Chit Chat Stocks - Roku (ROKU) | Deep Dive

Episode Date: July 4, 2021

Roku operates a TV streaming platform and also provides advertising. The company manufactures and sells smart TVs. In addition, Roku offers streaming players that can be plugged in via HDMI ports to other TVs. Listen closely as Brad, Brett, and Ryan dive into what Roku does and how they can continue to grow. As always enjoy the show! Subscribe to Potential Multibaggers: https://seekingalpha.com/checkout?service_id=mp_1308 Follow Brad and check out his work on Twitter: https://twitter.com/StockMarketNerd?s=20 Follow us on Twitter: https://twitter.com/chitchatmoney Subscribe to our Youtube Channel: https://www.youtube.com/channel/UCG5Ni-SI-jyrEsoNUhqftNQ Email us: [e-mail] Timestamps Company Background | (2:29) Industry | (9:22) Management & Ownership | (11:53) Valuation | (14:04) Earnings | (15:42) Balance Sheet | (17:01) Our Analysis | (19:10) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or recommendation. Now, please enjoy this episode. Welcome in. This is the Sunday Deep Dive episode. We have Brad Freeman on the show as always. You're coming from the Upper Peninsula in Michigan, so we're going real remote today.

I have Ryan here as always, but Brad, how are we doing? You ready to talk about it? Got to correct you. A little Michigan history. It is the northern tip of the Lower Peninsula. So I'm going to talk about Michigan, my man. No, I'm just kidding. Yeah, I need to know my Michigan geography. But yeah, vacation's going well. And for a stock market nerd like myself, this is actually an enjoyable activity for my vacation, believe it or not. So excited to talk about Roku. All right. And then, Ryan, do you want to introduce Roku? But first, we should talk about potential multibaggers, our flagship sponsor.

It started from our friend Chris, who's a pseudonym on Twitter, is at FromValue, and that's a pseudonym on Seeking Alpha as well. He started this as a side project while he was a teacher in Europe. I don't want to give away his location or anything like that, but now it's morphed into his full-time job. He's dedicating hours and hours each week. You can see the updates coming in basically on a daily basis and commentary, updates on the stock they're doing. but I should go over the service quick. So the aim of potential multi-baggers is to find stocks that can go up 10X over the next 10 years or about 26% per year. Not a guarantee, it's potential multi-baggers. So you're looking for those high growth names, but

his track record is sound. He picked Shopify at $77, Sea Limited at $54, Cloudflare at $39. The list goes on and on. And if you want to check out potential multi-baggers and become a multi, You can go to Seeking Alpha and look for From Growth to Value. Google it and you'll find it there or go to at From Value, F-R-O-M-D-A-L-U-E on Twitter. Ryan, you want to introduce Roku? Yeah, and I'll just add before that, kind of tack on to the sponsorship there. It's validation that this happened so naturally, that this service came about so naturally because it's less about him just trying to start a service and more people asking for

because he was, I mean, this was an alternative or a supplement to his actual job initially. So yeah, just kind of a testament to the service. But yeah, feel free to check it out. I'll get into Roku. Most of you, if you are in the investing world or on FinTwit have probably heard of Roku or if you're a consumer that has a TV,

you've probably heard about it. But they are a leading TV streaming platform and it is an end-to-end solution for connected TV. And I'll talk about why that is. But basically, users can buy a Roku TV, or they can buy a Roku stick, which is sort of their hardware, or their player sales. And the player stick just plugs into an HDMI port and a traditional TV. And then the Roku TV, I believe is manufactured and supplied by TCL over Japan. Sorry, if I'm getting that wrong. I think they have other partners as well. But you know, it's not them

making those yeah and they're really one of the low-cost providers um as far as tv goes but then the the staple of both players whether it's the roku tv or the roku stick is the roku operating system this is kind of what it's more known for um and so this is sort of an iphone like layout where you can access all your apps it's very intuitive um it's basically i think it's three three apps across you can scroll down go app by app and these are the ott media apps so think Disney Plus, Netflix, ESPN, YouTube, Prime Video. There's thousands to choose from. You can obviously just add them to your home screen if you want. You can take them out. It's really easy. But it does generate revenue from the hardware. I think it might be negative gross margins.

