Roku Bear Thesis Debunked Part III

June 23, 2022

Welcome to the third and final post that’s breaking down every Roku bear thesis.

If you haven’t already read Parts I and II, you can find them here and here.

To recap, we believe Roku is misunderstood — and more resilient than the bears give Roku credit for. We think buying in at today’s prices will provide an incredible return on our capital.

Let’s continue.

10) Roku’s Supply Chain Issues Are One-Time Solvable Problems

Bears: Roku doesn’t control its own destiny. It’s at the whims of other companies. This is, and will continue to be, a major drag on Roku’s long-term growth. So much so, Roku explored making its own TVs.

This is where we think Roku bears can make the strongest argument.

TV manufacturers have struggled with their supply chains. Just like every other company in every other industry around the world.

Roku doesn’t manufacture smart TVs. They provide a couple of components and serve as the operating system for powering them.

But… TVs don’t get sold if they’re not on the shelves.

This directly impacts the number of active accounts and/or TVs powered by Roku.

Supply chain issues have remained persistent longer than most thought. Therefore, Roku’s growth rate in its accounts have slowed as a result.

Here’s CEO Anthony Wood on the Q1 ‘22 earnings call (emphasis added):

“We interact with the TV supply chain in a bunch of different ways. So when we talk about device or screening players, supply chain issues, those are products that we build, we design and build and manufacture ourselves.

I mean we use contract manufacturers like the entire industry, but we manage that process. We source the key components or help source the key components. And so supply chain issues around players impact us when the main chips or what are called SoCs become -- when they become in short supply because of just general semiconductor shortages. That causes the price to go up. That impacts us in a bunch of ways, including it costs more to build the products, but also it causes our engineering team to have to spend time redesigning products to use alternate SoCs so that we can get access to more supply.

So it impacts us in a couple of ways. But in general, we're managing through that and those issues are mitigating over time. In terms of TV, TVs, we don't -- our role with The Roku TV program, which has been -- just I'll take a quick second and talk about The Roku TV program. I mean it's been hugely successful for us. This is the program where we designed the reference designs for a television and then we work with manufacturing and brand partners to build and sell those TVs and then we work with retailers to help merchandise them as well. And that program has been super successful for us, continues to be successful. We're the #1 TV platform in the country by unit sales as well as hours streamed. And we've become the #1 TV platform in Mexico by hours streamed, #1 in Canada by hours streamed. We're making great progress in other international markets, a lot of that through our Roku TV program.

But in that program, those TVs are built by TV manufacturers around the world and sold through retailers around the world. And so that's the supply chain. And what's been happening in TVs is that there's been a shortage of panels and then it has also been -- it's been much more expensive to ship televisions. It's been more expensive to ship players as well, but TVs are bigger, and so it impacts them more. So the result of all that is TV prices have gone up a lot for consumers, and that's reduced demand for TVs. And so that's the big picture of what's happening…

So that's some thoughts on Roku TV and supply chain, I don't know, Steve, if you want to -- if there's anything you'd like to add. The other piece, which impacts TV OEMs in terms of their unit sales and market share and thus the Roku TV market shares was some of our OEM partners had specific component in inventory outages. And so that impacted some of their sales in Q3 and Q4. And so that's a big piece that's a headwind for us on the TV side.” 

This has understandably put pressure on Roku’s share price. But we invest based on what the future beholds. Not what’s happened in the past.

So the real question we have to ask ourselves is: Are supply chains one-time solvable problems?

It’s one of the most important questions you as an investor need to figure out. Next, you should evaluate: Will this issue jeopardize the company as a whole? If the answer is no, then you should buy and/or hold.

Here are a couple of examples from a thread we wrote back on May 18th:

Chipotle’s stock fell as much as 65% from peak to trough when there was an E. coli outbreak back in 2015.

Chipotle took a massive hit to the business.Profits fell 44% and shares were down by 40% in 2018 alone. Many thought customers would never return to its stores.

Savvy investors who knew it was a one-time solvable problem bought after the drawdown.

Chipotle shares are up more than 5.5x over the past 6 years.

There are dozens of other examples. Issues that look like the downfall of a company. But end up being a blip on their radar.

McDonald’s Pink Slime. Johnson & Johnson’s talc-based baby powders. Amazon’s worker unionization. Tesla’s “funding secured” tweet.

The list goes on.

Does anyone think supply chains will be a forever issue? Probably not.

Roku still managed to grow their active accounts by 1.2 million from Q4 ‘21 to Q1 ‘22 despite supply chain issues. That’s 1.2 million account growth against Q4 — peak holiday season.

Supply chains have been an issue since the pandemic started. Yet Roku hasn’t seen a sequential decline yet.

