This column has been updated from September 5 to mention Roku’s pricing of its IPO on September 27.
Perhaps the first thing that someone thinking about investing in Roku post-IPO should realize is that the streaming device maker’s business model is far less like that of a smartphone or PC maker and far more like a game console maker’s. Which is to say, Roku is much less interested in obtaining huge profits from hardware sales than it is in monetizing users that it has sold hardware to at a low margin.
That’s a good thing, since if Roku was focused on hardware profits, it would have little chance of fending off a hungry Amazon.com Inc (AMZN) and several other direct and indirect rivals. As it is, Roku still has its work cut out for it, but the company’s installed base, solid execution and exposure to fast-growing streaming service and online video ad markets arguably make it an intriguing play on the massive shifts being seen in how video is consumed.
Roku, which filed to go public under the symbol (you guessed it) ROKU, has priced its IPO at $14 per share, the high end of a prior $12 to $14 range. That gives the provider of streaming set-tops and HDMI sticks an official valuation of $1.3 billion. That number rises to around $1.7 billion — about 4.3 times 2016 revenue of $398.6 million — after accounting for outstanding stock options and warrants.
The IPO is the latest evidence that the tech IPO market is — in spite of some high-profiledisappointments — perking up following a big 2017 Nasdaq rally and healthy debuts for a slew of Internet services and enterprise tech firms. Roku’s filing comes as Angry Birds developer Rovio pursues a Helsinki listing while reportedly aiming for a $2 billion valuation.
Roku’s revenue rose 25% in 2016, and 23% during the first half of 2017 to $199.7 million. However, hardware sales actually fell 2% during the latter period to $117.3 million. Revenue growth stemmed entirely from a 91% increase in Roku’s higher-margin “Platform” revenue. That business, which covers ad sales, software licensing, branded channel buttons on Roku remotes and revenue cuts on subscriptions and on-demand content purchased on Roku devices, increased to $82.4 million.
The boost there helped Roku’s net loss drop by $9 million to $24.2 million in spite of an 18% increase in operating expenses to $97.7 million. The company recorded just a 12% GAAP gross margin on hardware revenue, but a 76% margin on Platform revenue. That bodes well for Roku’s ability to turn profitable over the next year or two, provided it can keep Platform revenue growing quickly and its .
The recent hardware sales drop might stem from high penetration rates for streaming devices and a mix shift towards cheaper HDMI sticks relative to set-tops, rather than share loss. Research firm Parks Associates estimates Roku devices accounted for 37% of all U.S. streaming media players as of Q1 2017, up from 33% a year earlier.
Amazon’s Fire TV set-tops and sticks are estimated to have grown their share to 24% from 16%;Alphabet Inc./Google’s (GOOGL) Chromecast devices — they let users stream content from mobile devices and notebooks — and Apple Inc.’s (AAPL) Apple TV set-tops clocked in, respectively, at 18% and 15%. Parks believes that over a third of U.S. households now own streaming devices. In addition, 45% are believed to own smart TVs and nearly 50% are believed to own gaming consoles, nearly all of which now support streaming services.
Roku, for its part, reports its active user accounts grew by 900,000 sequentially and 4.5 million annually in Q2 to 15.1 million. It also reports 3.5 billion hours of content were streamed on its devices in Q2, up from 3.3 billion in Q1 and 2.2 billion a year earlier.
Working in Roku’s favor is the fact that its platform has a still-unmatched unmatched base of 5,000-plus streaming content channels. In addition, the company’s focus on being a streaming platform provider means that its user interface and remotes are optimized for streaming to a degree that, say, game consoles and smart TVs aren’t. Nor do they prioritize Roku’s content (it doesn’t have any) the way that Amazon and Apple’s devices prioritize each company’s respective video and music offerings.
In addition, even if a consumer owns a console or smart TV that supports his or her favorite streaming services, Roku’s sticks are cheap enough to act as an impulse buy for someone who wants a better user experience and access to a few more services. The standard Roku Streaming Stick, which gets solid reviews, retails for just $40, while an Express model that has a slower processor and swaps a Bluetooth remote for an infrared one costs just $25. Set-tops supporting 4K video and other value-added features cost between $60 and $100.
Roku has also struck deals with Sharp, Hitachi, RCA and several other TV makers to have its software built into smart TVs. The company expects over 150 Roku-capable TV sets to ship in 2017, up from about 100 in 2016.
Working against Roku, however, is the fact that Amazon, less interested in streaming hardware profits than driving usage of its video and music services and keeping consumers hooked on Amazon Prime, is also pricing very aggressively. A Fire TV stick that comes with a remote supporting voice searches powered by Amazon’s Alexa assistant costs just $35 (a 4K-capable set-top goes for $90). And while all of Roku’s current devices support voice search through a mobile app, only the $100 Roku Ultra set-top comes with a remote with built-in voice search.
Amazon has also made good progress towards narrowing Roku’s streaming channel lead. Here, it doesn’t hurt that Amazon’s devices run on Fire OS — Amazon’s version of Android — which makes it easy for Android developers to write for them. Roku’s OS, by contrast, relies on a custom version of Linux.
In addition, Amazon has inked a few software licensing deals of its own with TV makers. And the company is uniquely able to provide millions in free marketing for its streaming devices by promoting them to shoppers on its site and apps.
Apple also remains a threat, but a smaller one for now. Unlike Roku or Amazon, Apple does very much care about streaming hardware profits — Apple TV set-top pricing currently starts at $149 — and has little interest in putting its software on third-party hardware. Throw in the fact that Apple TV’s content base is weaker than Roku or Amazon’s, and it’s easy to see why its device has been — judging by Parks’ data and management comments about Apple TV revenue declines — losing share.
Still, Apple’s giant user and developer bases, along with Apple TV’s support for services such as Siri, iTunes, Apple Music and AirPlay streaming, mean that it can’t be fully written off. A new Apple TV supporting 4K video is expected to be shown off at Apple’s September 12th iPhone event.
Regardless, Roku’s recent active account, streaming hour and Platform revenue growth all bode well for its ability to own a large, well-monetized, streaming content platform in the years to come. Here, the company deserves credit not only for the quality of its user experience, but also its efforts to develop a slew of targeted ad services for brands and content providers. These include 15- and 30-second video ads that run against ad-supported content, interactive video ads that users can click on and “brand sponsorships” that appear on Roku’s home screen.
This business does face some challenges. For example, the fact that Netflix Inc. (NFLX) , single-handedly responsible for a third of all Roku viewing, isn’t a meaningful customer. Nor is Google’s YouTube, Roku’s most popular ad-supported channel. And one could see both Google and Facebook Inc. (FB) get more aggressive about selling video ads for content from third-party streaming services.
But Roku’s user data and control over the user interface do provide it with ways for its ad services to stand out, as does its ability to strike distribution deals for streaming channels that come with ad sales attached. And as video ad dollars gradually follow video ad viewing in moving online, there’s room for multiple players to thrive. Ad agency Zenith estimates U.S. online video ad spend will grow 23% this year to $27.2 billion, and another 21% next year.
Roku naturally only has a small fraction of that market. But if one assumes the company can get a slightly larger fraction in the coming years, while keeping its audience growing and highly engaged, a $1 billion IPO valuation looks pretty reasonable.