What’s interesting about Roku (NASDAQ:ROKU) stock at the moment is that it’s done what so many investors have expected other stocks to do. In just 16 trading sessions, the ROKU stock price has fallen some 40%.
It’s a stunning move — particularly since the news surrounding the stock seems relatively minimal. Rising competitive threats have been cited as a catalyst — but hardly seem like enough to drive such a steep decline.
Rather, the market seems to have finally soured on Roku stock and its peers. For years now, particularly in tech, valuation-focused investors have decried the multiples — on revenue, not even profits — assigned to stocks like ROKU. Those multiples have come in. And given ongoing fundamental concerns, that suggests more pressure on Roku stock going forward.
Why the ROKU Stock Price Has Plunged
Most coverage of ROKU has cited competitive fears for the steep decline from $170 on Sept. 6 to $104 as of this writing. Comcast (NASDAQ:CMCSA) is offering free streaming boxes to wireless-only customers. That announcement sent the ROKU stock price down almost 14%. Apple (NASDAQ:AAPL) launched its Apple TV+, priced at $4.99 per month, which may drive higher usage of its Apple TV devices.
That said, there’s something else at play here. Again, ROKU shares have dropped 40%. The Comcast announcement created less than one-third of that decline.
Competition alone isn’t the only, or even the primary, factor. Rather, this just seems like a momentum stock that has broken. The ROKU stock price went parabolic in August, after a strong second-quarter earnings report. It’s since come back to Earth.
And it’s important to note that Roku stock hardly is alone. I noted last week that the bubble in Shopify (NYSE:SHOP) had burst. Recent IPOs like Uber (NYSE:UBER) and Lyft (NASDAQ:LYFT) are at all-time lows. Many of the stocks seemingly most at risk of crashing have done exactly that.
It may be that the debacle of the failed WeWork IPO reminded investors of the risks — and the valuations — in tech growth stocks. It simply may be that valuations got too high for these stocks to find incremental buyers. Whatever the cause, it does appear like the days of paying any price for growth are almost over. That’s a problem for a stock like ROKU.
Fundamental Concerns and Wall Street
It’s also worth noting that, in retrospect, ROKU’s early September peak seems almost textbook. It began three sessions after D.A. Davidson boosted its target to a Street-high $185. Five days after that raise, another analyst more than doubled his fair value estimate.
This seems like a classic case of analysts trying to catch up with a stock, rather than leading it. And that often turns bullish right at the top. From there, as the old saying goes, when even bears turn bullish, there’s often no one left to actually buy the stock.
Meanwhile, one of the analysts still defending the stock highlights a long-running misconception about Roku stock. Needham analyst Laura Martin (no relation) noted that hardware drives just 5% of gross profit. So-called “platform revenue,” including ad sales, generate the rest. And so Martin wrote that “even if Roku’s hardware sales went to zero TOMORROW,” the impact on ROKU stock “would be minimal.”
But that misses the point about the competitive pressure from the likes of Comcast and Facebook (NASDAQ:FB). The issue is not hardware sales going to zero. The issue is hardware pricing going toward zero.
After all, Martin is correct in noting the minor contribution of hardware sales to gross profit. But that’s because hardware is a loss leader: ROKU loses money on those sales.
The company doesn’t break out exactly how much, but hardware gross profit has been just $23 million, total, over the past four quarters. Research and development spending for the entire company over the same period has been $214 million. At least a chunk of that spend is going to hardware, showing that operating profit from hardware is sharply negative. What happens if pricing comes down even further?
ROKU Isn’t Cheap
Meanwhile, the broader problem holds even after the decline: ROKU isn’t cheap. It’s still valued at nearly 300 times the high end of 2019 adjusted-EBITDA guidance. Enterprise value to revenue is above 10x, again based on full-year guidance.
But as I’ve long argued, investors need to value ROKU on only the platform revenue. Again, player revenues are unprofitable; there’s little real reason to pay any material multiple on those sales. With player revenue guided to two-thirds of the total — about $725 million — EV/revenue still clears 16x. That remains one of the highest multiples in the market.
To be fair, ROKU admittedly does merit a big multiple. It’s a key player in streaming and still has leading market share. I’m skeptical either Facebook or Comcast can really make a dent in that share, though their efforts may add to the pricing pressure on Roku hardware.
The launches of streaming services from Comcast, AT&T (NYSE:T) and, most notably, Disney (NYSE:DIS) will create new sources of ad revenue in the near to mid term. This is a good business that is going to grow — and going to be profitable.
But that’s not the issue. The issue is how much growth, how profitable and how expensive. And this is a stock, even just above $100, that still seems priced for something close to perfection. The last few weeks show how fragile a stock like that can be.
As of this writing, Vince Martin has no positions in any securities mentioned.