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Video/Media

Roku faces streaming headwinds as distribution piece of its biz slows – analyst

Roku's advertising business is red hot and poised to be a long-term growth driver for the company. But another important piece of its fast-growing Platforms business – distribution deals and obligations with Disney+ and other premium video apps and services – could create "headwinds" down the road for the streaming giant, reckons a top industry analyst.

The distribution piece of Roku's business has seen rapid growth. But it's questionable whether the pace will continue as the wave of launches of premium, subscription-based streaming services settles down, and as the market appears poised for more consolidation among large programmers and media companies that now operate these premium SVoD services. At least that's the view of MoffettNathanson analyst Michael Nathanson.

In a report that factors in an analysis of Roku's filings with the US Securities and Exchange Commission (SEC), Nathanson estimates that revenue from Roku's streaming obligations have surged by more than 250% compared to the second quarter of 2020, and are the source of more than 25% of Roku's growth.

Roku's distribution business has benefited from an unprecedented wave of new premium streaming services from major programmers and media companies.  
Click here for a larger version of this image.
Roku's distribution business has benefited from an unprecedented wave of new premium streaming services from major programmers and media companies.
Click here for a larger version of this image.

That represents a greater-than-expected boon to Roku's business, but Nathanson believes "growth in this segment will plateau" as the number of subscription VoD entrants dissipates and, perhaps, as some of the media giants combine with others. Signs of such consolidation are already apparent, as Discovery, which recently launched Discovery+, and WarnerMedia (HBO Max) prepare to merge. Meanwhile, rumors persist that NBCUniversal (Peacock) and ViacomCBS (Paramount+) could look to combine to help them create the scale necessary to succeed in the evolving direct-to-home, streaming market.

"[W]hile we strongly believe in the long-term growth opportunity that Roku can attain in video advertising, we think that investors are underestimating the extent to which the streaming wars have propelled recent growth," Nathanson explained in the report, which takes a deeper dive on Roku's revenue drivers to help refine the analyst's thinking on the stock. "[W]e do worry that the recent acceleration in Roku's revenues from distribution of an emerging class of SVOD platforms will face increasing headwinds as launch activity slows, new deals are reached and the losers in this new war quickly assess their raison d'etre and seek consolidation."

Nathanson estimates that Roku's video advertising business has reached a quarterly revenue run-rate of over $260 million, meaning that half of the revenues in Roku's Platform business are tied to other revenue drivers, such as the aforementioned distribution obligations piece with various SVoD partners. That second piece, the analyst believes, has been boosted by new premium entrants and "the advent of the streaming wars." But he also believes that recent data shows that this boost to Roku's Platforms business is already showing signs of slowing.

Keeping tabs on 'Customer H'

To amplify that point, Nathanson notes that there was a "marked deceleration" in the rate of change in Performance Obligations at Roku in the most recent quarter. This suggests that the slowing pace of new subscription VoD launches may be capping future revenue growth in that particular line item, he added.

Linked to that, Nathanson references a Q1 2020 disclosure that a "Customer H" was responsible for 13%, or $30 million, of Roku Platform revenues. He thinks that's a reference to Disney+, the premium streaming service that had about 116 million subs worldwide at the end of Disney's fiscal Q3, but recently warned that the pace of sub growth is slowing.

Click here for a larger version of this image.
Click here for a larger version of this image.

"Given that Disney+ launched in mid-November 2019 in the US, we assume that Disney is 'Customer H,'" he surmised. But after seeing Customer H revenues double in Q1 2021, it dropped below the 10% threshold in Q2 2021, "suggesting that promotional spend for Disney+ has begun to dissipate," Nathanson added.

Time will tell if this pattern will continue with Roku's other major SVOD streaming service partners. But the analyst points out that the launch of Disney+ was followed by a wave of others that subsequently forged similar distribution arrangements with Roku: NBCU's Peacock, AMC Networks' AMC+, WarnerMedia's HBO Max, Discovery's Discovery+ and the rebrand/relaunch of CBS All Access to Paramount+.

"For Roku, we have to imagine that all these competitive launches so close to each other felt like a never-ending cycle of big Christmas gifts," Nathanson wrote.

That cycle may not come to a complete stop, but it could certainly slow down as the market sees fewer new major streaming service entrants or some of the top players combine. So far, these worries aren't strong enough to cause a change in Nathanson's rating on the stock. He reiterated a "Neutral" rating on Roku and kept a price target at $360.

However, Nathanson's concerns about possible headwinds did have a small effect on Roku's stock – shares were down $9.44 (2.94%) to $311.80 each in mid-day trading Tuesday.

Still a bull on Roku's ad business

Although Nathanson has questions about the future growth of Roku's distribution-related business, he stressed that he remains bullish on the video advertising opportunity for Roku amid the continued surge in the broader advertising video-on-demand (AVOD) market.

Excluding YouTube, he estimates that the four largest domestic AVOD platforms are Hulu ($855 million of ad revenue in Q2 2021), Roku (domestic video ad revenue of $242 million), Pluto TV ($214 million) and Tubi ($120 million). He expects those leading AVOD platforms (again, excluding YouTube) will reach a combined $7.7 billion in revenues in 2021, up 60% from 2020, led by Hulu (27% share) and Roku (20% share).

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— Jeff Baumgartner, Senior Editor, Light Reading

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