommended caution after initial post-IPO gains.
The big catalyst was a massive 55% gain earlier this month after a blowout Q3 earnings report. Volatility has since hit the stock big-time, with the ROKU stock price ricocheting from $48 to $35 to $50+ in just two weeks, before settling in at a current $44. And though I’ve been wrong before, that price still looks too high.
There are reasons for optimism here: Roku is a pure-play on streaming growth, its so-called platform revenue is soaring, and the Q3 report admittedly was impressive. But the valuation here looks stretched, with ROKU stock much more expensive than even a nearly 9x EV/revenue multiple suggests.
A short squeeze no doubt has helped the stock of late, but as lockups expire and the float increases, that benefit should recede. To be sure, I have no interest in being one of those potentially squeezed shorts any time soon. But I still think investors should let ROKU stock settle down from both a valuation and volatility standpoint.
The Good News for Roku
Undoubtedly, the Q3 earnings report was impressive. Whether or not it was enough to drive a 55% gain that turned into a double over the next two sessions is less clear.
The headline numbers look fantastic. Revenue grew 40%, 16 points better than Street estimates. An adjusted loss of $0.10 per share was $0.19 better than analysts predicted.
User growth impressed as well. The number of accounts rose 48%; streaming hours grew 58%. Monetization of those users improved, with the trailing twelve-month ARPU (average revenue per user) figure reaching $12.68, up 37% year-over-year. And the key platform revenue category had a stellar quarter.
Revenue rose 137% year-over-year. Gross margin in that segment rose 570 bps to an impressive 77.5%, leading to a 156% jump in platform gross profit dollars. Roku isn’t profitable yet, but with that tailwind it’s getting closer.
Q4 guidance is for Adjusted EBITDA to range between negative $6 million and breakeven, which suggests some level of profitability in 2018. It’s exactly the type of quarter a growth stock needs to move higher. Still, there’s the question as to whether it merited a 130%+ gain in a little over three weeks.
Player vs Platform
Simply from an EV/revenue standpoint, ROKU stock doesn’t look cheap. A near 9x multiple to 2017 revenue guidance isn’t the highest in the market, or close. Stocks like Snap Inc (NYSE:SNAP) and Shopify Inc (US) (NYSE:SHOP) trade in the 14-15x range on that basis.
But the composition of that revenue needs to be considered. 54% of Q3 revenue still came from Roku players. And that business is unlikely ever to be profitable. As the company wrote in its Q3 shareholder letter, “we optimize this business around growing unit sales and active accounts,” not revenue or profitability.
In other words, the player business essentially is a loss leader. Gross profit dollars for the segment in Q3 were just $5.3 million, with margin below 8%. That was a sequential improvement over Q2’s 6.4%, but it’s still a significant compression from the 13.3% figure posted in Q3 2016.
Increased sales of the $29.99 Roku Express and more aggressive promotions are limiting player revenue and margins. Against the $5 million-plus in player gross profit, R&D spend was $28.5 million and sales and marketing spend $16.2 million. The hardware business is losing money and will continue to do so.
From a business model standpoint, that’s a good idea. But it also means that a investors shouldn’t be valuing player revenue all that highly. And yet those sales have accounted for 57% of total revenue so far this year, a proportion that should stay in the 40s next year, assuming current trends hold.
And that means that the ROKU stock price is nearly 20x its player revenue, a simply huge multiple. Yes, that revenue has grown 108% so far this year. But it will have to continue torrid growth for years to keep ROKU’s valuation reasonable.
The ROKU Stock Price Looks Expensive
That seems a big ask. As I detailed back in October, Roku still gets zero revenue from Alphabet Inc (NASDAQ:GOOGL) property YouTube and barely any contribution from Netflix, Inc. (NASDAQ:NFLX). Competition remains intense, from Google, Amazon.com, Inc. (NASDAQ:AMZN), and Apple Inc. (NASDAQ:AAPL).
So far, Roku is winning against those peers, and I’d expect it to continue to do so. But at 20x player revenue, winning isn’t enough. Valuation matters, even for a growth stock like Roku that clearly is running on all cylinders. And I’d expect the market will remember that problem soon enough.
As of this writing, Vince Martin has no positions in any securities mentioned.