I saw on the last 10Q only 3% gross profit contribution or gross profit growth from that. So it's negligible on a gross profit side. Yeah. And there was a time when they were selling it for a small gross profit, but at this point, they're basically just trying to be the low-cost provider. But then it generates the bulk, if not all of its operating income from what it categorizes as platform revenue. So this includes, and this is where it gets a little bit complicated, but includes a lot of different services or digital offerings within the platform revenue. So there's advertising sales and related services, subscription and transaction revenue sharing agreements, and then the sale of premium subscription services. And then there's also

this sale of branded channel buttons on the remote, which I'll talk about in the second half. Huge, huge business. We were debating that before. That does get grouped into platform revenue, not hardware revenue. And then there's licensing arrangements with service operators, but I'll talk about the ad. So the revenue sharing, it's think of it kind of like the iPhone software or the iPhone revenue from software. Am I saying the services revenue? Maybe it's what they have. They have a take rate.

Yeah. So I believe Roku has a 20% take rate on either subscriptions or SVOD. So video on demand, thank you, purchase a movie on Prime Video, something like that. But the advertising side, and this is a little bit complicated, but Deval Kotecha, who's a friend of the show, has done a thread on it this week. And there's basically two ways. If you're running an ad-supported channel on Roku, so whether it's like CBS, ABC, There's plenty of ad-supported channels. You can choose between two types of ad servicing systems.

I believe it's just two types. It's either inventory split or Roku sales representation program. I recommend going to his thread and looking at it because it's a little complicated, the backend workings of it. But either way, Roku is getting a share of that ad spend within the ad-supported channels. Does that kind of make sense? Yeah, that makes sense. If you want to get the full overview, definitely you'll follow the ball. You can understand how this business rather quickly by either talking with him or reading his threads. Yeah. And they don't break out the platform revenue into its subsection. So you don't know which is from sharing agreements, which is from ads, but obviously the section of the whole is

growing a lot. And I'll get into the history. It's actually kind of a fascinating story how it started. So it was founded in 2002 by Anthony Wood after his company Replay TV was acquired by sonic blue um and so replay tv was his company for his invention which he actually invented the dvr fascinating story um and so that was his company he sold it and then he started roku which is i believe japanese for the number six um because it was the sixth company he started and early on it became a part of netflix those parts kind of muddled i'm not sure exactly how it went but they were a part of netflix anthony wood became a vice president of netflix and then he actually because Netflix was thinking of doing a player, but they just wanted to do it through Roku.

Then Roku ended up spinning out. Netflix funded them with $6 million. I'm not sure what that's turned into today. I'm not sure if they sold that stake, but then the company, they obviously became their own company. And in 2017, they went public and they've made several acquisitions along the way. So they've done demand side platforms as far as advertisements. And then they also acquired Quibi's content for a hundred million recently. Other notable moments would probably be the content or the licensing disputes so several companies have held out on putting their app on roku probably over the revenue sharing agreements uh the two that come to mind are hbo max and google with youtube tv and they're still holding out currently i don't think so

i'm pretty sure youtube i've seen they pulled something from mine it was pulled but i think that was all i thought hbo was good and then youtube there were still some issues but i could yeah youtube i have some i have a black online rope i have a blank thing that says google's not supporting this right now i don't really know what it is i have youtube but it's something that google wants okay um i thought that one got resolved but i know hbo max did get resolved so i guess that's kind of if you're an ott media provider it's it's hard to neglect roku since they make up so much i think 38 of smart tvs sold in the u.s are roku tvs so obviously it makes up a huge part of the market and it's kind of a testament to

the value of their platform yeah they've been growing market share versus the apple tv amazon fire tv uh and really i mean that's those are the obvious competitors and i probably should have put it in this industry and landscape and competition thing but i it's honestly i don't know i really don't see them as a threat uh amazon fire tv and apple tv maybe they are but really roku's shown that they can defeat them in getting you know users on there so that's not something you know Maybe you should consider that, but that's not something, I don't know, maybe that was something you worry about in 2017, but not today. But I'll go into the industry. So Roku itself estimates that TV advertising markets be about $70 billion. So that's part of the business that they're going

after. And then the global smart TV market is now estimated to be around $200 billion. So clearly, rapid growing, large industry, there's tons of dollars to be had out there, but there are some large competitors so i really put because they have you know roku is they have the smart tv players they have advertising and then they basically have the operating system or the app store so they're competing in a few different buckets and i kind of put it into two different categories and maybe we can discuss others so one would be other video advertising platforms and mainly i'd say youtube linear facebook and tiktok in and of itself like you might not think that they're competitors to roku but the video advertising market as a whole there's only

