Nov 15 2021 - Roku: An Opportunity For A Netflix 2.0 Run?

Summary

  • We like being on the long end of disruptive companies playing in big industries. ROKU is one such company.
  • ROKU, on the surface, appears to be a FAANG 2.0 type of company, taking the spot of 'N', NFLX.
  • 3Q earnings suggest that ROKU was deeply gashed by supply chain issues. Hardware sales came down, and even platform revenue was a little weak.
  • We don't like the overemphasis on hardware sales as a way of reeling consumers into the platform, as it degrades long-term margin upside. As an ad platform, however, ROKU is quite disruptive to traditional TV.
  • Restarting coverage of ROKU at Buy, PT of 0. Bear case at 5. Bull case of 8. While the stock could be stuck short-term, r/r likely skews upward long term.
Roku sign and logo on the modern facade of consumer electronics and broadcast media company headquarters in Silicon Valley

Michael Vi/iStock Editorial via Getty Images

Q3 Recap - Supply Chain Headwinds Weigh On Results

Roku (NASDAQ:ROKU) has taken a beating of late, which has only intensified since the company reported 3Q earnings results and delivered their 4Q guidance. Let's briefly recap:

  Reality Cons. Expectations +Beat/-Miss
Revenue (in $m) 0 3.69 -0.5%
Platform Revenue (in $m) 3 2.2 +3.7%
Player Revenue (in $m) 1.49 -20.1%
Active Accounts (in m) 56.4 56.7 -0.5%
ARPU .10 .00 +2.8%
EPS .48 .06 +700.0%
Gross Margin (%) 53.5% 47.8% +570bps
4Q Rev. Guidance (in $m) 2.5 6.16 -5.7%
4Q EBITDA Guidance .4 -22.6%
4Q Gross Margin Guidance 43.1% 45.1% -200bps

Results were a pretty mixed bag that generally trended negatively. 3Q results were at best lukewarm, with strong KPIs in platform revenue, ARPU, gross margins, and earnings. Weakness stemmed from active accounts (relatively in-line w/expectations), player revenue, and total revenue. Meanwhile, 4Q guidance was downright atrocious. For a high multiple stock, consistent beat-and-raises are necessary to sustain and expand high multiples. EBITDA, a strong point of 3Q, was guided down significantly in 4Q, while gross margins, a 3Q strong point, were guided 200 basis points lower than consensus. Additionally, and possibly worst of all, 4Q revenue guidance came in ~6% light of expectations. It's really no wonder the stock has been in the deep red since. Let's look at the conference call to gain more clarity on the story.

Conference Call Notes - Supply Chain Issues Hitting Hard, Tough Comps, YouTube Negotiation Challenges,

While we continue to scale the platform, we believe that the slowdown in active account growth rate this quarter was in large part attributable to global supply chain disruptions that have impacted the overall US TV market. - Steve Louden, CFO

This is one of the first times in this call that Roku management calls out supply chain issues and it won't be the last. Considering that hardware is the lure into account creation for Roku, disrupted hardware supply chains lead to reduced hardware sales (TVs, sticks, audio bars, etc.). Reduced hardware sales lead to reduced account creation, leading to the miss we saw in the quarter. Competitive headwinds are not called out here, as it would probably be contradictory to the narrative management is trying to tell. Even still, we can see that global supply chain issues have adversely effected Roku new account creation.

Specifically overall US TV sales in Q3 fell below pre-COVID 2019 levels. We believe this was largely a function of lower inventory and higher component costs being passed along to consumers as overall US TV prices increased 42% year-over-year. We believe that some of our TV OEM partners were hit particularly hard with these inventory challenges. - Steve Louden, CFO

Adding more color to that, we see that this is a macro problem across TV products in general, not Roku TVs in particular. This is a challenging market dynamic. As lead times grow, supply shrinks. As supply shrinks and demand increases, prices rise, driving cost inflation. This is what management is referencing when it comes to component costs. Think about semiconductors in particular for these smart TVs. The chip shortage has been well known for some time now, and is just one example of these headwinds hitting TV OEMs, and Roku (indirectly), hard. OEMs, in order to keep margins intact, are passing on higher component costs to the consumer, leading to reduced demand. Less Roku TV sales, less account creation, etc.

