TIVP029: Roku (ROKU): Forgotten Streaming Giant w/ Shawn O’Malley & Daniel Mahncke

27:29For anyone over 25 or 30, you probably are familiar with him. But with that technology, he created a company called Replay TV. And I'm dating myself here, but for anyone who knows TiVo, you'll know they were the ones who really won out in the DVR market, partly because they were charging half the price as Replay TV's DVR devices. So after botching the pricing, would then make another fatal mistake by including an ad skip feature actually got him sued by a whole bunch of media companies who obviously did not want their ads skipped and you could say he was in the right place at the right time and he just sort of dropped the ball on building what should have been a DVR empire and the bears i should say would would argue that maybe the same thing is happening again with roku but that experience led him to stumble into other opportunities, like making it easier for viewers to watch what they want when they want and helping marketers unlock greater value by combining the power of TV with the precision of digital advertising.

28:34That is at a high level what Roku is meant to do. So it's not just about turning TVs into internet devices, but also about bringing the power of digital advertising to TVs too. Again, I must say that sounds very promising and you can see how big offer an opportunity this was and also still is. Totally. And during this time for context, more than 80 % of households in the US were connected to traditional paid TV services, offering hundreds of channels. And Wood saw how the internet could dramatically improve the TV watching experience for nearly every household in the country. And to do that, he had the idea to actually turn TVs into operating systems like with a computer.

29:19So in 2008, Roku launched its first streaming player to connect TVs to the internet. But before that, just to tell the Netflix part of the story, he had cold called Netflix's CEO, Reed Hastings. And I guess Reed recognized his name as being, oh yeah, this is the guy who invented the DVR and they ended up getting lunch together. And Wood would then join as a VP of Netflix's internet TV unit and oversaw Netflix's project to create its own streaming player. And that project would then be spun off into what is now known, of course, as Roku. And Netflix kind of seeded it with capital before then selling off that position a few years later.

30:00Wow, I had no idea that Roku started within Netflix. I mean, clearly Netflix's core idea ended up accruing the most economic value of the two businesses. But I think Netflix equity is now worth about 500 billion. and well, Roku is worth about 12 billion. So Netflix is, you know, something like 40 times more valuable than Roku. But it does make you wonder how Wood could have created the DVR and foreseen the value of a TV operating system like Roku, but didn't recognize the potential of what Netflix doing being, you know, much bigger in the end. Or maybe he did and he just wanted to chase his own idea.

30:38Something that I see as a positive sign is that Wood doesn't seem to be interested in selling Roku. at least he hasn't been in the past, would have been pretty easy for, you know, Amazon or Google to acquire it and then just eliminate a competitor and also scrap off some data. And after doing some research, it looks like there were multiple offers and rumors about acquiring Roku from all sorts of companies, the likes of Amazon, Netflix or Google, but Wood just didn't want to sell at those prices. And that just looks to me like he thinks Roku should be worth a lot more today or even back then. Right.

31:13So with Roku, though, we're now 17 years into its story and more than seven years into its journey as a public company. So I just think a lot of early believers and Wall Street have lost faith since we haven't seen any real payoff yet in terms of lasting profits. In learning from his DVR experience, Wood has always kept prices low for Roku devices. And if you ask them, maybe too low to the detriment of the business at this point. Roku is this potential honeypot that people have gotten really excited about in the past and briefly in 2021 that looked validated. And then those hopes were just dashed.

31:51So that is a pitfall I'm trying to avoid. I want to have sober eyes looking at this saying while also recognizing the potential and that the market souring on the company may give us a chance to buy in at a pretty attractive price, maybe not in valuation terms relative to the current business, but relative to what the business could eventually become, the TAM and the earnings power. Maybe to better understand that potential, it helps to look back. So why don't we go back and explore what exactly went wrong in 2022? Why did the results fall off so much? And why did the street sour on the company?

32:26Was this a strategy change or was it competition? are they taking the Amazon approach, which is investing a ton into building the business, which makes it less profitable today, but positions them for, you know, long-term success? Or is it a combo of those things? What exactly is it? I think to answer that, we need to better understand the structure of Roku's business. So there are two segments, the platform segment and the devices segment. And the platform side is the profit driver. It earns most of the revenue and is where profits would be generated from in the future. The company started by only selling low margin devices, but now 85 % of its sales come from this software enabled platform side.

33:11And this segment does the advertising we've talked about a little, including ads placed on the Roku home screen and ads placed between content on the Roku channel, as well as what they call content distribution revenue, where basically Roku gets those kickbacks for driving new subscriptions to the big streaming platforms. Or if Roku drives someone to rent or purchase a movie, they could also get kickbacks on that as well. And then this platform segment also counts some licensing fees earned from licensing the Roku operating system to other TV manufacturers like TCL who want to be able to sell Roku-powered TVs to help drive their own sales and just to deliver a better product.

33:54And they think Roku has the best operating system. So that's the platform segment with a couple of different touch points for monetization. And then when you look at the device segment, this is the loss leader. The gross margins here are negative. So they lose money upfront on every single device sale. And the platform business basically subsidizes this unit intentionally because they want to sell Roku devices for as cheaply as possible to get their platform ecosystem in front of as many people as possible that they can then monetize in these other ways that I've mentioned. And as an intentionally unprofitable business, the device sales are really just meant to instead bolster the earnings power of the platform segment by getting these devices in as many households as possible.

34:42That is how I would think of it. I mean, that's the Amazon 101 playbook, but it does not only remind me of Amazon, also a bit of Nintendo, Sony, or Microsoft who sell their consoles at a loss, or at least break even in Nintendo's case, to then profit off of subscriptions. Roku's playbook here is to sell low-margin devices or license their operating system to TV manufacturers, which expands the installed base, and that increases the number of active accounts and total viewing hours enabled through Roku, which creates more inventory and data for ad targeting. And that again should then allow them to better monetize the business with ads over time and also from revenue sharing, allowing them to reinvest into the scaled economic shared of their workgroup channel, giving away more content for free that further drives engagement per user.

