Roku's Latest Sell Rating - A MoffetNathansonburger

Corinthians Chapter 15 verses 1, 3-4 state, "Now, brothers and sisters, I want to remind you of the gospel I preached to you, which you received and on which you have taken you stand. For what I received I passed on to you as of first importance: that Christ died for our sins according to the Scriptures, that he was buried, that he was raised on the third day according to the Scriptures."

Tomorrow is Good Friday, the day Jesus Christ was crucified on the cross and died. It is a day to remember our Lord for His sacrifice and love for us. It is also a day to acknowledge that He not only died on Good Friday but rose from the dead the following Sunday as God.

Roku, Inc. (ROKU) has had a very tumultuous trading history over the course of the pandemic. Like other aggressive growth peers, ROKU has seen an extreme surge in its SP, only to see a precipitous fall thereafter.

Just over the last year, ROKU topped out at $490 in July 2021, since then, it's been a steep fall of 77% thus far in 2022. This would seemingly be correlated with a substantial reversal in the business model performance and Revenue. Ironically, this isn't the case - ROKU is no Peloton Interactive, Inc. (PTON) with expected declining Revenue for 2022.

Looking at the charts and no one would know the difference. This is the game afoot where Wallstreet had been calling for the reversal from the pandemic. Initially it was predicated on negative Revenue performance from the pandemic's inflated results. This changed to "slowing growth" narrative once it was clear that big winners were only going to continue to win, and yet companies like ROKU and PTON are pitted equally when the their futures are clearly divergent.

Even near ROKU's severely discounted low-point, MoffetNathanson has come out with a sell rating. Don't get me wrong, this firm has been bearish on ROKU for a while. And it's important to consider their points as detailed below, especially as I feel there are strong counters to them all:

  • Newly combined Warner Bros. Discovery (WBD) will combine HBO Max and Discovery+ into one and will also have greater leverage over ROKU when deal renewal arrives

  • Rising competition in the AVOD and ad-supported SVOD arenas will likely force ROKU into creating more and more original content, which will likely pressure GMs and FCF

  • U.S. consumers appear to be moving away from connected streaming devices to Internet-enabled TVs

Risk 1: WBD

I'll admit that I'm not completely done building all the data for comparisons for ROKU, namely Comcast Corporation (CMCSA) and WBD, but I have built out other peers like Alphabet, Inc. (GOOG), Amazon, Inc. (AMZN), Apple, Inc. (AAPL), Netflix, Inc. (NFLX), and The Walt Disney Co. (DIS). The problem is that none of them really have directly broken out details that are comparable to ROKU. It will take a little more time to deconstruct these out, but I digress.

The key point for Risk 1 is that ROKU has already negotiated deals with GOOG, AMZN, AAPL, former At&t, Inc. (T), now WBD, and CMCSA. That's a pretty big list of agreements updated the past year or so, so MoffetNathanson's concern with respect to WBD's leverage is highly questionable.

Will WBD try to leverage its content to stall an agreement? Yes, this is likely, but it is common practice in the media industry, and as ROKU continues to scale each quarter, there will be an equivalent, if not greater risk for WBD who will feel the pressure, especially from a FOMO perspective. It is debatable as ROKU's scale grows and data value increases as to who needs who more, especially with WBD being one of the later comers to the party.

There are also many risks and challenges that WBD will be facing to integrate its newly formed content and streaming businesses. Ironically, MoffetNathanson does not have a bullish stance on WBD either, and is also bearish on them. Execution risk and the timing for WBD to get things together will be pressured as they play catch-up.

Another important point, which will be discussed more below is AVOD v. SVOD. For those not aware, this is simply advertising-based video on demand versus subscription-based video on demand. I like to consider how my son and his peer group consume content, and the irony is on some days, they are watching completely free AVOD content, and on other days, they watch SVOD content. In any case, most families could easily have the option of going either way. As content continues to proliferate faster than conglomerates can acquire it all, their subscription-based services are really not as powerful as times past during the legacy cable/satellite TV days. Neither is their control over advertising.

While WBD may cause a little bit of a stink during agreement re-visitation and negotiation, I don't foresee any real pull to negatively impact ROKU"s business. Case-in-point, ROKU's most recent deal with AMZN was completed without any major fuss extending a multi-year contract agreement.

Risk 1 is clearly a MoffetNathansonburger.

Risk 2: Competition AVOD/SVOD

I simply disagree with this claim. It's actually a little confusing as AVOD, SVOD, and ad-supported SVOD will only continue to increase ROKU's ARPU, or monetization. It's clear that AVOD is outperforming SVOD. With the proliferation of add-based Apps, many users have found a vast amount of content that is free. Free content is great, and commercials are acceptable, especially for those who remember how horrific it was via satellite/cable between breaks, sometimes 2-4 minutes of lost viewing time. Many add-supported content Apps have 2-4 advertisements which are all typically less than 30 seconds, and in many cases 10 seconds or less.