Meanwhile Roku player unit sales remained above pre-COVID levels and the average selling price decreased 7% year-over-year as we chose to insulate consumers from higher costs. - Steve Louden, CFO

Players themselves are having a net stronger demand relative to TV OEMs, though ASP declines are real consequences of supply chain issues. This reduction in ASPs is what likely drove gross margin erosion, as Roku chose to prioritize account growth over short-term player margins, a wise move in my book.

Roku users streamed 18 billion hours in the quarter, an increase of 21% year-over-year as we continue to outperform viewing hour growth rates of both traditional TV and other TV streaming platforms. - Steve Louden, CFO

Engagement on platform continues to scale, even against the tough comps of 3Q'20. Strong performing KPI, and adds credence to the thesis that Roku is coming for traditional TV share.

Additionally, certain advertising verticals could reduce spend in Q4, due to limited product availability. - Steve Louden, CFO

Another interesting tidbit here from management that lines up with what we've heard from social media ad companies and others. Particular verticals seeing incremental supply declines because of supply chain headwinds are likely going to drop marketing spend, as they can't fulfill incremental demand. Roku's platform is not immune to this, and it could contribute to a deceleration into next quarter.

We anticipate that the ongoing investments we are making as we grow and expand our business will increase operating expenses on a sequential basis and as a result we expect Q4 adjusted EBITDA to be million at the mid-point. - Steve Louden, CFO

Sequentially, management is (pretty unsurprisingly) guiding to an uptick in operating expenses. Management is investing in the business through these headwinds, a potential sign of optimism around the long-term value of the platform.

So first one is tough comps from last year. So especially on the platform side, we delivered exceptional performance in Q4 of 2020, largely driven by very strong media and entertainment spending by content publishers strong results on the content distribution side. That was the time when you had a couple marquee services that we were launching or building up in terms of HBO Max and discovery+ launching. And so those are a couple of factors that make the year-over-year comp pretty tough. - Steve Louden, CFO

We've already heard a lot from management with regards to weakness in the hardware section of the business. Here, management seems to be calling to platform weakness as a potential driver of the guide. While platform is exhibiting great relative strength to player, platform is still in a period of lapping 4Q'20 comps. This was a time marked by the initial rollout and scaling of streaming services that were revenue accretive like HBO Max and Discovery+. Considering the fact that this is one of the most transitory headwinds management could call out, we think that's a good sign.

When you look at the Roku Player results, as you mentioned Roku revenue -- Roku Player revenues and Roku units are down year-over-year based on an extraordinary demand spike in the pandemic in Q3, 2020. But player unit and player revenue are actually in Q3 above 2019 levels. - Steve Louden, CFO

While this has definitely been a rough quarter on the player side of the business (and a rough guide too), compared to more normalized pre-Covid comps in 2019, player units and revenue are still net up. So the strength in the hardware business, when you take a step back is still pretty much there.

But also I think if you just think about the drivers of our ad business because some of your questions were about our ad business, the biggest driver of the ad business is not these kinds of details [regarding potential headwinds to particular ad verticals]. It's the fact that if you look at TV time in the US today adults 18 to 49 spend 42% of their TV time streaming. But if you look at the amount of ad spend on streaming versus traditional TV, it's only 22% has moved to streaming. So there's this big gap still and that gap is starting to close, but has a long way to go. That -- the rate of that closure because they will catch up eventually and the rate of all viewers moving to streaming those are the biggest drivers of our ad business which is a billion opportunity. - Anthony Wood, CEO

It's good to see management, in spite of the short-term headwinds the business faces from the supply chain crisis, call out the longer-term market opportunity. While we are definitely seeing some lumpiness in hardware, particularly from Roku's TV OEM partners, and even some lumpiness in particular ad verticals, the secular story remains intact. At least, it does in management's belief. The idea of traditional linear TV ad dollars transitioning to 100% OTT is still the story here. It's good to see the head of the company reiterating that confidence.

