HBO Max Deal And Two Other Reasons Roku Stock Could Hit $660
Where does market power come from? One answer: operating a toll booth through which video content suppliers must pass if they want to reach its consumers.
This comes to mind in considering the fate of Roku and its investors. How so? According to the Wall Street Journal, this streaming-media player maker controls 38% of the market for such players.
What’s more, Roku is using that market position to demand a chunk of the ad revenues generated by the streaming apps that run on its hardware.
Indeed the Journal reports that Roku used its market power to conclude on December 16 an eight month negotiation with Warner Brothers to carry its HBO Max service just ahead of the launch of its “Wonder Woman 1984” simultaneously in theaters and on HBO Max.
Roku stock is up 140% in 2020 as of December 16 — as the NASDAQ NDAQ rose 44%, according to Morningstar MORN . Here are three reasons that Roku could keep rising:
- Strong recent growth;
- Sustained growth through its exercise of market power; and
- A Create the Future CEO.
Roku Negotiates Deal To Carry HBO Max
Warner Brothers plans to release the latest Wonder Woman pic on December 24. But it was not until December 16 that Warner Brothers and Roku came to terms on a deal to grant HBO Max access to Roku’s 46 million active subscribers.
The details of its deal with HBO Max have not been disclosed. The Journal noted that Roku — which began negotiating with HBO Max in May when the latter launched — demanded that WarnerMedia supply programming to The Roku Channel.
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Citing anonymous sources, the Journal reported that Roku waived that requirement in exchange for compensation from other sources — possibly ad or subscription revenues. Variety reported that Roku’s standard terms with content partners are “to take 20% of subscription fees and 30% of ad inventory.”
Roku was happy with the deal. Scott Rosenberg, SVP of Roku’s platform business, said, “We believe that all entertainment will be streamed, and we are thrilled to partner with HBO Max to bring their incredible library of iconic entertainment brands and blockbuster slate of direct-to-streaming theatrical releases to the Roku households with more than 100 million people that have made Roku the No. 1 TV streaming platform in America,” according to a statement.
Given the lack of specifics, are investors being overly optimistic? Here are three reasons Roku shares could double.
Strong Recent Growth
Roku has been undaunted by the slowdown in advertising resulting from the pandemic. As the Journal noted, Roku got started selling streaming devices but now it makes its money selling ads in the more than 10,000 streaming apps it carries — generally getting a percentage of ad space.
Indeed the decline in ad sales this year has been significant. EMarketer forecast that the US media industry will spend 9.3% less than last year — or $6.28 billion by the end of 2020, while it expected the US entertainment industry to cut its digital ad spend by 6.9% to $7.03 billion.
But Roku was undaunted — enjoyed a 73% increase in third quarter revenue. Hours streamed on Roku grew 53% to 41.7 billion in the first nine months of 2020 and Roku added nine million new active subscribers.
While Roku is losing money and burning through free cash flow, according to Morningstar, that third quarter growth is far brisker than Roku’s three year average revenue growth rate of 41.6%.
Sustained Growth Through Exercise of Market Power
Roku’s dominant share of the market for streaming media players puts it ahead of giant rivals such as Apple AAPL , Amazon AMZN , Google, Samsung and others. Why don’t these larger companies squash Roku?
The simple answer is that the streaming media player market is the only egg in Roku’s basket whereas it’s a trivial line of business for those other rivals.
As David Wertheimer, a former president of digital products at Fox Networks Group who is now a media and tech investor, told the Journal, Roku’s aggressiveness springs from the fact that “streaming TV is its entire business. It’s understandable that they’re sticking to their guns. The reality is the game that they’ve been playing has worked.”
Roku is fighting fiercely with content providers to capitalize on its market power just as cable companies did with the TV networks. As Michael Nathanson, an analyst at Moffett Nathanson, said “[Roku has] kind of replaced cable operators as gatekeepers,” noted the Journal.
Roku also played hardball with NBCU in a negotiation to provide access to its Peacock app on Roku’s streaming platform and Roku-enabled TVs. A deal was reached on September 18, according to Variety, in which expanded NBC content will be added to the free, ad-supported Roku channel. While terms were not disclosed, Roku said it negotiated a deal for “a meaningful partnership around advertising.”
Such deals are creating a bright growth picture for Roku. Benchmark analyst Daniel Kurnos, raised his price target to $410, according to Barron’s. Kurnos argued that the deals with WarnerMedia and NBCU show that Roku’s negotiating leverage remains strong — which defies bearish analysts’ predictions that Roku’s bargaining power will fall.
Kurnos expects Roku’s platform revenue in the final quarter of 2020 to exceed by $20 million his prior forecast of $411.7 million with help from increased pricing.
He is also optimistic about Roku’s 2021 performance, noting, “We are now also ahead of consensus for 2021 on all metrics, effectively reflecting the flow-through impact and a slightly more optimistic baseline for underlying pricing even as the market trends a bit back toward more normalized levels,” wrote Barron’s.
Roku’s Create the Future CEO
If you are considering whether to invest in any company, it helps to understand the strategic mindset of its CEO. That’s one of the key conclusions of my new book, Goliath Strikes Back.
The most desirable strategic mindset for investors is Create the Future — a leader like Jeff Bezos or Reed Hastings. Such leaders keep creating the leading product or services in the industries they target for growth.
Anthony Wood, Roku’s founder and CEO, definitely fits the bill. Roku — which he founded in 2002 — is his sixth company and as the Journal noted, he is firmly in control. His 68% voting power gives him nearly $4.9 billion worth of Roku stock.
Wood has repeatedly reinvented the entertainment industry. He invented the digital video recorder to keep up with StarTrek episodes — founding ReplayTV in 1997. Sadly for Wood, TiVo rushed past him, became a well-known brand, and went public.
He then invented the streaming media player. His Roku backers saw him as ambitious and highly motivated never to finish second again. Wood — who was working at Netflix NFLX while operating Roku — added Netflix as the first app on the streaming platform.
The Journal reports that Wood is highly demanding in private and has delegated the negotiations between Roku and the content providers to Rosenberg.
The Bear Case Against Roku
Not everyone is so bullish on Roku.
On November 9, Morningstar Senior Equity Analyst, Neil Macker, launched bearish cover age of Roku — 4.4% of its float was sold short as of November 13. Macker’s “no-moat rating and a negative moat trend” suggested that he did not see Roku maintaining its strong bargaining power.
Nevertheless, Macker assumed that by 2030, its active accounts will more than double to nearly 113 million while streaming hours will pop almost five-fold to 286 billion a year. With its 90% price increase as of the date of his report, he concluded that Roku shares were overvalued.
If it exceeds analysts’ expectations for the fourth quarter as Kurnos anticipates, the Roku bears will wish they had gone into hibernation for the winter.