35:31Is that how it works out? And do I understand that right? You definitely did. You captured it very well, I would say. And so with that context, I can answer your original question about what happened after that one year of profitability. And for one, margins have just worsened considerably for the device segment. Supply chain disruptions, inflation, and now tariffs have just made the cost of manufacturing tech hardware so much worse. And Roku has no pricing power almost by definition with these devices, so it has to eat most of those increases in input costs. And that has not helped the overall business's profitability.

36:10In fact, much of the swing away from profitability is almost entirely explained by the surging losses for the device segment. And launching a line of Roku-branded smart TVs in 2023 as a way to increase the distribution of their operating system that we've kind of said is the ultimate goal, well, that's only added to the problems with their devices segment. And moving to sell more hardware at a time when hardware costs had already risen faster than the prices they could sell them for really helps to explain why the financial picture has worsened so dramatically for them in recent years. And now you could make the argument that their long-term earnings power has increased by pulling more people into the Roku ecosystem, which then can be monetized with advertising over time.

36:57So they're losing money up front, but these users have higher lifetime values. but still the short-term impact has just been really painful. They've said pretty explicitly that they're focused on building scale and will worry about profits later. And maybe there's something to be said for that, but if they can pull it off in hindsight, it'll look brilliant, but it doesn't look very good right now. And the hardware story actually doesn't end there either. In late 2022, for whatever reason, they partnered with Walmart to produce and sell a range of these smart home products from cameras to video doorbells, lights, and even these small little Roku solar panels.

37:36That sounds like just the next Amazon parallel when we talked about their device segmented. I'm just not sure whether Roku has the same market position to pull all these ventures off, especially when all of these are markets where you compete with the big names that we keep bringing up today. It might just be one of those stories where a company wants to keep expanding for the sake of it and into segments where it's not really a natural fit to add to their value proposition. And this reminds me of a company actually that we talked about recently. And I'm sorry to go on a brief tangent here, but I have to mention it.

38:09When you talked about Smith & Wesson, they actually did something similar. Do you remember how we talked about using their brand to expand into other segments? I found out afterwards they did that and they actually sold bicycles. Of course, they did. And of course it was a huge failure, but the conservative Smith & Wesson customers, they just prefer big pickup trucks. And all of that is just not the right for selling bicycles. The connection was that Smith & Wesson already built bicycles for the law enforcement. Anyway, of course, smart homes devices fit a lot more into Roku's business than bicycles into a gun manufacturer one, but I thought that's an interesting one to bring up.

38:52I'm glad you did some more homework on that. that past episode, Daniel. But yeah, the thing is, I don't disagree. I'm not sure how a smart bedroom light doesn't distract from their core focus of trying to get as many people accessing streaming content through Roku as possible, which they can monetize with different forms of advertising. But yet they have this smart home app to connect all these devices at the same time. So it's fair to look at this and be like, OK, what is going on here? It's as if they can't make up their minds on to what business they want to be in. And again, setting aside the bigger strategy conversation, selling all these devices at low or negative margins has just only added to their profitability problems further.

39:32So when does the but moment come in? When do you say, but this is why Roku is genius? After hearing that the Roku pitch that you got made you so excited, you immediately had to research it when you get home. I'm waiting to hear that side of why you got so bullish on it. I felt the same way looking at this thing for the first time after being told about how much potential the business has. And in a way, I think you could say that they're clearly just recreating the playbook from their streaming devices with the smart home tech stack. Sell devices on the cheap that make earnings look really bad today, but build an installed base that they can better monetize over time through their app and digital ecosystem.

40:13So if you want to view things through rose colored glasses, you might argue that just as they achieve profitability with their core business of selling cheap streaming devices and then making their money back and more with advertising, the results began to suddenly look worse because rather than just being happy with that success, they saw a parallel opportunity to chase, masking some of the progress they've made elsewhere as they ramp up the smart home business. Is that how you see it? I really don't want to be that guy who pitched Amazon and said how obvious it was that the underlying business was profitable and only seemed unprofitable because of the growth investments.

40:53And now I might miss out on the same playbook again. I'd like to think I see in shades of gray, but I'm at least very sympathetic to that viewpoint. My intuition is that they should probably, and this is true for any business, focus on the core business. Limit the distractions, especially when your core business is just finally finding some kind of footing. It almost feels like something you would do if you realize your core business wasn't as viable as you had hoped. So now you're trying to quickly pivot into some adjacent area that might work a little better. But, you know, they haven't totally abandoned their core focus either.

41:32We've already talked about how since 2021 they've significantly expanded the Roku channel as their free ad-supported streaming service available to the tens of millions of households who see the Roku home screen as the first thing when they turn their TVs on. And yet, here's the bad side again. I told you we would have a ton of good and bad moments, didn't I? The bad side being that they continue to move into areas with less attractive economics. Instead of just being the interface to connect to other streaming apps, they've been acquiring their own content to compete as a streamer, as we talked a little bit about, which is just expensive on top of doubling down on hardware which is also expensive unprofitable and obviously capital intensive so while meta had this year of efficiency to turn its business around two years ago roku has for the most part been scaling up its team since 2021 reinvesting in itself acquiring content selling more types of devices and also expanding more internationally though i guess it did have its own mini year of efficiency but if we look into it all of those reinvestments maybe materially contribute to their earnings power.

