Roku has established its position as a “strong gatekeeper” in streaming, poised to benefit from an influx in advertising, but it is also a small fish swimming in the vast ocean controlled by major tech firms.
That’s the mixed signal from MoffettNathanson analysts Michael Nathanson, who initiated coverage of Roku with a “neutral” rating and a 12-month price target of $145 on its shares. He issued a 62-page report to clients on Monday identifying the “green lights and yellow flags” he sees around the company. Roku shares are up about 9% in 2020 to date, having seen significant volatility as investors weighed the puts and takes of COVID-19. The stock was flat in mid-day trading Monday, at about $148.50.
As a major player in ad-supported video on demand [AVOD], Roku is well-positioned, Nathanson wrote in the report. “As cord-cutting accelerates, we believe advertising dollars will flow to AVOD services as linear TV ad buyers look to extend TV’s reach, leverage data targeting capabilities and control CPM
inflation in a brand safe, big-screen, ‘TV-like’ way,” he wrote. By 2024, the total ad market in streaming will more than quadruple, Nathanson predicts, reaching about $14 billion from $3 billion in 2019.
As it has grown to reach more than 40 million U.S. households, Roku’s importance in the entertainment ecosystem has only grown. It has had pay-TV-style carriage disputes with major programmers, indicating its willingness to assert its position. Last winter, it clashed with Fox Corp. on the eve of the Super Bowl before reaching a deal. This year, it has declined to accept terms from WarnerMedia or NBCUniversal to add their new streaming services, HBO Max or Peacock.
“Roku has built a strong gatekeeper position among streaming media devices (we estimate it is in around 40% of U.S. homes), which is creating a near-term opportunity to extract significant value from OTT companies seeking their shelf space to grow,” Nathanson noted. While it’s noteworthy that Roku is “flexing its muscles,” the analyst believes that kind of leverage is unlikely to last. “The marketplace is incredibly fluid as Alphabet appears interested in re-positioning their floundering efforts and as large media companies consolidate the industry,” he wrote.
Since the company’s founding in 2002 by noted tech innovator and early Netflix engineer Anthony Wood, questions have hovered over Roku in terms of its strategic path. Specifically, many investors and industry observers have questioned whether it could survive as a small tree trying to grow in a forest of tech redwoods. During these years of skepticism in some corners, however, the company has transitioned from being a hardware maker to a more platform-oriented nerve center for streaming with a more diverse, global revenue mix. Its interface is now on one in three smart-TVs and it has ramped up its advertising efforts significantly.
Nathanson described the company as “occupiers of an important, but small, piece of the connected TV landscape.” Fundamentally, he continued, “Roku is a small company in a marketplace packed with the world’s largest tech and media players who may not be willing to grant them the oxygen they need to flourish over time.”
In 2019, total revenue for Roku reached $1.1 billion. Its “platforms” unit — encompassing the share of subscription and ad sales it takes from activity on its platform — accounted for 66% of that. Within platforms, Nathanson estimates, video advertising is the largest, and fastest growing, component, with 52% of total platform revenues.
“In looking at the market today, there are two key questions for Roku,” Nathanson wrote. “1) How well will it monetize this large and growing user base?, and 2) How wide is the moat that they have built over the long term?”