I get the case for Roku (NASDAQ:ROKU) as a business. The concern — or one of the big concerns, anyway — is the ROKU stock price.
ROKU stock has risen 260% in 2019 alone. It’s added some $9 billion in market value over that period. To be sure, ROKU had crashed at the end of 2018, and likely was too cheap at those lows. Still, the gains are close to staggering: none of the 720 stocks with a market cap over $10 billion have outperformed ROKU stock so far this year.
Again, there is a bull case here. In fact, I’ve made that bull case. I also argued last month, with the ROKU stock price over $100, that the rally had gone too far. For a moment, that call looked prescient, as the stock promptly fell over 10%. But a more confident market has bid ROKU back up to an all-time high.
Ahead of earnings, coming on Aug. 7, those highs look too high. There’s value here. But to even stay at these levels, Roku will have to answer some key questions.
So much success is priced in at this point that it seems difficult to get too excited. Of course, I — and other skeptics — have said that before.
Can the ROKU Stock Price Hold the Valuation?
On its face, ROKU looks expensive. The company is guiding for over $1 billion in revenue this year — which suggests something around a 11x+ EV/revenue multiple, backing out some $285 million in cash.
Of course, in this market, 11x sales — even for an unprofitable company — isn’t all that extreme. Whether it’s Shopify (NYSE:SHOP) or MongoDB (NASDAQ:MDB), growth stock investors have become accustomed to paying those types of multiples. Even streaming giant Netflix (NASDAQ:NFLX), accounting for its post-earnings decline on Wednesday, trades at 9.4x EV/revenue, based on 2019 analyst estimates, with slower growth.
But, as I’ve written before, it’s important to remember a key aspect of Roku’s business. The company’s player business — the actual sales of Roku hardware — is unprofitable. Players generated gross profit of just $7 million in the first quarter, for example. It’s the platform revenue from advertising, the Roku Channel, etc., for which investors are paying.
That revenue is guided to two-thirds of this year’s total. That in turn means investors are paying roughly 17x platform revenue — one of the highest multiples in the entire market. It’s difficult to see that moving any higher — and there are reasons to think it might move lower.
Will Netflix and YouTube Play Ball?
That multiple might seem acceptable given Roku’s key position in the growth of streaming. But the problem is that Roku isn’t monetizing that position all that well.
Notably, per the Roku 10-K, Netflix and Alphabet’s (NASDAQ:GOOG,NASDAQ:GOOGL) YouTube account “for a majority” of hours streamed on Roku devices. Roku does not get “material revenue” from YouTube, however, and still appears to receive few dollars from Netflix.
That might not be a terrible thing in terms of growth. The lack of dollars from those streaming giants means that new streaming services from Disney (NYSE:DIS), AT&T’s (NYSE:T) WarnerMedia, and Comcast (NASDAQ:CMCSA) subsidiary NBCUniversal all can provide catalysts to revenue and profits.
But from a long-term perspective, it’s hard to see how ROKU stock is a clear and easy play on streaming when it’s not making money from the industry’s two biggest players (at least for now). And it’s difficult to see why Disney or WarnerMedia would pay Roku when they’re competing against Netflix and YouTube.
Who Buys Roku?
These questions are largely moot if Roku gets acquired. Rumors have swirled since even before the company’s IPO. At this point, Roku clearly has out-competed Alphabet and Amazon (NASDAQ:AMZN) in terms of streaming devices. As such, it would make sense that some company might want to acquire it as an entry into the streaming ecosystem — or a way to profit from it.
The problem at this point is: who? If anyone involved in streaming acquires Roku, it then owns a gateway for cord-cutters. But so many other companies are involved in streaming, that the new Roku owner instantly would own the distribution mechanism for its competitors.
That’s a sticky situation. It makes streaming providers more hesitant to deal with Roku; they might instead turn to Amazon, who is having some success licensing its Fire TV operating system (OS) to television manufacturers. It puts Roku, at this point a subsidiary of a larger player, in an awkward position.
Meanwhile, Alphabet, Amazon and Apple (NASDAQ:AAPL) all have their own hardware (Apple’s platform is on the way). Disney and NBCUniversal won’t be looking to provide streaming services for their competitors. Smaller media companies, at this point, might be too small given Roku’s about $12 billion enterprise value.
It’s easy to assume that Roku will be bought out. But the same assumptions were made about TiVo (NASDAQ:TIVO). These aren’t the same situations, of course, but the names of potential Roku buyers being floated around don’t make all that much sense — at least not yet.
Be Careful Ahead of Earnings
Particularly with Netflix’s post-earnings flameout, ROKU stock simply looks dangerous here. Valuation is a question mark. Competition remains intense. An acquisition is far from guaranteed.
And, as we’ve seen with Netflix, streaming growth isn’t quite as linear as some would like to believe. For ROKU, so much success is priced in that anything short of a blowout quarter next month is going to be a problem. There’s a wonderful business here, to be sure. It just might not be quite as wonderful as the ROKU stock price suggests at the moment.
As of this writing, Vince Martin has no positions in any securities mentioned.