42:40So you could argue that the hiccups in earnings today will just look like the cost of building powerful moats in hindsight. It's just a really messy story, isn't it? You cannot really simplify it into a short pitch because there are all these extraneous qualifiers. It's not a streaming service, but actually now it kind of is, and it's not a true hardware company, but in a way they kind of are. as they expand the product offerings and they have all this supposedly valuable digital advertising real estate in streaming and yet they're moving to smart home apps. And coming back to Amazon and its device segment and perhaps even Google's other best segment, the reality is that they also burn cash and they can afford it because they have those two or three businesses that are just money printing machines.

43:29From what I've heard though, Roku doesn't have those machines yet And then it's just a messy company and a messy investment pitch. And it's hard to get through it all. Well, that is why I'm trying to figure out with you if there is an investment opportunity here, if you can disentangle things. It would be so easy to just put this in the hard pile. And I think a lot of people have done that as a result of never come to fruition. But there are some parallels with early Amazon, right? Just constantly reinvesting themselves to boost their earning powers behind the scene, moving into all these tangential areas that look inexplicable and then kind of masterfully pulling it all together.

44:09And for the record, I'm not that bullish on Roku, but you can see a similar pattern where they're absorbing short-term losses in a bid to build a stronger positioning long-term. And whether you agree with how they're doing it and the ultimate size of the opportunity they're going after, that will probably shape how you feel about the business today. The smart home stuff is probably just a distraction though. It's not substantial to store here. And if anything, I've heard some rumors that it's just a pet project of Anthony Wood. That's how one long time Roku stock follower explained it to me. So I don't know if that makes you feel any better.

44:46And don't get me wrong. There's some kind of a plan, but I would not call it a master plan. In some ways, what they've been able to accomplish in the market penetration that they've had and their ability to hold onto that market share for years now is very impressive. but I don't think Wood is playing 4D chess like Jeff Bezos was. They have very much at times simply been just responding to competitive pressures. The move into smart TVs, for example, is probably not something they wanted to do, selling even bigger pieces of unprofitable hardware to boost the reach of their operating system. But they saw Amazon entering that area, which is obviously one of their biggest competitors.

45:25So they kind of got pushed into doing it by Amazon, who can happily afford to enter with no expectation of profit. But for Roku, it just drags their business down and worsens their profitability with the only benefit being maintaining, but not even necessarily improving their competitive positioning. To be fair, of course, there's hindsight bias working and also survivorship bias. When we look at Amazon and see this master plan by Jeff Bezos and all of it worked out so perfectly. And perhaps this might be the case with Roku. You just don't see this. And we focus on that a lot in the Amazon episode, this ecosystem that just gets strengthened and strengthened with everything they do.

46:05And Roku doesn't have that. But we talked about Amazon and you also brought it up again here. So why don't you mention all the other competitors? Rip up the bandage and tell us who are all those competitors and what are the ways they compete with Roku? when you move from licensing your operating system and selling co-branded tvs in partnership with traditional tv manufacturers to actually directly manufacturing tvs as roku did in 2023 well obviously now you're competing with more and more companies now you're competing with samsung invizio lg and a ton of others just on the hardware side while also competing with amazon fire tv chromecast and apple tv and in different ways so you're competing with the various smart tv operating systems and the actual TV manufacturers and also the plug-in streaming stick device manufacturers.

46:57And I would say it's mainly because competitors like Amazon are trying to undercut them on price that they have to just absorb the losses on their devices and hope to make the money back later. So that is maybe one very tangible illustration of how intense competition has hurt them. When a Fire Stick is like$35 and it can do what your Roku device does and turning any TV into a smart TV, well, what leverage does Roku have to charge higher prices? The answer is very little. And then they have to sell all those devices at a loss, which drags down the profitability of the platform segment. We have discussed in our portfolio review a couple of weeks ago how powerful specialization can be.

47:38And despite its ventures, Roku is still a specialized company. But I also argued that I'm a bit more cautious whenever your competitors are the Max 7. They have a history of beating more specialized competitors just due to their sheer size, their scale advantages, and also their still innovative culture. And that's why it's a bit scary to me to see who Roku competes against, all those giants. I don't disagree. And the reality is that everybody wants to control how millions of households access digital content on their TVs. And so it's actually very impressive that Roku has been able to maintain its leading position given that backdrop.

48:19It's been fending off very stiff competition for a decade now. That in part comes from what I think was the very brilliant decision to start licensing their operating system to smart TV manufacturers originally. Unlike their competitors, Roku's OS was built from the ground up for smart TVs, which you can't say the same for with Android and Google. Android was built for mobile devices. And actually, because Amazon's Fire OS is a fork of the Android OS, Alphabet has actually restricted them from licensing operating systems that are based on Android. So that has limited the licensing that Amazon can do with other TV makers and helps to explain why they moved into making their own smart TVs directly.

49:07The point being, Roku benefited, especially early on, from having the best quality and most seamless operating system and licensing it to TV manufacturers who really wanted to access it because it improved the quality of their own products, which help them with their land grab to try and take as much market share as possible in the TV operating system market. And that first mover advantage has proved to be pretty sticky despite the pressures from Google and Amazon. So Roku's app-based OS for TVs was really innovative and that underpinned their advantages, which have helped them to retain the scale that is now starting to support their advertising business.

49:50And on the platform side, Roku's again, granted less directly in this case, competing with the big tech companies for advertising dollars. We've talked about Amazon's advertising ecosystem in our episode on them previously, and the same with Google with its search advertising business. There's just only so much money to be spent on digital marketing each year. And Roku is trying to prove why spending on ads on the Roku channel or at its home screen is a worthwhile alternative. Part of that for them has been to double down on programmatic advertising, which is sort of like an automated ad you might get as opposed to more tailored campaigns over time.

50:35Those are the ads that you see at the start of YouTube videos. And then you can skip after five seconds, right? Those are these programmatic ads. and as opposed to the sponsors on our show, which are more lasting relationships and not one-off automated ads. Exactly. And so not only does that competition put pressure on the advertising rates they can sell for, but it also puts pressure on them to continue investing in their ability to serve targeted ads to different types of audiences and better track the performance of those ads for sponsors, which again does not help profitability in the short run, but should increase their earnings power long-term.

