I find myself in an unusual position with my InvestorPlace colleagues. As I read through recent articles on Roku, I find myself to be on contrarian island. Because while I think Roku (NASDAQ:ROKU) is a great product for consumers, I’m not sure ROKU stock is a great investment. At least not in the way many investors think about it.
The conventional wisdom is that as consumers continue to cut the cord, they will flood to streaming services. And Roku is like a filing cabinet that houses a consumer’s streaming services in one Smart TV that conveniently includes Roku’s app.
That’s great for consumers. They don’t have to specifically pay for the Roku app. But Roku has to make money somewhere and that’s where the problem lies for me.
Ad Revenue Is Falling While Platform Usage Increases
In April, I wrote about Roku’s underlying problem. Roku makes the majority of its revenue by selling unsold ad inventories. These are the ads that a publisher or network could not sell or could not sell at a premium.
During the pandemic, there was no shortage of unsold ads for Roku to sell. The challenge was that digital advertising was declining. So, while Roku may have had no problem finding ad content to sell, they may have had a tough time selling those ads at appropriate rates.
At the time I called this Roku’s “coronavirus conundrum.” Even as the company was seeing higher engagement, it wasn’t getting higher revenue.
For advertising revenue to increase, the economy needs to open up.
As the economy opens up, consumers will likely be looking to do anything that doesn’t involve watching digital content. And that includes watching content that’s available on traditional television services.
Roku offers consumers with an essentially free lock. But the key to revenue is the streaming services.
Live Sports Are Roku’s Kryptonite
I know that there is a significant group of investors who could care less about sports. And they would be wrong. I kid of course. When it comes to entertainment, to each his own is my motto. However, sports have a way of uniting a country in ways that are not quantifiable. I think about the World Series after the terrorist attacks of 9/11. I think of the way the world comes together for the Olympics.
There’s a powerful draw to watching live sports. And there is pent-up demand. In the last couple of weeks, it has become more likely that the National Basketball Association (NBA) will resume its season and Major League Baseball (MLB) will start to play.
Now keep in mind, Roku is just a vessel. And it’s a vessel that is counting on consumers to not watch live sports. This is because live sports are not available on Roku unless consumers sign up for that channel.
But wait, you say, that’s just semantics. It is for a consumer, it’s not for an advertiser. Because if I’m going to pay for advertising for the NBA playoffs (which may be the most watched in history), I have to pay that revenue to Time Warner’s Turner Broadcasting, ESPN which is owned by Disney (NYSE:DIS) or any of the other networks broadcasting the games.
And with the likelihood that these games are going to draw huge numbers, a company’s advertising spend is likely to shift to more traditional forms. That may be done at the expense of digital advertising.
But according to eMarketer, 70% of digital advertising revenue comes from Amazon (NASDAQ:AMZN), Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL), and Facebook (NASDAQ:FB).
Roku gets the unsold ads. And you better believe those tech giants will want a piece of whatever spots those advertisers are willing to buy online.
Manage Your Expectations for ROKU Stock
By early May, ROKU stock had more than doubled from the March selloff. But it seems that investors are starting to rethink the stock. In the last month, the stock is down over 20% from its pandemic-driven high of $137.50. The consensus price target suggests that Roku can make up that difference. But I’m not so sure. Analysts are all over the map on this one. Consensus in this case is really of an average.
Roku is not yet profitable despite the fact that they are gaining users. The pandemic appears to be showing both the best, and the worst that ROKU stock has to offer. And if you’re willing to listen to a contrarian opinion, the future is not as clear as some think.
Chris Markoch is a freelance financial copywriter who has been covering the market for over five years. He has been writing for InvestorPlace since 2019. As of this writing, Chris Markoch did not hold a position in any of the aforementioned securities.
