Roku IPO: Netflix and YouTube generate huge streaming hours, no revenue

Roku has spent the last few years fighting for your living room against fearsome competitors — Google, Apple and Amazon — and it has more than held its own. Now it gets a payoff, via an IPO.

The pitch to investors: Get a piece of the next generation of the cable TV business, where video programmers who want to reach a huge audience will pay Roku to reach them.

A red flag for investors: Some of Roku’s biggest programmers don’t make Roku any money at all.

Let’s back up. Roku is going public as it moves from a low-margin business — selling video streaming devices — to a potentially high growth, high-margin business — taking a cut of advertising and subscription fees programmers generate using its devices.

First the good news: For now, Roku’s strategy of pushing its prices down has helped it compete against very deep pocketed rivals. In the first half of this year, it saw a 37 percent increase in device sales, led by its $30 Roku Express stick.

That cost its device business — Roku calls it its “player” business — both revenue and gross profits: They are down 2 percent and 28 percent, respectively.

Roku says it’s ok with that. All of those new devices helped its services business — Roku calls it is “platform” business — bump up revenue by 91 percent, while gross profit jumped 104 percent.

And Roku has been at this for several years. It now has 15.1 million monthly users, up from 4.8 million three years ago. And it is generating an average of $11.22 in service revenue for each one of them, up from $4.65 per user three years ago.

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It’s certainly possible those trend lines continue. Then again, once you have a Roku box, or a TV running Roku’s software, it’s entirely possible to use Roku as a consumer, or as a programmer, without generating any extra revenue for the company.

Consider: Roku says that Netflix, the most popular video service on its boxes, makes the company next-to-no money. I don’t know if that’s because consumers are signing up for Netflix outside of Roku, so it doesn’t get a cut of revenues, or if the bounty Netflix gives them for sign-ups on Roku’s devices doesn’t amount to much.

It doesn’t matter. Roku does “not expect revenue from Netflix to be material to our operating results for the foreseeable future.”

Meanwhile Roku says that YouTube, its most popular ad-supported service, doesn’t give Roku a cut of its ads, or any other revenue. It’s a zero.

Roku would likely respond that it’s going to keep adding more programmers to its platform, and it will find a way to make money from at least some of them. In 2008, Netflix accounted for 100 percent of Roku’s streaming hours. Now it’s down to a third.

So here are two questions for a Roku investor: Right now five programmers account for roughly 70 percent of the company’s streaming hours. Do you think it’s going to be able to diversify those numbers significantly? If so, do you think the new guys will be up for giving Roku a taste?

There’s definitely a version of this where it works. All of the new streaming services that have popped up in the last few years, and all of the services on the drawing board, want help from distributors.

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That’s why you see Netflix striking deals with cable guys like Comcast, and Amazon selling HBO Now. And as Roku notes in its prospectus, it now has more video users than Dish Network, the fourth-largest pay TV distributor in the U.S.

On the other hand, if you’re a must-have programmer, then Roku has to have you — unlike cable TV, there’s no lock-in. It’s incredibly easy to swap out internet TV hardware. And Roku has just told the world that the two biggest players in internet TV are paying it zilch.

Meanwhile all of those deep-pocketed competitors Roku has been fighting are still around, and still have deep pockets. And, crucially, they don’t depend on making money from video to survive. They’re using video to help build up their other businesses — the ones that gave them the pockets.

So they can afford to be as flexible as they need to be to get this stuff on their platforms. Apple doesn’t really care whether it makes any money when you use ESPN’s new service on an iPhone next year — it just wants you to use ESPN’s new service on an iPhone.

That puts Roku in a tough position. Good thing for them is that they’re used to it.

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