51:17And just to keep talking about competition, last but not least, by moving into ad-supported streaming on the Roku channel, you're also now taking on Netflix, Peacock, and Hulu, as well as these lesser-known ad-supported services that we've mentioned like Pluto and Tubi, as well as Freevi. So there is seemingly very intense competition everywhere you look. And Roku is touching on a number of different areas with these different types of competitors. And it's just a reminder of how brutal capitalism is. I actually personally have an Amazon Fire TV after previously using Roku sticks for years. And so now I see Freebie all the time instead of the Roku channel.

52:01But that's also why it's so impressive that the Roku channel has risen to become the second most popular app on the Roku platform behind YouTube and ahead of Netflix. And just one of the biggest streaming platforms generally, even despite all these competitive pressures. So again, as a theme for today, for everything good, there's something bad. It's not every day we find a company competing distinctly in three or four different parts of an industry, which increases the surface area for points of attack from competitors who could undermine the overall business structure. That's a great way to put it.

52:38Surface area for attack. And also, I'm not surprised you do own an Amazon Fire TV. I think you're really the best Amazon customer out there. But if you're a hedgehog, as Jim Collins, the author of Good to Great, would put it, if you are focused on doing one thing better than anyone else, maybe being the best streaming platform, the best TV manufacturer, or the best aggregator of paid and free content, Roku is spreading itself across all those three areas. I hesitate to mention it, Daniel, to throw off our good to bad ratio, but we have not gone through the stock pace comp numbers either. So maybe there are two negatives for every pro, it's starting to feel like.

53:22Maybe before you do that, please give us another pro. It feels like they're seriously lacking today. Okay, so I'll give you one. On the financial side, the pros are that they have more than$2 billion in cash in negative net debt. So they have a very strong cash position and can live off the balance sheet for a while, which is important as they continue to reinvest in themselves and try to build a more stable and profitable business long term. And all of its debt are leases too. So this isn't a company with any real conventional forms of leverage. It is not financing itself with loans to survive.

53:59They also have a ton of first party data tracking how people interact with digital content. And that should be very valuable if correctly monetized. But yeah, stock based comp has been about 10 % of revenue on average in the last few years, which is massive. Every year, you're just continuing to dilute existing shareholders' ownership of the business on top of delivering negative profits that destroy equity. You know, I take that cash point, but 10 % of revenue is a lot. Even when you have healthy top line and profit growth, which Roku doesn't even have at the moment, the policy of granting stock worth 10 % of revenue diverts a big chunk of that growth to new equity.

54:41unless Roku finances substantial buybacks, which I think they're not doing, odd share price rises fast enough to make each grand by fewer shares. So I think the value per share you own compounds at barely half the headline rate. In other words, the company grows at 10%, but your position only gets about 4 % of that growth. And of course, it's always nice to see a large cash balance, but it's also not their most valuable asset either. And at this point, I'm not totally sure I know what this even is. Is it Roku's channel? Is it the first party data that you just mentioned, the Roku hardware sticks that you can plug into any TV?

55:16Is it the Roku home screen that we mentioned? Or maybe it has something to do with how their smart home app will complement their TV operating systems. I'm being facetious here just to make the point again that they just have a lot going on to disentangle. But truly, let me ask you, what is Roku's most valuable asset? What is their crown jewel in your opinion? Well, the cash is not the crown jewel, but it is around 20 % of the market cap. So that provides some operating cushion for them and some conservatism in the valuation, assuming that they can eventually profitably realize the value of all the eyeballs they get and the kind of digital real estate they hold on people's TV.

55:59So that's the crown jewel. That's the value. Millions of people, either through Roku TVs or Roku Streaming 6, interacting with the Roku ecosystem to use their TVs because that shapes which apps they use and what they see as they navigate across those apps. And particularly, I'd argue the home screen is the most important part of all those different touch points. It's the most valuable and monetizable asset, in my opinion. And what you think that real estate can be worth would be the primary driver of what you think Roku is worth as a company. And as I mentioned a moment ago, implicitly, what makes that so valuable is all the first-party data they're able to collect.

56:42They see how long you're looking at the screen before deciding what app to open. They see what apps you actually do open, how long you're viewing those apps for, how often you switch between apps, what shows you're watching, and much more granular data on your viewing habits across platforms, which is different from, say, Netflix, which can really only see your habits on their specific platform. And as Alex Morris, a friend of ours of the Science of Hitting blog, has put it, and I'm paraphrasing, helping viewers discover the quote-unquote right content using their first party data, while also creating experiences where they can integrate marketing and advertising and promoting primetime college football games or other sporting events in their sports zone section will be a key way of monetizing engagement for Roku.

57:32Oh, you hit a sweet spot there. Sports have become such a mess to watch. So many different streaming services and cable channels. If Roku can just simplify that, then I already see the value. And jokes aside, when I researched the streaming sector a while ago, I think it was while the whole debate was going on about streaming fatigue, you saw in the data that sports is one of the most powerful sign-up and retention tools for any of those streaming services. For sure, for sure. And when we look at the rise of the Roku channel too, it has doubled its share of TV streaming hours. in the US in the last year.

58:09And to me, that confirms how powerful the Roku home screen is. They have made their app that doesn't have sports content into it one of the biggest streaming apps in the world. And not necessarily because it has the best content, but because of the power of suggestion, convenience, and visual proximity. They are responsible for setting the programming on people's TVs. And with the success of the Roku channel, they have shown to potential advertisers how powerful that can be. Because let's be honest, without that proximity and promotion, the Roku channel would have a fraction of that reach. They are not curating ultra valuable content like Disney or HBO there, yet they are getting a ton of eyeballs and engagement on it.