So on YouTube, I don't have new info for you. I would point you at our recent blog post for our perspectives on the topic. One thing I will say is as we said before, it's not about the money, it's about our ability to create the best possible experience for our customers. We're working to resolve this matter. We don't have an update and our goal is to land it in a way that's positive for Roku and for our customers. As for the -- your Amazon question, we have renewal discussions with hundreds of partners each year. It's normal course of business. Our goal in these discussions is always to reach an agreement that's good for our partner, good for our customers, delivers a great user experience. Despite what you may have read, our Amazon agreement is not up for renewal or in negotiations at this time. - Scott Rosenberg, SVP of Platform

In a business where content is king, losing content on your platform is the exact opposite of what you want. Building out a walled garden approach is exactly what has made Netflix (NASDAQ:NFLX) so successful. While Roku isn't losing Amazon (NASDAQ:AMZN) as a partner, as some believed, losing YouTube could be a real blow. Again, owning their own content portfolio would solve this, but this takes a lot of time and a lot of money. This is a problem investors should monitor in the coming quarters. What is the likely reason for losing YouTube? The motivation might have to do with building out a degree of exclusivity on Alphabet's (NASDAQ:GOOG) (NASDAQ:GOOGL) Roku competitor, Google Chromecast. While obviously Alphabet would assert the opposite, the synergies are definitely there to make it worthwhile to have 1P content in the loop of other content.

Yeah, in terms of active account growth, we haven't broken out the specific of international, but the vast majority of the active account base is in the US historically. International has been growing faster than the US. And so over time that will continue to grow in mix. And we're really excited that not only are we making good progress in existing international markets in terms of having scale and market share in existing countries, but we're continuing to increase the footprint. So we just announced entering Germany with player -- starting with players here that just happened. We launched with SEMP TVs in Brazil and we're expanding the Roku TV footprint in Latin America also adding Peru and Chile later in the year. So over time, international will become a greater share of the active accounts. - Steve Louden, CFO

The vast majority of revenue and active account creation on the Roku platform has been domestically generated. The opportunity to expand internationally in terms of both users and revenue remains quite robust. They're already moving into Germany and Brazil with hardware, while adding Peru and Chile to attack the LatAm opportunity. One of the great TAM unlocks for businesses in general is international expansion. Considering B+ in the domestic market alone, moving internationally could unlock an even greater market globally. This starts with hardware partnerships in global markets to generate the account adds that they would need to fuel long-term advertiser value.

Just in terms of the way the TV business works is there's different roles, different companies take in the supply chain. And the results of all of that if you were to dig into it is the brand you sell your TV under does not affect the price. It's not a factor in the price. - Anthony Wood, CEO

So Roku, in spite of Wall Street's curiosity, is not looking to take a more active role in the manufacturing or distribution of their TVs, and likely prefers to stick with OEM partnerships and licensing their operating system. This means Roku can focus on what's more to the core of their vision rather than branch into things outside of their expertise, or move into commoditized, lower margin businesses. Management believes that branding on TVs, unlike many other consumer technologies, is largely irrelevant when it comes to end purchase intent.

We are a first stop for anyone in the streaming services business because we have an effective promotions platform our scale our data our tools make it cheaper ultimately for the streaming services to acquire and retain users than all their other options where they might spend.

So, the M&E category in Q3 grew faster, substantially faster than the overall platform and the ads business. The growth is still strong although it is moderating. It's more normalizing as we come off of the pandemic. - Scott Rosenberg, VP of Platform

M&E is a part of Roku's business that essentially helps content distributors and platforms get new audiences across the Roku platform. Display ads on the OS are one example of M&E in action. Roku's key advantage is scalability, data, and tools to add users to apps and to reduce attrition. I think that if anything, Roku acts as a great tool for SVOD and AVOD services to promote content and reach across platforms to grow audiences. While it's slowing short-term as society spends less time streaming content over the internet, I think this is a long-term business that can win.

There's also a pretty long runway in our view around the M&E business. It's not ultimately just about user acquisition but as these services get bigger they also need to drive engagement and retention of those users that they've acquired. We've been building out the tool set, so that our partners can promote not just on that big home screen unit that you see when you start your Roku up, but in the channel store through video ads on and off the platform.

