Examining Roku Inc. (NASDAQ: ROKU) is one of the best ways to assess streaming video’s profitability.
To explain, Roku manufactures the digital media players that make streaming video possible. Therefore, you can claim Roku invented binge watching. Additionally, Roku’s video platform has a huge user base.
Statista estimates Roku had 32.3 million active users in the United States in 3rd Quarter 2019. If Statista is right almost 10% of Americans have Roku devices. To elaborate, Worldometer estimated the US population at 331.003 million in January 2020.
Plus, Roku claims its research indicates “roughly 50%” of cord-cutters in the United States are Roku customers, Cordcutters reports. Interestingly, Roku claims its users streamed 10.3 billion hours of video in 3rd Quarter 2019.
Is Roku Making Money?
However, Roku lost money in 3rd Quarter 2019. To explain, Roku reported a -$26.55 million quarterly operating loss on 30 September 2019.
In contrast, Roku reported a quarterly gross profit of $118.48 million on quarterly revenues of $260.93 million on 30 September 2019. Yet Roku reported a quarterly operating cash flow of $10.25 million on 30 September 2019. That left Roku with an ending cash flow of $10.49 million on the same day.
Consequently, Roku had $388.36 million in cash and short-term investments on 30 September 2019. That number was up from $387.36 million in cash and short-term investments on 30 June 2019 and $179.73 million on 30 September 2019.
Can Streaming Video Make Money?
I think Roku’s cash-flow and losses raise serious questions about the profitability of streaming video. For instance, Roku is losing money despite a 50.49% revenue growth rate for the quarter that ended on 30 September 2019.
Roku could demonstrate that streaming video cannot make money on its own. For example, Roku loses money despite charging $29.99 for monthly subscriptions. Theoretically, Roku could generate a vast amount of float.
To clarify, float is Warren Buffett’s description for a stream of cash generated by regular subscription or premium payments. For instance, float from premiums gives an insurance company a large stream of cash it can use to pay dividends, make acquisitions, or expand.
How Much Cash is Roku Generating?
Roku’s cash flow is growing, but the amount of cash it generates is small.
For instance, Roku reported an ending cash flow of $10.49 million on 30 September 2019, down from $113.53 million on 30 June 2019. I think it could take a long time for Roku to generate large amounts of float, which raises questions about its moneymaking potential.
A related problem is that Roku’s cash flow fluctuates dramatically. For instance, Roku reported a negative ending cash flow of -$36.50 million on 30 September 2018 and $262.85 million on 31 March 2019.
Therefore, Roku has a limited capacity to generate cash. That is problematic because Roku faces a dangerous and deep pocked competitor in the form of Disney (NYSE: DIS).
Can Roku compete with Disney?
The Walt Disney Company (NYSE: DIS) reported $6.833 billion in cash and short-term investments on 31 December 2019. In addition, Disney reported a quarterly operating cash flow of $1.63 billion and a quarterly ending cash flow of $6.874 billion on the same day.
Consequently, Disney can charge far less for Disney+ and Hulu. Disney, for instance, was charging $12.99 for a combination of Disney+, Hulu, and ESPN+ on 10 February 2019.
Disney can charge such low prices because of all its cash. In addition, Disney has many other sources of income, Roku cannot tap. For example, Disney generates money from the movie box office, TV advertising, merchandising, comic book sales, theme parks, and other businesses. Roku only relies on subscriptions for income.
Is Roku Overvalued?
Consequently, I think Mr. Market overvalued Roku at $139.05 on 13 February 2020. Conversely, I think Mr. Market undervalued Disney at $140.90 on 13 February 2020.
Plus, Roku paid no dividend while Disney paid an 88₵ quarterly dividend on 13 December 2019. Thus, I think Mr. Market gives Disney a high margin of safety. However, Mr. Market gives Roku no margin of safety.
Thus, I think investors need to stay away from Roku and investigate Disney. Given the realities, I consider Disney a value investment.
Will Disney buy Roku?
Under these circumstances, I wonder if Disney will acquire Roku. Disney has the resources to buy Roku.
I think Disney could buy Roku because Disney CEO Bob Iger wants a partnership with a device maker. To explain, Iger praises an Apple (NASDAQ: AAPL)/Disney combination in his book The Ride of a Lifetime: Lessons Learned from 15 Years as CEO of the Walt Disney Company.
Owning Roku could enable Disney to control the distribution of streaming video and compete with Amazon’s (NASDAQ: AMZN) Prime Video. Remember Disney bought 21st Century Fox for $85.1 billion in 2019 to get control of Hulu.
Hence, I think a Disney acquisition of Roku could be a logical move. Thus, the only value Roku could have is as an acquisition target.