58:56And when looking at Vizio, which does something similar, Walmart paid$2.3 billion for that company in early 2024, while Roku has four times as many active accounts. So if we're really trying to ballpark it then, that would very roughly suggest a fair value of around$8 to$10 billion in market cap just for that part of the business, right? Very roughly. Well, maybe, but that doesn't account for the benefits of scale not being exactly linear in advertising. And to maybe put it all in a different language, let me read this quote from Anthony Wood for you, who says, it's still very early. There are about 1 billion TVs in the world that are in households with broadband.

59:42And every one of those TVs is going to switch from whatever they've got today to a TV with a purpose-built streaming operating system. And so he continues saying, it's the same phenomenon we've seen in the history of computing platforms and technology. There were a lot of PCs when they first started. Now you have Windows and Apple. There used to be lots of different companies that made phones with their own software. Now every phone in the world runs Android or iOS. That same phenomenon is happening in TVs as well. The US has made more progress on that transition than the rest of the world, but the rest of the world is also moving in that direction.

1:00:20So in my words here, if Roku can become one of these oligopoly players and global connected TV operating systems, that would be a much, much bigger business than a$10 billion market cap. So that was a kind of long quote to read. And while that's promising, I should say that Roku is very far behind in Asia, Western Europe, obviously for you, Daniel, and inline America as well. And so five years ago, investors, when they were most bullish on Roku, were betting on it being a global story. and now it's just harder to have that same conviction. It hasn't panned out. The bet now is really just that they can continue to better monetize the business in North America primarily and as the scope of that ambition has moderated, you could probably say that is really what has driven the market to sour on the business and maybe overly sour on what is a potentially decent business.

1:01:11Yeah, that can be. I mean, as I mentioned, we don't have Roku and I gotta be honest, I don't miss it. Like you said, most TVs that are sold are smart TVs anyway. And otherwise, you would just, you know, put an Amazon Fire TV stick in there. But maybe there's also a greater opportunity in Roku Pay, too. I mean, I could imagine that at a certain scale, Roku's negotiating power dramatically increases over the DSPs like HBO and Disney+. And if so, they might be able to significantly grow their take rate on those signups that they drive. Is that something that makes sense or something you think about?

1:01:45I like the idea. but it would only have a finite life. At some point, you can't really drive that many new incremental signups. Everyone is signed up. So the long-term business, I think, is more around content suggestion, as they did with severance or with recommending sporting events to watch. The other interesting thing, though, with Roku Pay is that once you have your card uploaded there, you could shop for a whole lot more than just signing up for Hulu in one click or buying a movie. Roku has actually partnered with Walmart to sell all kinds of different products. So if you could see an ad for, I don't know, camping gear on your Roku and then click to purchase it directly, again, that would make Roku's advertising ecosystem way more effective and compelling, especially when compared with, you know, just think about traditional forms of TV advertising.

1:02:33It's just a billboard on your screen. There's no mechanism to directly act on that ad. And intuitively, I just see that optionality of having the one-click payment process and your card data on hand as being potentially very, very valuable if monetized correctly. But that if there is doing a lot of lifting, it's a big if. It was kind of cool, though. In November 2024, Walmart and Roku released a full-length Christmas movie called Jingle Bell Love on the Roku channel. And the film enabled viewers to buy products showcasing specific scenes directly from their TVs. and that kind of perfectly exemplifies the potential of Roku and shoppable long-form entertainment, if that's what we want to call it.

1:03:21That's such a great idea. I mean, I haven't seen it, so I don't know if I would feel the same way as a viewer, but with my investor glasses on, that sounds genius. When I researched Amazon, I came around something pretty similar. I think they will start with these AI-powered pause ads on Prime later this year. So whenever a viewer hits pause, The platform's model scans the paused frame and then inserts a contextually matched ad. So I imagine there's food on the table, then you might get an ad for Uber Eats. I think we'll see many such ways to turn old TV ads, those billboards that you described, to turn them into much more effective ads that massively increase the revenue per user.

1:04:01But to keep the theme of the episode going, let me immediately follow up with some more concerns regarding Roku. The first one would be that it seems like there are low switching costs to Roku, for example, to use an Amazon Fire Stick instead, leaving little reason to be fiercely loyal to Roku, whereas someone might be very loyal to Amazon, thanks to the value of Amazon Prime. and then with the content acquisition and the smart home stuff they just seem very inconsistent on on cost discipline with their operating expenses per active user fluctuating all over the place while netflix has been very steady and then there's the question of whether roku loses advertisers whenever their streaming wars start to cool down too so from a look into this sector it seemed like it might be dominated by you know the biggest two or three players in the industry in the end.

1:04:55And that begs the question whether you even still need an aggregator then. Although to kind of counter my own point here, the switch to integrating ads and therefore reducing subscription fees, I think did a lot in terms of reducing the subscription fatigue of viewers. I see that in my own behavior as well. And more players in the space, which could be possible by going down the more ads instead of higher fees for a subscription, would then again increase the need for an aggregator like Woku. But then again, structurally, this isn't a pure software business either. And the hardware sales materially hurt the overall business and would still be negatively impactful even if gross margins on devices improve to, let's say, break even.

1:05:39I think there's a pretty long laundry list of concerns to have as we've established, which is why I don't ever see this being a$200 billion business. But if you can get it at$10 or$12 billion, dollars maybe it's worth 20 billion dollars or so in a few years but but yes this is no tech giant destroying your profitability by having to sell devices at a loss is not a great indicator of having any kind of moat it sort of reminds me of peloton in some ways where they also have tried to sell hardware and then digitally monetize the software and so comparisons to peloton which is just a flailing company kind of make the bear case by themselves.