We've also made a lot of progress on our optimization technology so that we can deliver to the partner new users at their target customer acquisition costs. So, overall, although the business is normalizing as it comes off -- as we come off of the pandemic, the business continues to grow and I think is ultimately a tool a service that's going to be a great asset for our partners going forward. - Scott Rosenberg, VP of Platform

There are long-term tailwinds in this business, as I mentioned earlier, as these newer SVOD and AVOD platforms reach maturation. Keeping audiences engaged and reaching audiences is critical to sustaining and growing these services. Roku is in a unique position to serve appropriate ads to meet the objectives of their partners.

We're also seeing great strength in our performance or growth advertising set and these are advertisers that are driven primarily by optimizing to outcomes. That segment roughly tripled year-over-year and I think is indicative of our ability to attract a new class of digital or social first advertisers, who are less interested in reaching a demographic and more interested in optimizing for a site visit or a product purchase. - Scott Rosenberg, VP of Platform

One of the chief concerns I've had with Roku is the potentiality of linear TV advertisers (generally more top of funnel) to move to social and other formats of digital advertising. That said, it appears that more direct response and bottom-of-funnel advertising is growing on Roku. Actionable advertising is something that we think if anyone in CTV can do, it's Roku because of the depth and breadth of their offerings. This is something to keep an eye on long-term.

You mentioned the Shopify partnership this is a relatively new partnership. We were excited. It was - we have a beta program running with them where basically a merchant on the Shopify platform can opt through their platform to purchase advertising on Roku. And we've got a whole host of brands Jambys, Moon Pod, Birthdate, OLIPOP in that beta working with us through that Shopify connection.

It's still early days but the program was oversubscribed on the first day. - Scott Rosenberg, VP of Platform

Again, we've been skeptical on the ability of Roku, and TV more broadly, to attract a competitive presence relative to social in digital advertising. Considering that this beta was oversubscribed on day one, it seems there is plenty of SMB demand for CTV advertising, particularly in partnering with Roku.

Yes, as you alluded to and the way you framed up the question, the disruption and the noise around the loss of cookies and device IDs like Apple's IDFA in general is a net benefit to Roku, really for two reasons. First, independent ad tech is very challenged in an environment, where these identifiers are getting more scarce because, they don't have these identifiers. They don't have a direct consumer relationship, whereas Roku does. And so we're always working on our platform with our own first-party data and it's a fundamental advantage for us and ultimately is bringing brands to us. - Scott Rosenberg, VP of Platform

On top of this, management is calling out IDFA, a headwind for social, to actually be a potential tailwind for CTV. Roku's access to high quality first party data means they don't really need those third party insights that social needs to target ads more effectively. This could prove if IDFA headwinds are resilient in social, that CTV is a reliable option for direct response campaigns.

And Roku is a beneficiary there in the sense that brands are generally underinvested still in streaming relative to our scale and our capabilities. And we've got user, identifiers and data just like some of these big platforms. So in general, we come out ahead as brands step back and reevaluate their digital and social investments and it accrues to our benefit. - Scott Rosenberg, VP of Platform

The digital advertising business has been in a state of relative disarray since the sweeping IDFA changes made by Apple (NASDAQ:AAPL) reduced third-party ad targeting signals. Because of the sophistication of Roku's on-platform data, they are much more accurate in targeting without having to look cross platform. While advertisers have pulled back on budgets in social, Roku is popping up as an interesting option.

It's just built entirely on a digital big data targeted platform. It's got all the characteristics of a typical digital ad platform. And so we don't usually talk about that much but that market that uses those kinds of tools is just as big as the TV ad market. - Anthony Wood, CEO

Roku has the tools to support the vision too. Enabling a sophisticated ad platform with different formats, ad measurement tools, and more is crucial to scaling a digital advertising business. Roku has the tools to capitalize on the budget shift from linear to OTT.

There's SMBs there's direct-to-consumer brands that have grown up nationally. All these brands tend to approach their ad spend with a performance goal in mind. And we've got the tools to compete for it. - Anthony Wood, CEO

What's interesting here is the idea of CTV competing for DR dollars. This is where we feel that synergies between the Amazon commerce ecosystem and the Amazon CTV ecosystem would be more beneficial to direct response advertising, particularly eCommerce, then say Roku. That said, moving outside of linear TV, Roku clearly has an eye on a large TAM in social, SMBs, and direct response advertising.

