Where Does Roku Stock Go After Its IPO

Roku (NASDAQ: ROKU) had a great first day of trading, opening high and closing even higher. The stock closed at $23.50 per share, 68% above its $14 IPO price. That gives the video streaming device maker a $2.2 billion valuation.

Most investors probably missed out on Roku's big first day of trading. And with big-name competitors Apple (NASDAQ: AAPL), Amazon (NASDAQ: AMZN), and Alphabet's (NASDAQ: GOOG) (NASDAQ: GOOGL) Google, some investors may still have concerns about the company.

Diving into the company's S-1 and management's comments can give investors some insight into where the company goes from here, and whether that $2.2 billion valuation is justified.

Not just about selling devices

Just about everyone knows that Google and Amazon don't sell the Chromecast or Fire TV to make a profit off the hardware. Even Apple is focusing less on hardware sales as it works to build its services business. All three likely make more profits from owning the platform than than selling the hardware. (Although Google has been getting much more serious about its hardware business recently.

While Roku started as just a simple hardware company, it's quickly transforming into a platform company. It has 15.1 million active accounts using its devices, each spending about 3 hours per day streaming video to their TVs.

Roku monetizes those users through advertising and taking a cut of revenue from subscription and transactional video-on-demand partners. Over the last four quarters, Roku has generated over $11 per user from those sources.

What's more, Roku's margin on its platform business is much greater than on its player sales. Despite accounting for just 41% of total revenue, Roku's platform generated more than four times the gross profits as its hardware sales.

Growing the platform

"We've had game plan of driving active accounts and building out scale, getting people to become engaged with the platform, and then driving monetization," Roku CFO Steve Louden told Barrons. With 15 million people spending 3 hours per day on the platform, the company is heavily focused on the final piece of that strategy.

That said, it's taking a three-pronged approach:

  • Grow active accounts. This is done through the sale of more Roku devices as well as licensing its operating system to smart TV manufacturers.
  • Grow hours streamed. Management aims to accomplish this by finding more content partners and improving content discovery capabilities.
  • Grow average revenue per user. The previous point will help improve ARPU, but Roku is also developing more advertising capabilities and striking bigger upfront deals.

Roku has some advantages in its efforts. First, it's the preferred partner of smart TV manufacturers, taking one-fifth of all smart TV shipments, according to Louden. That ought to help grow active accounts as people upgrade their television sets, but it does face competition from Google in the space.

More importantly, Roku doesn't have its own content. Amazon is built with selling Amazon digital content. Apple TV wants to sell you stuff on iTunes and the App Store. Google wants to sell you everything through Google Play. Roku just wants to give its users the best content at the best price. That's not only friendly to consumers, it's friendly to smaller content distributors.

Is Roku really worth the price?

Roku's stock is currently valued at about 5.5 times last year's sales after its spike on day one. Revenue is growing quickly -- up 23% year to date -- but not as quickly as investors would like to see a stock valued as highly as Roku.

Understanding that the company's profits really stem from its platform revenue, though, can give some better insight. Platform revenue is up 91% so far this year. What's more, the gross profit margin is improving. While Roku can't break out operating expenses for each of its segments, it's showing operating leverage for the company overall.

With a greater percentage of revenue coming from much higher gross margin products going forward, Roku might be worth the price even after day one. It's still quite a high valuation, and the larger competitors present quite a bit of risk. The company will have to execute on growing active accounts, hours streamed, and ARPU, but thankfully, management seems willing to provide investors with those key metrics to judge their progress going forward.

10 stocks we like better than Roku, IncWhen investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Roku, Inc wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of September 5, 2017

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Adam Levy owns shares of Amazon and Apple. The Motley Fool owns shares of and recommends Alphabet (A and C shares), Amazon, and Apple. The Motley Fool has a disclosure policy.