September 18, 2017

Breakingviews: Roku IPO Warrants Swimming Against Stream

by Breakingviews

It’s a good time to capitalize on cord-cutting. Roku, which already does so by selling devices that stream video over TV, may be about to take advantage of investor zeal, too. A $1.3 billion valuation for its initial public offering is lofty, though.

Originally conceived inside Netflix in 2002, it was spun out six years later when Chief Executive Reed Hastings had second thoughts about the hardware business as he made the transition from mailing DVDs to delivering movies over the internet. With some 15 million accounts, Roku is now the one reshaping its business model.

Compared to rivals, Roku provides simple search functionality for some 500,000 movies and TV shows on everything from Netflix to HBO. For the first half of the year, device sales accounted for nearly 60 percent of the company’s $200 million in revenue. It was a small decline from a year ago, however, in the face of mounting competition from Apple and others.

That’s why Roku is selling commercials inside the likes of Hulu and sharing the proceeds. It’s a smaller but faster growing part of the business, which also includes receiving cuts of subscription fees from some streaming services. Through the end of June, this so-called “platform” revenue nearly doubled.

Assume Roku, which remains unprofitable as it plows cash into marketing and R&D, can increase its top line 30 percent for 2017, a little faster than the previous year, to over $500 million. While there’s no easy comparison, Roku is something of a blend of TiVo, which makes digital video recorders, and Pandora, the music-streaming service powered by advertising. Split the difference on the multiple of revenue they fetch on public markets – about two times – and Roku would be worth around $1 billion.

The company disclosed on Monday, however, that it is aiming for a valuation of no less than $1.1 billion and as high as about $1.3 billion.

While Roku sensibly has anticipated the hazards of being an equipment manufacturer, perhaps after witnessing the hard post-IPO falls by Fitbit and GoPro, advertising is equally volatile. Roku warns that it expects to keep losing money for a while. And the company has a two-tiered ownership structure that will subvert the power of new shareholders. Investors would be wiser to swim against the Roku stream.

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