The COVID-19 pandemic accelerated several major trends that were already forming in the late 2010s. One of these was a shift to streaming video over linear TV, as nearly every major media company launched a new streaming service and had a captive audience to sell to. One of the biggest beneficiaries of the pandemic period was Roku (NASDAQ: ROKU)that operates the world’s largest connected TV platform.
Roku’s stock price more than tripled in the six months from mid-August 2020 to mid-February 2021, with shares hitting an all-time high in late July of that year. But shares fell precipitously through the end of the year and into 2022.
After a strong rally in 2023, Roku shares appeared poised to continue their momentum in 2024. But the market had other ideas. Shares are currently down about 25% year-to-date and more than 85% from their all-time highs.
But now it could be a great opportunity for investors. Roku is posting strong operating results and the potential is great, especially if you take a long-term view. The ills of the past few years seem largely behind us.
The biggest barrier to Roku’s results
Roku posted strong results in 2020 and 2021 as media companies launched their own streaming services. As the largest streaming platform in the United States (and many other countries), Roku had a lot of leverage with media companies looking to attract large audiences. As a result, it was able to negotiate favorable terms for revenue sharing, ad inventory sharing, and ad buying on its platform.
In addition, growing competition among streaming services has led to higher ad prices for some of its core ad inventory. Platform revenue, including its advertising business and revenue sharing, grew 80% in 2021.
Then the Federal Reserve began raising interest rates, investors pressured media companies to make streaming profitable, and further consolidation occurred in the industry.
The competition and ad sales that fueled Roku’s incredible success in 2020 and 2021 dried up, leading to a massive hangover in 2022. Additionally, high inflation and a shaky economy led to a general decline in ad spending, further dampening Roku’s results.
Platform revenue grew just 20% that year, but shrank 1% in the first quarter of 2023. Gross margin also shrank every quarter.
Media and entertainment (M&E) ad spending continues to weigh on Roku’s results today, but there are signs the worst is now behind us.
The future looks bright
Despite the setbacks, Roku is still growing its platform revenue at a good pace. In the second quarter, platform sales grew 11%. Management expects 9% year-over-year growth for this segment in the third quarter.
More importantly, gross margin is recovering from its bottom in Q3 2023. The platform’s gross margin was 53.4% ​​last quarter, and management’s guidance suggests a similar gross margin next quarter.
In the fourth quarter, management expects platform revenue to accelerate and deliver seasonally strong gross margin. Management also believes platform revenue will accelerate in 2025 as demand recovers and the company expands its ad inventory.
Roku’s core user metrics look great. It added 2 million net new users during the quarter and saw increased engagement as well. The average Roku household watches four hours of content on the platform every day, up from 3.8 hours a year ago. Roku accounts for 47% of all U.S. streaming time on connected TVs, according to data from Comscore.
That’s a hugely engaged audience for advertisers, and they’ve noticed. Excluding M&E ad spend, Roku saw ad revenue grow faster than the overall ad market and the U.S. streaming video ad market last quarter. Investors should expect that trend to continue, more than offsetting any weakness in M&E.
The distant future looks even brighter
The investment thesis for Roku, as CEO Anthony Wood continually emphasizes, is that all media will eventually move to streaming. When that happens, Roku, with its substantial share of connected TV streaming hours, will benefit enormously.
As mentioned, the shift to streaming intensified in 2020 and 2021 as media companies rushed to launch their streaming services and poured a ton of money into them, in part by advertising on Roku’s platform. The dust is starting to settle on that frenzy, and media companies are now being forced to justify their spending. But the long-term trend remains intact.
In fact, we’ve seen more and more deals between media companies to push users into streaming. The next frontier is sports entertainment. Disney, FoxAnd Discovery of Warner Bros. are planning to set up a joint streaming venture called Venu for their sports offering. Amazon has just acquired the rights to certain NBA games.
And even Netflix Roku Inc. is getting into sports streaming with an NFL deal. Sports could be a huge opportunity for Roku, as media companies could spend money to drive viewers to their properties in real time, and Roku could leverage its position to grab a slice of the ad inventory within streams.
While Roku has had a rough patch, it appears to be returning to form and its long-term thesis remains intact. At the current share price, it appears to be a steal for a leading company in the sector with excellent growth prospects.
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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Adam Levy has positions in Amazon, Netflix, Roku and Walt Disney. The Motley Fool has positions in and recommends Amazon, Netflix, Roku, Walt Disney and Warner Bros. Discovery. The Motley Fool has a disclosure policy.
1 Incredible Growth Stock That’s Down 85% And You’ll Regret Not Buying It When It Dropped was originally published by The Motley Fool