1:06:20And on the content side, again, there's nothing special about the Roku channel in terms of the content differentiation and quality and adding more content to it has only widened their losses without necessarily improving their earnings power enough to justify the cost. Roku probably had a chance at one point to be a tech giant maybe a decade or so ago. And now we just have to accept that this is not in the future for them. The original product was genius, but they just didn't scale it quickly enough to then be able to pivot into the other areas that they would need to, to really entrench the business and become a major tech giant like these other names we've talked about.

1:07:01And now again, we've got a risk that future growth may not even be profitable due to declining ARPUs outside of North America, which just further weigh down the unit economics of the business further. So you could argue they really should just focus on dominating North America, where ARPUs are the highest, and establish a proof of concept on profitability while fending off competitors before trying to expand internationally with growth that almost looks destined to be unprofitable for an even longer period of time. Well, that's something that we can probably work with, right? Just trying to figure out what a mature version of Roku focused only on North America would be worth?

1:07:43Yeah, yeah. It's a good way to think of the end goal. And maybe to go back to the core thesis, it's that streaming needs an aggregator, an interface between users, content providers, and advertisers. Roku is that layer with really deep first-party data, device distribution, and increasingly advertising infrastructure underpinning all of that. So that positions them to be one of the biggest beneficiaries of advertisers moving away from traditional linear cable TV to connected TV and streaming. Advertising on connected smart TVs hit around$30 billion last year in the US, with US adults spending an average of over two hours per day watching content on connected TVs, second only to the amount of time they spend looking at their smartphones.

1:08:33Meanwhile, as we all know, cable is in decline. In terms of hours of media consumption, traditional TV viewing consumes about as much of our collective time as streaming still, but that number is shrinking. And yet, advertisers still out of habit spend much more on cable than on streaming advertising. I think something like roughly$60 billion is spent on traditional TV advertising, which are basically just, as you said, inferior billboard ads. Whereas with an ad on Woku, you can actually directly drive a sign up for a streaming service or drive them to watch a certain show with one click. And when you think of it that way, it really is hard to believe how much money cable still commands.

1:09:16I guess when you have a relationship with advertisers for 60 years, there's some momentum there that just takes a while to fall off, even if viewership is clearly declining. it makes total sense but i do see the move away from cable as inevitable to some extent of course and advertisers will ultimately follow the eyeballs and in my opinion connected tv advertising is just a much better medium for advertising as it grows with the majority of the population eventually moving to having smart tvs and relying exclusively on streaming services as anthony wood talked about in that quote I shared earlier, then platforms like Roku should soak up those cable advertising budgets.

1:10:00So there's kind of an additional tail in there where you can make an argument that ARPUs should increase because of that, that all those cable dollars that are going to flow across. So for example, Roku can track a user from a TV ad to then see an app install or streaming signup, and that closes the loop in ways that linear TV can't. Point being, over the next few years and beyond, tens of billions of advertising dollars should rotate from cable and broadcast TV to on-demand digital content, with Roku in the middle of that transition. Much of that money will increasingly go to the prime videos and Netflixes of the world, But intuitively, we can probably agree that some of that will still spill over onto Roku too.

1:10:48If we believe Anthony would, he thinks all TV will eventually be streamed, meaning everything on TVs would be delivered solely through the internet, really widening the programmatic advertising world. And so that's how I start to get excited about Roku at current stages. They've got all these eyeballs. They've been investing ways to better retain those eyeballs more directly with the Roku channel. and then in ways to get even more eyeballs by making their own smart TVs. And that leaves them with a lot of, I think, underappreciated earnings power as the world of streaming advertising catches up and surpasses traditional TV advertising at the expense of cable companies.

1:11:32And the way that will really manifest should be with higher ARPUs per eyeball that Roku gets. I totally see that appeal of that thesis. I mean, traditional TV, I'm sorry to say this, but I think in our generation, it's kind of dead. I mean, personally, I haven't owned a TV at all for years now. And after moving into this apartment, I have a huge smart TV now in my bedroom. And I think I turned it on twice. I think I've lived here in the last three months. And I think generally Gen Z, if you look at some data, they not only consume significantly less linear TV, they also spend much less time in front of a TV in general, even if it's smart TV.

1:12:08But even if that's the case, as you mentioned, when ads on streaming finally get paid like traditional TV ads have been all this time, that seems inevitable. Then even a decrease in TV usage overall won't stop this from becoming a way more profitable business in the future. But after all that, we have to mention another negative. and for me just looking at the insider trading data which can tell us what management thinks based on their actual actions the selling over the last year has been pretty overwhelming we are talking about an order of magnitude more shares being sold than being purchased so even if i could get comfortable with the arguments in favor of roku here and that's not even so hard to do it's just hard to buy in when the management team quite literally isn't they seem to be selling at every chance they get as soon as the stock is over$70.

1:13:00I can't argue with that one, Daniel. And it's a good reminder why it is important to look at insider trading activity. Most of the time, it's kind of mixed and inconsequential, but in certain cases, it can really matter. And with that probably being true in this case, the only thing I can say is that Anthony Wood does still own 12 % of the company, or almost 12%. So as the founder and CEO, I do think he believes in the company. And you'll notice most of his sales are these automatic dispositions that have been planned out over time. But yes, some of the other selling from insiders, that just looks a bit messier and more random and is more of a yellow, even maybe a red flag.

1:13:41And this is exactly why I like to talk things through with you, Daniel, and why having a community like our intrinsic value community is so valuable because people can help you point out blind spots that you just would otherwise miss. Absolutely. Well, it's safe to say that there are many warning signs when it comes to Roku, but I've yet to see a company that lost over 80 % of value over four years with a huge amount of good news and good press. and I did some digging into the investor sentiment around the company and it turns out that there are quite a lot of bullish investors out there and to be honest that's what scares me most if I buy into a company that lost that much value I want to buy it when the momentum is gone when it's at its lowest and when I feel like there's only one way and that way is going up and in the last 12 months the stock has already gone up 50 percent and that doesn't mean it can't go further but it does mean that we're not the only ones discussing a bull thesis.

