Roku's Growth Story Intact

lelinvestmentllc
Feb 15, 2024
3 min read

Summary

Roku's Q4 earnings showed mixed results with a significant stock drop due to concerns about declining ARPU and lower than expected free cash flow margins, though its international expansion is viewed positively for long-term growth.
Despite a lower than expected free cash flow margin for 2023, optimism remains for margin improvement in 2024, potentially leading to a 12-24% stock price upside.
Roku's strategy to expand internationally, especially in TV advertising, could see substantial stock appreciation if it captures 2-3% of the global market share.
Despite risks from competition, Roku's focus on customer experience and leveraging AI for ad optimization supports a strong buy rating, with the company poised for growth.

Roku's Q4 Earnings Results

Roku announced their fourth quarter earnings on Thursday, and the results were a bit mixed. The stock dropped as much as 17% in after-hours trading, which seems to be because of worries about decreasing average revenue per user (ARPU) and lower than (our) hoped for free cash flow margins.

We can understand why some investors were disappointed by those metrics dropping. But when we look closer at what's driving the ARPU decline, it's actually due to Roku's expansion into international markets. That puts them in a much bigger long-term market, which is exciting. The company also grew its number of active user accounts by 14% compared to last year, and by 5.6% compared to last quarter. So their overall growth story still looks good in our view.

Lower Than Expected Free Cash Flow Margin

The 5% free cash flow margin for 2023 does look light compared to what we expected. In our financial models, we conservatively assume a 5% long term free cash flow margin, which supports the fair valuation of around $80 per share. That lines up with how much the stock dropped after hours.

Optimism for Improving Margins in 2024

However, we're optimistic that by 2024 their free cash flow margin will continue improving as they further optimize operating costs. If they can get that margin even 1-3% higher, it suggests a potential upside of 12-24% versus the current price based on our sensitivity analysis. Roku's Q1 outlook of 15% revenue growth and margin improvements points in this direction.

Growth Potential through International Expansion

We're also conservatively assuming Roku can get about 1% global market share of TV advertising. As they expand into more countries beyond Canada, Mexico, Brazil, and the UK, they should gain share. For example, Roku has become the #1 TV operating system in Canada and Mexico already. If through international growth they can get even 2-3% global share, our models show the stock could see 36-70% upside based on sensitivity analysis.

Focus on Improving Customer Experience

On top of that, Roku is working on improving customer experience and engagement. More time spent on Roku should drive continued growth.

Risk

Roku has some risks to consider as it expands internationally, but I'm not too worried. Competition from companies like Xiaomi could be tough, since they're strong players in TV streaming devices too. But Roku's affordable prices should help it gain market share globally. Even just over 1% global market share could mean upside for the stock, based on our analysis.

Conclusion

So we are comfortable holding and even buying more Roku shares around the current price. We don't think there's huge downside risk here. We are still very bullish on Roku overall. AI should help optimize their ad costs, plus there are other tailwinds at their back. That's why we are maintaining a strong buy rating on this one.