Roku Inc’s (NASDAQ:ROKU) fourth-quarter report wasn’t popular with the market — but I liked it. With the Roku stock price off 22% in pre-market trading, ROKU looks more intriguing after the report.
I’ve been skeptical of ROKU for a while, arguing back in December that it looked overvalued at $44. But fundamentally, the Q4 report looks exceedingly strong. And the company’s commentary in the quarter, and its detailed plans for future expansion, suggest the opportunity here goes well beyond hardware.
Significant caution still is advised. Even at the after-hours price near $40, the ROKU stock price implies a very steep valuation. Lock-up expirations could lead to selling pressure in the coming months. And with Roku still expecting to be unprofitable on an EBITDA basis in 2018, valuation expectations can change dramatically.
Still, ROKU is worth watching. The company that management described in Q4 is a company that could become a significant force in the content space. That would imply significant appreciation going forward — even if those gains will take some time and a lot of volatility (like what we’re seeing right now).
ROKU’s Q4 Earnings
Fundamentally, it’s difficult to see what drove such a huge dip in the ROKU stock price. Revenue rose 28% year-over-year, about four points better than Street estimates. ROKU actually turned an adjusted profit of $0.06 per share in the quarter, better than consensus of -$0.10.
Guidance looks strong as well.
The full-year revenue outlook of $660-$690 million looks better than the $662 million projected by analysts. It also implies 29-35% growth in 2018 — a larger increase than that seen this year.
Adjusted EBITDA is guided to a $10 to $25 million loss, roughly in line with the $18.3 million consensus. But management explained on the Q4 conference call that there is a $10 million headwind from an accounting change — without which Roku would be nearing break even next year.
Early media coverage has suggested that light Q1 guidance is driving the selloff — but that seems unlikely. It’s possible investors were simply expecting a bigger beat. Revenue growth did decelerate from the 40% increase in Q3 that led ROKU stock to more than double in three sessions.
Whatever the driver, it’s hard to see much wrong with the quarter. Platform revenue — the major growth driver here — rose 129% year-over-year. Roku said most of the growth came from advertising, and figures in the Q4 shareholder letter suggest advertising revenue increased roughly 165%, to about $64 million from just $24 million the year before.
User accounts rose 44% year-over-year. Hours streamed increased 55%. Roku is driving more usage, doing a better job of monetizing that usage and improving profitability.
As far as Q4 goes, Roku did its part.
Fundamental Concerns and the ROKU Stock Price
Even with all this, valuation still is a question mark. At the after-hours close of $39.80, Roku has an enterprise value of $4.56 billion. Against 2018 revenue guidance of $660-$690 million, that suggests an EV/revenue multiple of 6.6-6.9x – not ridiculously out of line for a fast-growing company.
But the problem is that ~45% or so of that revenue is likely to come from the player business. And that business is basically unprofitable. Player gross profit in the quarter was less than $10 million. Total operating expenses were $64 million. The player business is a loss leader for platform revenue (mostly advertising, along with subscription revenue sharing). Looking at Roku based solely on platform revenue, the EV/revenue multiple still looks to be a steep 12-13x.
So far today, Roku has fluctuated from a low of $39.75 to its current perch of $41.20.
In addition, that revenue has to grow with minimal contribution from Netflix, Inc. (NASDAQ:NFLX) and zero revenue from Alphabet Inc (NASDAQ:GOOGL,NASDAQ:GOOG) unit YouTube. 115% full-year growth suggests Roku is doing just fine without those two giants so far. But at a double-digit revenue multiple it will have to keep that type of growth going for some time.
The Future for Roku
The Roku story looks interesting.
One of my fears is that Roku could go the way of TiVo Corp (NASDAQ:TIVO), a pioneer who got lost competing against giants. But Roku argued in Q4 that it already is a giant — with plans, unlike TiVo, to diversify away from the TV.
In the Q4 letter, Roku highlighted its plans to build out home entertainment network, including ‘smart’ soundbars and speakers. It’s launching its own voice assistant this fall, a competitor to Google Home and the Amazon.com, Inc. (NASDAQ:AMZN) Echo. The Roku Channel is drawing a number of advertisers. And concerns about ad placement on YouTube could lead major advertisers to Roku’s curated platform instead.
Meanwhile, Roku made a very interesting point in both the letter and on the call. The company’s account base makes it the third-largest content distributor in the company, behind only Comcast Corporation (NASDAQ:CMCSA) and AT&T Inc. (NYSE:T), and ahead of Charter Communications Inc (NASDAQ:CHTR).
With that kind of scale and the company’s plans to truly create a Roku-based ecosystem (including licensing of smart TVs, and effort that is growing nicely), Roku can be a major player in content.
That opens access to the $70 billion TV advertising market. It offers the ability to drive better economics from content owners. And it means Roku has a lot more in the way of growth opportunities than advertising sales and the $29.99 Roku Express.
The Bottom Line for Roku Stock
It’s an intriguing story — but I’m still not quite ready to pay 12-13x platform revenue for it. Selling puts might be an interesting strategy here (particularly if implied volatility spikes).
But if Roku can put together another quarter or two like Q4, and if the market keeps the ROKU stock price down, a buying opportunity might present itself soon enough.
As of this writing, Vince Martin has no positions in any securities mentioned.