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WarnerMedia-Discovery merger could spell trouble for Roku

The way MoffettNathanson analyst Michael Nathanson views it, things are tough all over for Roku these days.

In addition to concerns that an expected combination of the HBO Max and Discovery+ streaming services could spell trouble for Roku's business, he's worried about slowing player revenues at Roku as consumers continue to gravitate to connected TVs. What's more, he frets about the risks that Roku faces as the market for ad-supported streaming services heats up further.

Analyst Michael Nathanson kept his 'Sell' rating on Roku shares.  
  (Source: Richard Levine / Alamy Stock Photo)
Analyst Michael Nathanson kept his "Sell" rating on Roku shares.
(Source: Richard Levine / Alamy Stock Photo)

Together, those represent "three critical strategic issues that will continue to pressure the stock," Nathanson explained in a new report (registration required) about the streaming giant.

That set of issues adds to earlier ones that Nathanson has expressed about Roku, which he downgraded last November over concerns that revenues and earnings estimates "are just too damn high," partly because growth from subscription VoD (SVoD) services was showing signs of slowing. Nothing's changed since then, as Nathanson maintained his "Sell" rating on the stock along with a price target of $100.

Nathanson said that the just-closed merger of WarnerMedia and Discovery (the combined company is now known as Warner Bros. Discovery, or WBD) raises a potential red flag for Roku.

If WBD goes through with plans to combine HBO Max and Discovery+, that could be problematic for Roku. MoffettNathanson's analysis of proprietary data from Antenna indicates that those two streaming services are sizable contributors to Roku's distribution revenues. Given its higher monthly price compared to other direct-to-consumer services, HBO Max appears to be the largest source of SVoD revenues for Roku – generating $32 million in Q4 2021.

Click here for a larger version of this image.  
(Source: Antenna, company reports, MoffettNathanson estimates and analysis. Used with permission.)
Click here for a larger version of this image.
(Source: Antenna, company reports, MoffettNathanson estimates and analysis. Used with permission.)

"[W]ith the closing of the Warner Bros. Discovery merger, we believe it will be more challenging for Roku to extract economics from HBO Max/Discovery+ during the next carriage negotiation," Nathanson wrote.

Higher content spending a 'dangerous, yet inevitable, path'

Nathanson is also skeptical that Roku can scale The Roku Channel in a market that is becoming increasingly competitive amid pure-play advertising video-on-demand (AVoD) rivals such as Pluto and Tubi, YouTube's recent move to expand its ad-supported fare and new advertising-supported tiers for HBO Max and Disney+. Meanwhile, Amazon is expected to raise its AVoD game after buying MGM.

His concern is that this scenario could compel Roku to invest more in content, a move that will weigh on margins.

Nathanson notes that the content assets on Roku's balance sheet have already surged to $224 million at the end of Q4 2021 (versus $8 million at the start of Q1 2021). "We believe content spending is a dangerous, yet inevitable, path for Roku to go down, especially given increasing competition from major media companies like YouTube, HBO Max and Disney+ in addition to Pluto and Tubi," Nathanson wrote.

The health of Roku's player business is the analyst's third concern. Player revenues at Roku have declined (down 9% in Q4 2021) despite supply chain issues that have limited supply and raised prices for smart TVs.

Although Roku has a solid smart TV business through its dealings with several TV makers, Nathanson frets that slowing player unit sales "will be a headwind to account growth longer-term."

"It appears that consumers are watching more smart TVs, and a variety of TV OS platforms besides Roku are growing in popularity," Nathanson wrote. He cited Conviva data showing that Android TV, LG and Samsung saw jumps in viewing time in Q4 2021 in the range of 20% to 40%, versus +12% for Roku.

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— Jeff Baumgartner, Senior Editor, Light Reading

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