Most companies expect supply chain issues to remain throughout 2022 and into 2023. Especially with China’s lockdowns.

So we’d expect Roku’s account growth to remain muted throughout the rest of the year.

What’s remarkable is how Roku has been able to maintain 1/3 market share in the U.S. despite supply chain issues.

But what happens when Roku’s TV manufacturers’ supply chains ease?

What happens when they’re able to sell through at max capacity? When shelves can be stocked with the newest models.

And what happens to Roku’s account growth when all of the above happens?

These are all questions that contribute to the bull case for Roku once supply chain issues ease. However, our true Roku thesis isn’t dependent on account growth. It’s on average revenue per user (ARPU) growth. You can read why in Part I here.

Bottom line is Roku is at the whims of other companies. This provides a significant headwind in its account growth. One we think should be taken seriously. However, we believe the market has already baked that into its share price.

11) Why Roku Will Be Okay During Economic Uncertainty / Recessions

Bears: Roku’s story is predicated on account growth. People aren’t going to get new TVs during recession… hindering Roku’s growth.

Bears are 100% right here about account growth slowdown. Similar to supply chain headwinds.

Consumers obviously won’t spend on higher discretionary items like TVs during recessions. Most U.S. households buy new TVs roughly every five to eight years. That means Roku won’t be growing active accounts as quickly.

However, that means Roku’s competitors (i.e. Samsung, LG, Amazon) won’t see TV sales growth either.

Implying Roku will still maintain its king of the hill status — with 1/3 market share in the U.S.

This should provide decent downside protection on Roku’s accounts as subscribers hold off on upgrading their TVs.

Hypothetically, Roku may be the connected TV (CTV) of choice for those that do upgrade during recessions.

Consumers are price sensitive during recessions. They’re also more likely to be brand agnostic.

So the consumer will pick the cheaper TV, all things equal.

Roku’s TCL 50” 4K Smart TV is around $300 on Walmart.

An equivalent 50” Samsung 5K is $380-$700 on Walmart:

Prices are roughly the same on Amazon, too.

LG 50” TVs are in the $350-$550 range.

We’re not in the business of comparing the quality of Roku vs. anyone else. Nor are we assuming Roku will maintain its growth rate during an economic downturn.

(Again, our thesis is predicated on ARPU growth. You can read our ARPU thesis here in Part I.)

But because the average consumer is brand agnostic, our guess is they would prefer to save $100-$400 on their TV when times get tough.

Meanwhile, during economic downturns — and during the inflationary times we’re seeing now — people are choosing to stay at home. And are saving on discretionary purchases like eating out. Going to the movies. Among other activities.

That means more time at home. Watching TV and/or movies.

More TV and movie consumption means more hours watched on Roku devices. Which means more ad impressions that Roku can monetize.

Yes, advertisers will pull back overall. But they’re focused on return on ad spend (ROAS). Roku delivers hyper-targeted advertising placements. So as long as Roku provides advertisers with results — which they have — advertisers will maintain their spend on Roku.

Anthony Wood called it out briefly on the Q1 ‘22 earnings call:

“I mean, the other thing to kind of accelerate -- will accelerate things as in the past, is any time there's macroeconomic stresses on businesses, then they start to get more serious about how they should be efficiently spending their money. But I think this is just something we've seen before in other industries.”

Bottom line: Everyone gets hurt in recessions. Roku included. However, we’re making the argument that Roku does have some insulation already due to it having the #1 market share in a category people don’t spend up on during hard economic times.

12) Why Roku Benefits From Apple + Google Cookie Deprecation

Bears: Apple and Google control the entire app store ecosystem. They’re moving away from cookie-based retargeting. This keeps the power within and away from Roku.

Apple has added privacy to their unique value proposition (UVP) over the past couple of years.

This led to the rollout of their Apple App Tracking Transparency (ATT) framework.

The change was a big value add for Apple users. But devastating for advertisers through Apple’s App Store.

Apple removed the unique identifier (IDFA) which let advertisers attribute that ad spend.

Advertisers now need to ask users for explicit consent before tracking their activities. This shows up as a pop-up. It’ll lead to less data collected. And likely lower conversion rates as consumers may be turned off from the prompt in the first place.

What are the chances you’d give second thought to downloading an app after seeing this:

(Source: Appleinsider.com)

Apple’s announcement took Facebook (now known as Meta) down 22% in a single day. Snap fell 18%. Twitter fell 8%. And Pinterest fell 11%.

It erased $315 billion in market value from these four companies alone.

