Here’s Why You Should Not Jump All over Roku Inc Stock Just Yet

Advertisement

Roku stock - Here’s Why You Should Not Jump All over Roku Inc Stock Just Yet

Source: Shutterstock

Streaming platform aggregator Roku Inc (NASDAQ:ROKU) has become a battleground stock. On one side of the aisle, there are bulls pounding on the table that this is the next Netflix, Inc. (NASDAQ:NFLX), so buy Roku stock now while you can.

On the other side of the aisle, bears are pounding on the table that this is the next Fitbit Inc (NYSE:FIT), and competition from big tech players will eventually send this stock into the single-digit range.

Who is right?

Both arguments have merit. Roku is in the right space and the right time. Being content neutral could also be a major driving which propels this company to global dominance.

On the other end of the spectrum, everyone from Apple Inc (NASDAQ:AAPL) to Alphabet Inc (NASDAQ:GOOG) to Amazon.com, Inc. (NASDAQ:AMZN) is aggressively pushing into this space. Those are the three competitors that made Fitbit and GoPro Inc (NYSE:GPRO) irrelevant.

Because of this intense polarity and lack of clarity when it comes to Roku stock, I think this is a wait-and-see scenario. Buying now seems too risky. But if the growth narrative does play out like some bulls expect it to, then buying in 6-12 months won’t be too late, either.

Here’s a deeper look:

Why the Bulls Think $50 Is in the Cards

The bull case on Roku stock rests almost entirely on the thesis that this company is turning into the default, content-neutral aggregator of over-the-top streaming services. What will allow Roku to do this, versus competitors, is the company’s content-neutral foundation.

Moreover, because over-the-top streaming is the future, Roku will consequently turn into a major company with a huge valuation. How big? Well, Roku is growing both its user base and average revenue per user at around 50% year-over-year.

The user base is currently just under 21 million, versus Netflix’s 125 million global user base. Average revenue per user, meanwhile, hovers around $15, versus $20-plus globally (nearly $100 domestically) for Facebook Inc (NASDAQ:FB).

Thus, the growth runway for Roku both in terms of streaming audience growth and per capita ad spend growth is quite robust.

Netflix currently has 55 million members. Lets say Roku gets to around 55 million members in five years. Facebook has a global ARPU of above $20.

Lets say Roku gets to an ARPU of $30 in five years, given higher domestic concentration in user base. That leads to Platform revenues of roughly $1.65 billion in 5 years. Throw in $300 million to Player revenues and you get $1.95 billion in net revenues in five years.

Platform margins should run around 75%. Player margins should run around 10%. The aforementioned modeling, then, leads to just under $1.3 billion in gross profits in five years.

Taking out what should be a more moderate operating expense rate of roughly 35%, you arrive at operating profits of about $585 million. Less 20% for taxes and on 120 million shares, that equates to earnings per share of roughly $3.90 in 5 years.

A market-average growth multiple of 20-times forward earnings on $3.90 implies a four-year forward price target of $78. Discounted back by 10% per year, that equates to a present value north of $50.

Why There Are a Ton of Risks to That $50 Price Tag

The one big thing Roku stock has in its favor when it comes to chasing that $50 price tag is content neutrality.

As more and more over-the-top streaming services emerge, content creators will continually try to bias consumers towards their content. Considering the class of Roku’s competitors (Amazon, Google, Apple, so on and so forth) are also content creators in this space, Roku has a huge differentiating factor in that it is truly a content neutral aggregator.

But how important is that content neutrality?

The big risk to the Roku user growth narrative is that content neutrality isn’t all the important. For example, a Google Chromecast owner can currently just as easily stream Netflix as a Roku device owner.

Right now, then, content neutrality doesn’t seem to be all that important. Over time, as competition grows, content neutrality may prove to be extremely important, but benefits of content neutrality as of this moment remain unclear.

Moreover, Roku’s competitors have a suite of smart home products to exist alongside streaming device players. For example, Google has Chromecast and Google Home, while Amazon has Fire Stick and Echo & Alexa.

Roku doesn’t have any accompanying smart home solution. Thus, as the smart home market matures to integrate all these devices, Roku devices will be left out of that integration.

Therefore, unless Roku gains significant scale before these integrations happen or unless the company develops accompanying smart home products, Roku could get left in the dust by competitors.

Bottom Line on Roku Stock

I understand the bull thesis behind Roku stock. If content neutrality is that important and truly a differentiating factor in the long-term, then Roku will morph into a global aggregator of streaming content services. In that scenario, a $50 price tag on Roku stock today makes sense.

But that scenario seems increasingly unlikely the more competition ramps up, the more smart home markets mature, and the less content neutrality appears to be a differentiating factor.

All in all, then, while the bull thesis makes sense, there are also major risks inherent to this growth story. As such, Roku stock seems like a wait-and-see scenario at current levels. After all, no one is crying about buying Netflix at $100 as opposed to $50. Both buyers have won big-time.

As of this writing, Luke Lango was long AAPL, GOOG, AMZN, and FB. 


Article printed from InvestorPlace Media, https://investorplace.com/2018/05/roku-stock-should-jump/.

©2024 InvestorPlace Media, LLC