1:14:39And that case is definitely valid. You know, they either have this huge opportunity and gold mine before them, or we will learn that Roku was slowly displaced and the business will go down in history for, you know, being so promising, yet never realizing its actual potential. And I could see Roku being a beneficiary of streaming platforms, embracing those lower priced ad supported tiers as they have started to do, which basically changes the economics of these companies and pushes them to prioritize scale even further to have a viable advertising business. And that would theoretically leave streamers even more desperate to bit on eyeballs through Roku's home screen, in which case Roku is probably undervalued after all.

1:15:24And I have less conviction in this idea, but you could also say that they benefit from being a truly neutral TV operating system and suggesting content as opposed to Amazon and Apple, which both offer operating systems for connected TVs, but also have their own streaming apps and original content. With Prime Video and Apple TV, they're biased towards promoting their own apps to greater extent than Roku is with the Roku channel, and users probably also pick up on that. Well, I feel validated, because I'm glad you understand why I've had such a tough time with this one. There's just enough here that I can't sleep at night by totally writing it off, And yet there are all these negatives and red flags that are just like, hey, you should probably just leave this thing alone.

1:16:10So I'll be the first to admit this has been one of the harder companies for me to wrap my head around their future because there's just such and I've said this before, but gosh, it's true here. There is just such a wide range of outcomes that could plausibly occur for this company. It really in either direction. So I would just say kind of a cop out. If anyone does understand Roku really well or this industry, please reach out to us because I would love to revisit this in a couple of months and say, okay, clearly we should own it or we should not own it. So if you do know a lot about the company, you can email me at sean at theinvestorspodcast.com.

1:16:49Sean is spelled S-H-A-W-N. I would love to chat with anyone about it. the both of us really want to prevent, you know, not seeing this, what might be a phenomenal playbook in five years out and sitting here and just, you know, writing off this company. So, so let me ask you then, given all that, did you try to put together a valuation for Roku? I did. And if you valued Roku like an ad platform, you could maybe compare it against It's companies like the Trade Desk and Magnite. And these are companies that trade between 50 and 100 times operating earnings because they're very profitable and are growing very, very quickly.

1:17:29These are better businesses than Roku, though. They focus only on high margin digital advertising, and they don't have the hardware losses that Roku has. And if you compare Roku against competitors like Sony and Samsung on the tech hardware manufacturing side of things, you get a range of 10 to 20 times operating earnings on the valuation. And none of these are perfect comps because Roku does a mix of things. And with Sony and Samsung, they trade in different markets and different stock exchanges. So it's just meant to provide a very rough idea of how different types of companies in these industries are valued.

1:18:07And the point being, the hardware losses make Roku a much lower quality business that deserves a lower valuation multiple than pure play digital advertising companies yet it is higher quality than a pure play tv manufacturer too broker is really like both of these different models plus an ad supported streamer without paid subscription mashed into one a hundred percent that that's maybe the best description i've heard of them yet and if in just one sentence that's my takeaway way after spending a few weeks trying to learn about this company. Assuming Roku has become a reliably profitable business by 2029, which is a big assumption, with perhaps slightly above average growth prospects still as the migration from cable to streaming tailwind continues to boost them, then in sort of a base case, I don't think it would be crazy to imagine that Roku could trade at around 25 times operating earnings by 2029.

1:19:07That puts them at a slight premium to tech hardware manufacturers, TV manufacturers, but also a pretty good discount to these really truly profitable software first advertising business. So like I said, this shows that this is not as good of a business as pure play digital advertising companies, but it is still better than just being a hardware maker. And Netflix, for example, as a pure play streaming company, it's at about 50 times operating earnings. So again, at half that, we're showing that Roku captures some of the benefits of streaming through the Roku channel and its digital advertising real estate while seriously being held back by the losses on its hardware and not directly having recurring paid subscriptions like Netflix.

1:19:48And then from there, I dug into their gross margins over time, tried to account for hardware losses, making up a smaller share of the business over time, maybe adding in some operating leverage from R &D and admin costs, making up a smaller percentage of sales as a business scales over time. And with all of that, I put together a pretty rough estimate of their operating income by 2029. And from there, I looked at their average rates of dilution from issuing new shares of stock, which is definitely a real cost we have to account for. And I got an idea of what their operating income per share might look like by 2029.

1:20:22And with that mid-20s exit multiple we talked about, I was able to discount back that expected terminal value to what we might call a fair value for the stock today in current dollars. Now, that is where it gets interesting once again. We always try to capture the best way to account for the risk of an investment. And this time, I think that's not too difficult since a change in the discount rate is probably enough if we assume there's no risk outside of Roku, not being the huge quality business with a mediocre and arguably even no moat. So is that how you approached it? And if so, what discount rate did you go with?

1:21:03Yeah, well, by default, we normally go with 8 % for these really high quality companies listed in developed countries as sort of a rule of thumb. But I don't think Roku is that high quality company. And I'm not really convinced it's been run super well either. So it's hard to say it deserves that same kind of discount rate. I think we have to use a higher discount rate to account for the competition and the risks that they might not execute well. And because of that, I went with a 10 % discount rate. And if you don't have clearly deep moats around your business or aren't operationally excellent, again, it's hard for me to justify a discount rate below 10%.

1:21:40But yeah, after digging through the financials and making some basic assumptions in my models, like thinking that platform sales can grow by roughly 14 or 15 % a year still on average over the next five years, and then adding back their net debt to convert from enterprise value to equity value, I get a fair value target of about$70 per share with a margin of safety intrinsic value target price in the mid 50s. So then after the recent 10 % jump, the stock would look slightly overpriced, but generally you would say it's about fairly value. The market is not missing out on anything. You had the big opportunity perhaps.