Here’s a well put example from Forbes:

“When a company like Lyft or Kabam runs user acquisition campaigns to gain new mobile customers, a mobile measurement partner like Adjust, Singular, Kochava, or AppsFlyer can help them connect a click on an ad with an eventual app install on a specific device. That helps Lyft know that an ad worked, and that whatever ad network they used for it succeeded.

Plus, if the person who installed that app eventually signs up for an account and takes a ride share, Lyft knows where and how to attribute the results of that marketing effort, and connect it to the ad spend that initiated it. Even better, from Lyft’s perspective, it can use the IDFA to tell mobile ad networks essentially: I like users like this; go find me more.”

And here’s Snapchat CEO Evan Spiegel on the impact of the IDFA rollout (emphasis added):

“While we anticipated some degree of business disruption, the new Apple-provided measurement solution did not scale as we had expected, making it more difficult for our advertising partners to measure and manage their ad campaigns for iOS.”

Advertising got more expensive and less reliable simultaneously after the rollout.

Facebook said as much on their Q3 ‘21 earnings call after the rollout.

Now, Google has mentioned they’re looking to make similar updates to their operating system sometime in 2024. (Although, Google’s whole business model is advertiser targeting, so we think this will likely be some watered down version relative to Apple. They’ve also pushed back this rollout once or twice… Showing they’re figuring out how to try and have their cake and eat it too. Full disclosure: Google is a Disruptor holding in the Mighty Portfolio.)

Apple & Google control the entire app store ecosystem. Their changes affect everyone.

Advertisers need to adjust their metrics. Or find other mediums with strong first-party data capabilities that have complete visibility into ad spend. Original and retargeting.

That’s the only thing advertisers care about. Return on ad spend (ROAS) and lifetime value (LTV).

Advertisers simply shift their budgets to where their marketing dollars are most efficient. You can only get that answer when you have as much complete data/information as possible.

As tech site The Verge explains:

“Across the board, ad-driven companies will have to figure out a solution to what's proving to be a seismic shift: the old way of measuring ads is no longer effective on one of the biggest platforms in the world. They'll either have to figure out new ways of making money or new ways of proving that their ads actually work.”

That’s where Roku comes in.

Roku has more than 61 million users. Every user is linked to a different profile with a credit card on file.

This makes transaction-based advertising simple and seamless.

Roku has been going all-in on data analytics too with their OneView platform.

They’ve acquired Nielsen’s Advanced Video Advertising (AVA) business, including Nielsen’s video automatic content recognition (ACR) and dynamic ad insertion (DAI) technologies, which will “accelerate Roku’s launch of an end-to-end DAI solution for traditional TV.”

They’ve launched Roku Clean Room which is:

“A privacy-first data collaboration environment that allows advertisers and agencies to use their encrypted first-party data to make planning and measuring advertising campaigns with Roku easier, all without relying on cookies or consortiums…”

“Within Roku’s clean room, advertisers then have the freedom to query matched data and run their own analyses to understand potential campaign reach, current audience delivery, and advertising impact on product sales and sign-ups.”

(This is similar to Apple’s update where advertisers don’t get access to Roku’s data.)

They’ve also struck deals with marketing tech providers — Analytic Partners, Ipsos MMA, IRI, and Nielsen — to enhance data analytics on its platform.

This allows them to optimize and monetize their ad inventory more effectively. Roku has plenty of it.

From Digiday:

“When it comes to data on creative types, Roku will break out information by video ad and display ad, such as the banner ads appearing on the CTV platform’s home screen. The video-specific creative data will also include the duration of an ad so advertisers will be able to gauge the impact of traditional 15- and 30-second spots as well as the newer six-second placement.”

“Creative types are super important,” said the first agency executive. “Nobody talks about the role of creative in all of these conversations on effectiveness. We know that 70% of the impact [an ad has] is from the creative and the context it appears in. So to the extent, they’re providing this information, that’s a great thing.”

The transition to CTV advertising is still in the early innings. Less than 20% of TV ad budgets are streaming.

Advertisers will continue to look for more efficient spending. Roku has proved (see #9 in Part II here) their ad inventory is yielding significant ROAS.

Meaning Roku is — and will — be a longterm beneficiary due to the privacy changes.

Here’s CEO Anthony Wood on what Roku is seeing right now:

“Our per account spending is up 50% year-over-year, and we see significant increased commitments across every 1 of our segments, our large customer segment, our growth performance segment, our M&E segment.”

Bottom line: CTV streaming is still in the early frontier stage. Apple & Google control the mobile app ecosystem leaving advertisers vulnerable to major changes — like Apple’s ATT rollout. This forces advertisers to look for other channels to spend their ad budgets. Roku is one of those channels with incredibly valuable data on 61+ million customers and counting.

Good investing,

Lance & Mike