This is likely why only 18% or so of linear TV advertising has shifted to streaming as it is a hard sell to lose a lot of time for the streaming advertising model. This is also where ROKU has been very innovative in using its main screen and controller as a further direct advertising option. There are many more innovative ways for ROKU to use this approach to continue pushing content, notably for those willing to pay more for this visibility and space/time.

I don't believe ROKU will be forced into excessively spending on exclusive content development. ROKU has been very strategic in taking a moderate approach through strategic acquisitions with notable discounts (Quibi), combined with its own production. ROKU's primary goal is to optimize its advertising services through its data analytics. ROKU knows AVOD, SVOD, ad-supported SVOD, and direct consumer content purchase information, and has an infinite amount of data to slice and dice how this can add value to both content producers and viewers alike. There remains an infinite amount of possibilities of the power and value-add here.

Risk 2 is clearly a MoffetNathansonburger.

Risk 3: Internet-enabled TVs

This is another confusing risk. Connected streaming devices versus Internet-enabled TVs or Smart TVs, is an area where ROKU is leading the charge. ROKU, via TCL is the number one Smart TV selling operating system in North America. This fact actually completely negates this risk. ROKU is expanding globally through Smart TVs, already penetrating the Mexico market by 20% in two years.

There have been recent bearish takes on ROKU based on the loss of exclusivity with TCL of late, as well as analysts assuming that ROKU will never land a Tier 1 hardware deal with the likes of Samsung or LG, which all are more valid concerns. Regardless, ROKU continues to expand its hardware partnerships towards 20 or so hardware companies, now has a ready program for ROKU certification, that TCL has entered into, has partnered with Nielsen, and has more recently even been rumored to be considering directly manufacturing its own Smart TVs. In other words, ROKU is well prepared to deal with partnership challenges and exclusivity, and has a long history of understanding the value of these variables with respect to the business model.

The number of TV households in the U.S. continues to increase with average number of TVs per household being near two. ROKU by far is the leader versus the core competition in GOOG, AMZN and AAPL. More than 33% of those who streamed the Super Bowl this year did so through ROKU. Smart TV technology is most advanced in the U.S., ROKU continues to dominate this market, and through rapid success globally, will be capable of doing the same internationally. From an operating system perspective, ROKU expects the players to be few that win out over the long-term, and they expect to be one of them.

Risk 3 is a whopper of a MoffetNathansonburger.

ROKU Remains a Big Opportunity

ROKU went public back in 2017. The company has witnessed a very volatile valuation multiple ride since this time, with the peak occurring during 2019/2020. 2018 was consistent with most growth peers witnessing a very poor year. Year-to-date is also similar for selectively targeted aggressive growth leaders, and as the PTON example shows, unduly so. The bottom line, ROKU is undervalued, the question is by how much.

NFLX is the closest peer to compare against ROKU as all other peers are valued on aspects that are more complicated as most have streaming businesses reflecting less than half of their total Revenue, and even less with respect to OCF. NFLX also has a rich history of historical data.

NFLX's story is easily observed through its valuation history. During 2011/2012, the company was pivoting to the streaming model and naysayers were pounding them based on execution risks, and competitive threats. I had a call with Discovery Communications during this time and they didn't even take NFLX's pivot seriously, oh the irony. This was also the best time take the risk in NFLX, aside from legacy investors during the early DVD business days.

We can also clearly see the impacts on Cash Flow as streaming content spend took off post-2014. Since 2015, NFLX's YTD EV/Sales is at the lowest level in the company's streaming-based history. The fact that NFLX is trading with a higher EV/Sales than ROKU is absurd. NFLX is expected to grow at an annualized 14% Revenue growth rate over the mid-term, and is looking to pivot into gaming as the streaming model continues to slow. ROKU on the other hand is expected to grow at an annualized Revenue growth rate of 33% for the mid-term. I also expect NFLX to revert back to a negative OCF/Share result as content spend ramps back up. NFLX streaming model has never been able to sustain positive Cash Flow.

Adding my financial model forecast to the historical valuation perspective, and I'm looking for ROKU to head back towards 15 times EV/Sales, and grow into its Cash Flow with a multiple of 70 times OCF/Share. I am forecasting ROKU to be headed towards $10 billion in Revenue by 2026, with the potential to achieve a 20% OCF margin. My Price Target is just below $1,000 per share, affording a potential annualized 55% return for investors over these next five years.

ROKU has gifted investors with a return to 2018 December valuation levels. The valuation is arguably discounted by 50%. My Price Targets for 2022 and 2023 stand at $255 and $425 respectively. The market is highly schizophrenic at the moment which means valuation is out the window. The next decade is going to really see a shift in herd mentality for aggressive growth as winners will only become more clear, as will losers. Today, unfortunately, many winners are being lumped in with the losers - ROKU is not a MoffetNathansonburger.

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