1:22:20I think so. I just can't be quite comfortable enough with how they're going to ultimately monetize all the data and digital real estate that they have to say that the stock is aggressively undervalued. But this is one of those valuations where it's just so hard to have conviction in it. And that's just a sign that it belongs in the too hard pile. But after digging into it and talking with you a bit, I'm not sure we found enough pros to balance out the cons. I can see the argument for how they have much more valuable data than the market has given them credit for. But until we can really see some of the results come from that, where the business starts to inflect toward profitability, I just can't trust that management will ever guide this thing to where it needs to be without feeling like I was totally speculating.

1:23:06I'm not inclined to give them the benefit of the doubt. I don't think they deserve it. And again, the range of outcomes here is just insane. They have such little room for error. Slightly tweaking the estimates of their profitability margins or some slower growth expectations in a bear case. And all of a sudden, quite literally in my model, you have negative equity value. The company would be essentially just destroying shareholder value going into the future like it honestly has been for the last few years. Whenever you're on that brink of profitability, just a slight tick in margins to the upper downside changes the entire valuation.

1:23:43And I don't necessarily have a problem with uncertain futures. I actually prefer those situations over the ones that seem very obvious to everyone who looks at them. But that's when the market might completely miss something. But I care a lot more about the downside than the upside in these scenarios. We spent quite a lot of time today to discuss where this company could grow. My takeaway is that a bull case scenario could send the stock far higher than it is today. But from what I heard, I like the insights on how likely that actually is in Wilco's business. Is it actually a cashflow machine in disguise or not?

1:24:17And looking at the downside, at first glance, I see no real bottom here either. The company's unprofitable and the competition are all those big tech giants. You have$2 billion in cash, that's right, and that's great, but that can be gone quickly too. However, at$12 billion with With all the high quality data Roku has gathered from the tens of millions of households across the US and in times of AI where data is even more important than ever before, it's a very attractive takeover target. And perhaps that's the downside protection. When the business doesn't work out, Amazon, Google, or perhaps Netflix just come by and snap Roku up at a nice premium for shareholders.

1:24:55this. I could see that in the bull case where maybe losses on devices stabilize and platform advertising takes off and Roku pay enables more and more subscriptions and shopping experiences. Yeah, I get a fair value of like$115 per share or much more. So there definitely is upside, but it's just a risky bet without really making crazy conservative or aggressive assumptions. the stock could be worth a 50 to 70 percent premium to the current price or it could be worth almost nothing and although that's just a modeling exercise that is really genuinely how i see its future but as you said roku would probably never be worth zero they have that really great data and you know i would think amazon would pay at least a few billion dollars to own roku's data So the downside is maybe more capped than you might think.

1:25:50It's maybe equal to the upside, but not totally zero, I wouldn't think. That said, one of the key lessons from the Roku story is knowing when to subsidize your platform and when to monetize, as in when to go for scale and try to grab as much market share as possible and when to try and raise prices to make your business actually profitable. And on that front, Roku has pretty impressively grabbed and held market share, but hasn't timed things well with fully monetizing the business, at least not yet, which is maybe why the company is so interesting. The biggest bulls are probably disappointed by their current scale, but there's still some room to grow internationally in places like Canada and the UK that are at least fairly similar to the US.

1:26:33And with our portfolio company, Reddit, they went 20 years without being profitable, just slowly building their earnings power and base. And now that they're prioritizing profitability more, the business looks dramatically better. But anyone who had carefully studied Reddit all along would have known that that was possible and maybe inevitable. And to a lesser extent, I think you can make a similar argument with Roku too. I just feel it's uncertain. It's not like in Reddit case, also in hindsight though, it seems way more likely that it should have happened. In Roku's case, I just don't know. In summary, for me, there are too many warning signs when it comes to the business.

1:27:12It's less about the uncertainty and more about the feeling that the management team wants to go the Amazon route, but just can't seem to pull it off. The business has no mode, if you ask me, at least where I'm standing right now. And it competes with these industry giants. SBC, so stock-based compensation, is cutting my stake of earnings in half. I would be an owner. And wherever the stock goes above$70, we see waves of insider selling. So I'm by no means sitting here and saying the bull thesis couldn't come true, but I would prefer to buy Roku at an inflection point. The stock might be more expensive then, but if the bull thesis actually plays out, paying 20 % more doesn't really matter much.

1:27:50And the risks of permanently losing capital are significantly lower if that should happen. I don't disagree with you, Daniel. I think that's pretty fair. So it sounds like we're going to hold off on Roku and not add it to the portfolio. So we keep moving along here. Why don't we do a little transition here and you give us your hints for what your pitch will be next week, Daniel. As you say, the train just keeps moving. Well, we already covered, I would say, let me not lie now, I think two companies that can be counted as in the same sector as the company I will pitch next. It's a sector where we famously say and repeat all the time that it's outside of our circle of competency.

1:28:36But I think by now we can say that we're slowly getting to understand the dynamics in that sector a bit better. And it's also a company that I'm sure everyone in the audience knows. Although just like in the case of Nike, it tends to be more popular or used in this case in in Europe nowadays than in the US. And maybe last but not least, because the other hands were quite vague, the company was born out of a merger and the group of founders all became even more famous after leaving the company. And I think that's all I can say. Okay. All right. Well, it should be a good one. And as always, let me close this out with a quote.

1:29:13Andrew Delaney, a marketing director at the Trade Desk, tells us, quote, it's important to know where your audience of potential customers is today and where they might be tomorrow. And for the bulls betting on Roku, they're very much hoping that Roku will continue to be where the audiences are and that advertisers will increasingly appreciate that reality as they move away from cable. That is, in a nutshell, what we talked about today. So that's all for now, folks. We will see you again with another company breakdown next week.

1:29:51Thank you.