... roughly half of TVs sold in the US are still running proprietary homegrown, operating systems not a licensed operating system.

And I personally, as we said before, we don't think that's sustainable. And you see that in the market share generally declining for these legacy TV companies as companies like Roku license ROS and gain share. - Anthony Wood, CEO

This is interesting, as it contextualizes Roku's unit runway with regards to deals involving new TV OEMs. The value proposition for building an Android-based in-house operating system for the TV is dead. It's expensive, requires maintenance and updates, higher memory capacity, bigger processors, etc. Licensed OS is likely the future of the connected TV market, and Roku is likely a player that can snag more OEM deal wins down the road.

We're also - as fast as we're growing we're still -- we still sell a minority of the ads on our own platforms. So there's a lot of inventory flowing through the Roku platform, for us to both sell as well as through our OneView Ad Platform to add value.

So even if the transaction isn't our own media sale even if it's a publisher on our platform, we can apply the same identity data optimization capabilities through our OneView Ad Platform that our advertisers have come to expect when they're buying media from us directly. You talked about ad load, which I heard is like would, we float the ad load up. We're pretty passionate about the user experience here and not floating the ad load up. - Scott Rosenberg, VP of Platform

Ad inventory remains high on the core Roku platform, and most of the ad sales Roku is doing is across platform via OneView. Roku is still very much in the early innings of filling through core platform inventory, in spite of their early success across platform. Additionally, they don't plan on materially increasing ad supply over the long term, a move that would likely be a negative to the user experience and could lead to greater attrition. This is somewhat negative, as unless they increase the number of ad formats (outside 15-30 second spots), they might have trouble scaling long-term ARPU. Obviously demand is another factor that probably goes up in time as CTV becomes the main method of TV advertising. But one thing that has propelled digital ad businesses like Meta (NASDAQ:FB) is their ability to continuously unlock ad supply through new formats. Roku should find new formats in time, but it would be hard to expand the core 15-30 second spots.

What's The Story With Roku? Continued TAM Unlocks (Social + SMB Mkt. Share), OTT 3.0, International Expansion

The optimistic vision of Roku's story is quite interesting. The Roku story centers around the inevitable push from cable and pay TV advertising to OTT/internet TV advertising. Streaming is simply superior to cable in terms of maintenance, cost, and customer satisfaction. Cord-cutting was a trend ongoing since 2014 that has been exacerbated by the pandemic. Roku's operation as a content aggregator allows them to capture net upside from the move to OTT content consumption.

The Roku story is likely to be fueled going forward by aggressive TAM expansion as pay-TV advertisers migrate online, encroachment into SMBs and social media budgets, content-based user interfaces (a concept called OTT 3.0), and expanding the business internationally.

Right now, we believe Roku is well positioned to capture incremental ad dollars leaving traditional TV for internet. Sports is the key blockade to progress to OTT, but over time, we see all content being viewed over the internet. This is a long-term trend and won't happen overnight, potentially enabling a decade long thematic to be at play here with Roku.

Additionally, as Roku optimizes the platform over time, expect a reorganization to curated feeds rather than simple navigation between apps. This likely leads to even greater engagement, streaming hours, and account adds as the content aggregation model grows increasingly efficient. We think OTT 3.0 likely leads to an acceleration in ad budget migration towards streaming.

The final factor is this broader theme of internet-based TV consumption playing out on a global scale. This is a long-term thematic that will not be limited to the US, and extends that decade plus long TAM attack opportunity.

Finally, we believe that if there is a long-term drag on ad efficiency on social channels, that SMBs, direct response advertisers, and large brand advertisers may begin to look for alternatives. While we are cautiously optimistic on a 'return to (relative) normal' in the post-IDFA world of social media advertising, we believe that advertisers will seriously look into Roku. If Roku can continue to flex its platform and data advantage in the CTV arena, advertisers may re-evaluate budgets in an incrementally positive way for Roku.

