(Note: The author of this fundamental analysis is a financial writer and portfolio manager. He and his clients own shares of GOOGL.)

Some analysts on Wall Street view Roku Inc. (ROKU), a streaming media hardware provider, as a pure play on streaming media consumption. But when taking a deeper dive, it's clear that Roku is an advertising company selling a media device that is quickly becoming commoditized, while battling some of the most prominent technology companies such as Apple Inc. (AAPL), Alphabet Inc. (GOOGL), and Amazon.com Inc. (AMZN AMZN).

Roku is merely a device that offers users a way to access content with no competitive or first-mover advantage, and is not worthy of a $5 billion valuation. (See also: Roku: Needham Lifts Price Target as Stock Surges.)

Roku first went public on September 28, 2017 in a $220 million offering priced at $14 a share. That helped the company raise about $117 million, while $86.8 million went to selling stockholders.

Roku shares rocketed nearly 165 percent higher after the company reported its third-quarter results on November 8. The market has fallen in love with Roku's metrics, such as its 48 percent growth in active accounts to 16.7 million users, and its 58 percent rise in streaming hours, to 3.8 billion.

ROKU Chart

ROKU data by YCharts

Competition

The problem for Roku will be fending off competition, which will be nearly impossible. Roku saw revenue growth from media players of only 4 percent in the third quarter, as the company shifted its focus to growing active accounts and not on maximizing hardware revenue.

The average selling price of a Roku media player was down 23 percent due to consumers shifting to a cheaper version of its players. Put another way, competitive forces are causing Roku to focus on selling more inexpensive media players.

Roku currently sells five different versions of its media players, ranging in price from $29.99 to $99.99. By comparison, Alphabet's Google Chromecast sells for only $35. An Amazon Fire costs $39.99, and an Apple TV is $149.

Most new Smart TVs come pre-loaded with the apps needed to watch streaming content providers such as Netflix or Hulu. Roku does offer its software preloaded on TVs made by TCL, Sharp, RCA and few others. 

Ads

Roku generates some platform revenue through sharing agreements with content providers, but the majority of its revenue comes from advertising. As of June 30, 2017, advertising revenue was 67 percent of total platform revenue, an increase of 4 percent from January 2016.

According to Roku's IPO filing, the top 5 streaming channels account for 69 percent of Roku's total hours of streamed content. Netflix alone accounts for one-third of all streaming hours and is the largest provider of content across the Roku platform. But Roku does not generate any material revenue from Netflix, nor does it see Netflix being a material provider to its operating results in the future. Additionally, the Roku makes no income from YouTube, its most-viewed ad-supported channel by streaming hours through June 30, 2017.  

Roku is undoubtedly not a pure play on streaming media. It has no content, no competitive advantage, and is merely a way to play advertising in the streaming media world, a place where viewers go to get away from ads. The convenience of streaming media is the ability to watch what you want, when you want, and without interruption. 

The biggest ad-generating company in Alphabet through Google Chromecast will surely figure out a better path than Roku has. 

Michael Kramer is the Founder of Mott Capital Management LLC, a registered investment adviser, and the manager of the company's actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of three to five years. Click here for Kramer's bio and his portfolio's holdingsInformation presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future performance.

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