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After reporting a net loss of subscribers for the first time in over a decade in its quarterly report on 19th April 2022, Netflix’s (NASDAQ:NFLX) stock nosedived by roughly 36% in a single trading session. Currently, Netflix is down by ~70% from its all-time highs recorded in November 2021. Despite being a mega-cap stock, Netflix has simply imploded.
Over the last twelve months or so, we have seen a massive valuation contraction for stocks that were deemed to be pandemic plays, e.g., Zoom Video (ZM), Roku (NASDAQ:ROKU), Teladoc (TDOC), and many others. After undergoing a violent valuation re-rating, Roku was forming a base in the $110-$130 zone. However, Netflix’s blowup is now dragging Roku down even further.
Netflix is considered a bellwether for the streaming industry due to its industry leadership, scale, and global presence. Hence, a slowdown at Netflix is being construed as a slowdown for streaming. This correlation is leading to losses in shares of other streaming-related companies like Roku, Disney (DIS), Paramount (PARA), etc. While Roku is undoubtedly a play on streaming, both of these companies have very different business models.
Netflix’s business model is quite simple – monetizing original and licensed content via paid subscriptions. Before making a u-turn on advertising in their latest commentary, Netflix’s management has taken a hard stance against entering the Ads business. Here’s how Reed Hastings put it back in Jan 2020-
Google and Facebook and Amazon are tremendously powerful at online advertising, because they’re integrating so much data from so many sources. I think those three are going to get most of the online advertising business. For Netflix to grow to a $5 billion-$10 billion advertising business, you need to “rip that away” from incumbents. Long term, there’s not easy money there.
We’ve got a much simpler business model, which is just focused on streaming and customer pleasure. We want to be the safe respite where you can explore, get stimulated, have fun, enjoy, relax — and have none of the controversy around exploiting users with advertising.
Netflix may bring an ad-supported tier to its streaming service soon. However, Roku’s platform was purpose-built for digital advertising with the idea that all content will eventually be streamed. As you may know, Roku is entering the content business with 50+ Roku Originals set to launch on ‘The Roku Channel’ in the next two years. I would say ‘The Roku Channel’ is a direct competitor of Netflix. However, Roku is much bigger than TRC.
Many people still think of Roku as a low-margin streaming media player business that will be obsolete in a few years with the advent of smart TVs. However, every 1 out of 3 smart TVs sold in the US is a Roku TV (TVs running on Roku’s operating system). For years, Roku has been out-competing the likes of Amazon (AMZN), Apple (AAPL), and Google (GOOG) in the TV OS space, and despite being the market leader, Roku is getting no credit for its monopolistic powers as a gatekeeper. Roku also happens to have a rapidly-growing digital ads business line.
Simply put, Netflix is a media company. Roku is a digital advertising company.
With Netflix’s subscriber count reaching saturation levels in the United States, Canada, and EMEA regions, the company is struggling for growth. Recent price increases led to a surprise decline in subscriber count, reflecting weak pricing power. For Netflix, the streaming wars are getting expensive, with multiple deep-pocketed rivals entering streaming and competing aggressively for market share (and subscribers). Rising content costs and a shrinking subscriber base are massive issues for Netflix: In Q1, Netflix’s revenues grew by 10% despite losing 200K subs (due to price increases). However, Netflix projected a loss of 2M subscribers in Q2, and if this trend continues, Netflix’s revenues could start shrinking in the future. If revenues shrink, content spending will have to shrink, and that would lead to more subscriber losses and so on.
Netflix’s management is trying to address this threat by cracking down on password-sharing to improve monetization. While management estimates suggest 100M users are using Netflix for free, I think this estimate is probably too high. Then again, an attempt to monetize these users could backfire and lead to further subscriber losses. In my opinion, Netflix’s existing subscriber base of 200M users and annual content spend of $20B should enable the company to survive the streaming wars and still be around five years from now. However, this will depend on the quality of Netflix’s content, which has been waning recently. With all of this being said, Netflix’s issues are very much idiosyncratic, and they have nothing to do with Roku.
Roku’s content aggregation TV OS platform makes it a winner regardless of the outcome of the streaming wars. Five years from now, Amazon Prime Video and Disney+ could emerge as the top players at the cost of Netflix; Roku will still be a winner. While Netflix has reached saturation in its primary markets, Roku (56.4M accounts) has more room to grow in the US, and it is still only just getting started with its international expansion. Roku’s business is centered around advertising, and original content is only a small part of it. Since the company will be financing its content via the free cash flow generated by its advertising operations, I am not concerned about this new business line.
In my view, Roku is on track to become a ~$40B per annum digital ads business by 2031. While Roku is not as cheap as Netflix right now, it is the cheapest it has ever been in its history as a public company.
Considering the fact that Roku is projected to grow revenues at 35% in 2022, with further improvement in margin profile (as revenue mix shifts towards advertising), Roku is an absolute bargain at current levels. Netflix’s blowup is dragging Roku down amid a broad sell-off in growth stocks; however, this selling is outright stupid. Roku’s business is not impacted by Netflix’s issues. Here’s my latest work on Roku (find my detailed investment thesis here):
While Roku’s stock remains in a downtrend, it is looking more and more like a coiled spring. In my view, the buying opportunity here is as good as buying Roku at $27 in 2018. Roku is an incredible business trading at a massive discount to its fair value. At ~$100 per share, I think Mr. Market is presenting us with a once-in-a-lifetime buying opportunity in Roku.
Netflix is trading at 18-19x P/E with ~10% sales growth, i.e., terminal growth is priced in here. For the long-term, Netflix could be a decent buy at these levels; however, Roku will be a much stronger business ten years from now, and it is less risky than Netflix due to the inherent nature of its business model. Hence, I strongly prefer buying more Roku over taking a new long position on Netflix.
Key Takeaway: Avoid Netflix, Buy Roku.
Thank you for reading. Please feel free to share any questions, thoughts, or concerns in the comments section below.
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This article was written by
Ahan Vashi is the Head of Equity Research at L.A. Stevens Investment LLC’s Seeking Alpha Marketplace service – Beating The Market. He is a “Quantamental” investor who specializes in identifying market-beating stocks by capitalizing momentum of business fundamentals. Some of his top picks include Upstart at $58, Palantir at $9, and Asana at $22.
Prior to joining L.A. Stevens Investments, Ahan worked as an Associate Fellow with Jacmel Growth Partners, a middle-market private equity firm where he acquired the art of analyzing financial statements and business valuation. Ahan holds a Master of Quantitative Finance degree from Rutgers Business School and a Bachelor of Technology degree in Electronics and Communication Engineering from NIT, Surat.
At Beating The Market, Ahan works with Louis Stevens, Jared Simons, and one of the most vibrant and dynamic investment communities on earth in pursuit of identifying the next Facebook, Amazon, and Salesforce. Beating The Market brings the potent wealth-creating power of Venture Capital to the public markets. For his part on the team, Ahan does this by systematically analyzing hundreds of public companies each year via BTM’s rigorously defined set of 23 standards/criteria – BTM’s Crucial Characteristics.
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Disclosure: Ahan Vashi is a promoting contributor for Louis Stevens’ SA Marketplace service – Beating The Market
Disclosure: I/we have a beneficial long position in the shares of ROKU either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.