In essence, the reason to be bullish on the business is the broader thematic of OTT cannibalizing pay-TV advertising, and that Roku is probably an incremental winner as this decade plus tailwind picks up steam.

Why We're Cautious: High Third Party Reliance, Competition, Little Leverage In The Business Model, Low Moat, Medium Switching Costs, Gross Margin Headwinds From Hardware, Streaming Demand Pull Forward

We come away from Roku after restarting coverage in relatively neutral territory because of an elevated risk profile. While the broader thematics are almost second to none, this is a business with a heightened risk profile.

Roku is going to be highly reliant on third parties to succeed down the road. This can be broken down into two main categories: publishers and OEMs.

Roku signs deals with publishers to allow them to participate in the Roku ecosystem, and allow them to gain access to Roku's audience. The value proposition goes both ways. Take YouTube for example. The value for YouTube in being on the Roku platform is that YouTube gets exposure to 56m potentially new eyeballs on their platform, viewing their ad inventory, bolstering revenue, etc. For Roku, this increases streaming hours, locks users into the ecosystem more, and generates revenue from the ad inventory they slide off YouTube. The problem is, YouTube is in a position of leverage. They have 1b+ users, so while 56m potentially new users is a lot, it's not a make or break. So they can take advantage at the negotiating table on ad inventory, licensing fees, etc. They are in a position of leverage.

We find this to be similarly true with most of Roku's partners. While Roku does indeed provide good value for their partners, particularly the TV OEMs, we are not ever certain about their contracts with partners. For TV OEMs, the value proposition is a little bit more balanced. TV OEMs help add new users to the Roku ecosystem with sales of compelling devices. In turn, Roku provides an efficient, low-cost operating system that performs well and helps the OEMs' already low margin profile. While this dynamic is likely more stable than Roku's relationship with publishers, there is risk nonetheless. Specifically, as partner OEMs start to lean into competing offerings, or when competing platforms like Amazon go after taking greater ownership of their supply chains. Overall, while it isn't as worrying as their relationship with content partners, OEMs leaning into new offerings will make the market more competitive.

If key services like Amazon Prime Video or YouTube get pulled off platform in the long run to be utilized on Amazon's OTT service and Google's OTT service, that could be devastating to Roku. As Netflix has so clearly demonstrated, in the streaming world, content is king. We think that Wall Street underestimates Google and Amazon's ambitions to own their own content, and become dominant players in the CTV ad space over time. In essence, Roku has the lead, for now. We think if content is pulled off platform, Roku's lead is damaged significantly. However, if Roku can keep YouTube and Prime Video under contract, this stock can probably re-rate higher.

This underscores what we think is a fundamental tenet of the bear case on the stock: a very small moat. We do not see Roku as a business that is truly building a walled garden. They are incredibly dependent on third-parties and successful contract negotiations with distribution partners to fuel their success. If distribution partners walk, we think streaming hours meaningfully decline, users switch to content-rich OTT services, and Roku's business model gets crushed.

As extreme as this is, we acknowledge that based on almost all data points, Roku remains the market leader. Market share, customer satisfaction, and more KPIs seem to suggest that assuming none of these distribution deals fall through, Roku can continue to lead in this massive and fast growing market.

Additionally, we think that the Covid pandemic's effect on stay-at-home trends likely juiced subscriber adds and streaming hours, setting up Roku for difficult comps into the back half of this year. This could also mean that Roku witnessed a large pull-forward of long-term streaming demand, and could make the next few years a little bit more lumpy.

The final piece of the bear case is low margin player revenue. While we understand this isn't a core business driver, it is still a mid-teens percentage of revenue and dampens gross margins significantly. Platform gross margins are mid-60s, while company-wide, it's low 50s. This is because Roku is selling players at cost or below cost to fuel the user acquisition flywheel. This isn't necessarily an unwise approach, it's just weighing on margins. We would applaud a spin-off or directly outsourcing the business to an OEM so that the margin drag might be reduced. That said, as accounts grow and incremental opportunity for net adds shrinks, the player business probably dwindles into obsolescence, allowing for long-term platform margins to shine.

All in all, we feel that Roku's risk profile is relatively high considering (a.) the lack of true moat, (b.) little negotiating leverage w/YouTube and Amazon Prime Video, (c.) exposure to low margin commoditized hardware, and (d.) potential pull-forward of streaming demand from the pandemic.

Valuation: Restarting Coverage At Buy, PT Set At 0, Bear and Bull Case Established

We're restarting coverage of Roku with a buy rating, and establishing a base case price target of 0 by YE'22. We have a bear case of 5 and a bull case of 8.

Base Case  
Metric Value
2022E Rev. Growth +34.5%
2022E Revenue (in $m) ,760
2022E Gross Margin 47.0%
2022E EBITDA (in $m) 0
Target YE'22 Rev. Multiple 11.5x
Target YE'22 Valuation (in $b) .240
Shares Outstanding (in m) 134.36
YE'22 Price Target 1.82
+Upside/-Downside +16.86%
Rating Buy

Base case assumes revenue growth slows into the mid-30s next year as Roku laps tough comps on platform, competitive headwinds ramp, and supply chain issues effect the player business in the first half. We're modeling gross margins deteriorating y/y as supply chain constraints weigh on Roku's player sales in the first half. We model relative stability in platform margins, however, as we believe that is the real KPI going forward margins-wise. We're also targeting slightly ahead of Street on EBITDA margins as opex efficiency improves and platform margins stabilize. Our target multiple of 11.5x reflects the upside in the business: large TAM, market leader (currently), growing in the mid-30s, with solid mid-60s margins in the platform business. However, it also reflects the downside: looming competitive threats, downward pressure to hardware margins, supply chain constraints, etc. We think the multiple reflects both the massive upside of the TAM and Roku's current ability to execute against this opportunity, as well as the relatively high risk profile associated with the business.

Bear Case  
Metric Value
2022E Rev. Growth +30.0%
2022E Revenue (in $m) ,634
2022E Gross Margin (%) 45.5%
2022E EBITDA (in $m) 0
Target YE'22 Rev. Multiple 6.5x
Target YE'22 Valuation .621
Shares Outstanding (in m) 134.36
YE'22 Price Target 5.80
+Upside/-Downside -36.16%

Bear case revenue expectation set at 30% y/y in 2022. This model assumes a deceleration in streaming hours growth as YouTube is pulled off platform, and Roku's moat degrades further. This model also assumes weaker gross margins from prolonged supply chain damage into next year. Our multiple at 6.5x reflects a more downbeat view on management's ability to execute against the company's TAM opportunity. Competitive headwinds become the focus of the narrative, and domestic account adds slow further. If competition comes at Roku hard, it could be a tough long.

Bull Case  
Metric Value
2022E Rev. Growth +38.0%
2022E Revenue (in $m) ,857
2022E Gross Margin 49.0%
2022E EBITDA (in $m) 5
Target YE'22 Rev. Multiple 17x
Target YE'22 Valuation (in $b) .578
Shares Outstanding (in m) 134.36
YE'22 Price Target 8.07
+Upside/-Downside +77.23%

In our bull case, we have Roku keeping growth in 2022 at our 4Q run-rate growth rate of ~38%. A strong bounce back in global supply chains pushes player revenue and margins higher than in the bull case and base case, while EBITDA margins and platform margins continue to expand. In this narrative, Roku sorts out content issues with YouTube and Amazon, the company executes against the TAM opportunity, and continues to pick up international market share. In comparison to the bear case, we are more constructive on the bull case coming to fruition.

Summary - Dip Your Toes In, The Water Is Warm (For Now)

In spite of the elevation of Roku's risk profile over the last few months, we're coming away from the narrative pretty constructive. Roku is currently the leader in a massive CTV ecosystem with plenty of room for continued 30%+ revenue growth at margin expansion. While the downside case is quite scary, we like the business as a vital player in a strong and growing industry.

In terms of position sizing, while we aren't making financial recommendations, we're not comfortable going full position on Roku yet, but incrementally adding over time seems prudent. The stock might be stuck for a little bit, but the long-term opportunity is still present.

49381769-16368708328790393.png(Roku logo)

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