so many dollars being spent if they're going to youtube and facebook they're not going to roku so i consider them to be pretty big competitors of their and then non-advertising video services I don't, they're not competitors because like Netflix, HBO, Disney Plus are working with Roku. But if, you know, Roku channel, they're kind of on the OTT side there. I guess they're competing there too. Yes. So, you know, you might think, all right, well, the growth of these are good for Roku. But if all of these companies or services are ad free, and all of the watch hours flow to these services, then that's potentially leaving less advertising dollars in TV. So I kind of, you know, there's a give or take, it might not be zero sum,

but it'll be interesting to see how the market develops. If it goes more and more ad free, like it has been the last five years, that could be some competitive dynamics that hurt Roku. But on the flip side, if we see more ad, you know, supported services that can benefit Roku as well, I guess. Yeah. And I'm not sure they might have a different agreement with Netflix, given that they were sort of born out of them or got funding from them but yeah it's unknown it's worth mentioning that they gain revenue either way whether it's ad supported or subscription or transaction based uh they get a take right on that too potential if you sign up through roku um so i don't think netflix is really paying them that much because it was basically a

lot of existing accounts so if you had it like before you got a rope tv and you just sign in I don't think Roku is getting any dollars there. Yeah. All right, Brad, you want to hit management and ownership? Yeah, Anthony would. As we've kind of highlighted before, there are very few bigger names in the CTV slash programmatic ad or streaming service landscape. Maybe Jeff Green of Trade Desk and Reed Hastings of Netflix, you kind of lump in. But he I mean, he's a superstar. We talked about VP of connected TV at Netflix, we talked about inventing the DVR, I mean, talk about relevant experience. Founding Replay TV, founded several other successful companies. He's the current board chairman of BrightSign, which is a digital signage company. So he's got

extensive experience. He's been successful everywhere he's gone. Yeah, there's nothing bad to say about him at all. CFO is Steve Loudon. Sorry if I pronounced that incorrectly, but he's the former Expedia treasurer and he's a senior VP. He was a senior VP there. He's a current advisory board member at Silicon Valley Bank. He was a manager and analyst at Walt Disney, consulted at McKinsey, and he graduated from Harvard Business School. So casual there. Ownership. So this is a little off. There's this dual share class structure that makes the sources that I generally like to use a little bit inaccurate. So Yahoo, Koi Fin, and all that. So I went into their investor relations page to try and find some primary stuff, and they don't disclose a ton of it.

What they do tell us is class B shares equal 10 votes per class A share. And then, so again, Yahoo and Coifin all say that Anthony Wood owns nothing. But if you look in their, in their, in the primary sources that that Roku is publishing, Wood owns 13% of the outstanding class A and B shares, but he owns over 50% of the voting power. It has, these sources have institutional ownership right around 70%. That is not voting power. That, that is just share ownership.

So normal class A common equity. uh yeah that's it yeah it's i mean this one's pretty simple once you get down to it it seems like wood has the control here uh and that's kind of who you're betting on it's one of these dual class ones where you know the founder has all the control uh brad yeah and i forgot to oh no i did mention the institutional ownership so never mind i think i covered everything there yeah yep all right i'll hit valuation market cap 58.3 billion dollars tickers r-o-k-u so just the name. EV is closer to $56.5 billion, trailing EV to sales of $27.8, trailing EV to gross profit of $54.4, and then trailing EV to operating cash flow of $285. And that one's large, but they're

still in a high growth mode. So I wouldn't look at that cash flow number while, you know, the evaluation number or metrics are clearly, sorry, the multiples are clearly high on a sales and gross profit ratio, the cash flow, you know, the reinvesting lines of the business through the income statement. And then just as a note, they have a little over 10 million in RSUs and stock options outstanding compared to the current share count of 132 million. So decent amount of dilution coming down the line that might not happen. It's not gonna happen immediately. Like we always say it could happen over the next five years, but just expect further dilution coming. Yeah. And it's, they had, I think, I don't have the number right here in front of me,

but I want to say it was around $40 million in stock-based compensation over the last 12 months, which amounts, I think, of like 2% of revenue. It's like a double-edged sword because it's almost irresponsible if you have this highly valued currency, essentially, in your stock, and you're not using it. Well, I'd say it's irresponsible if it's high because that means it's overvalued and you're giving people shares. But if you're granting stock options at a low multiple, I'd say that's good. It's kind of the opposite. Yeah. And I'll talk about the kind of spend here in a second, but earnings as far as that goes, trailing 12-month revenue was just over $2 billion, up 63% year over year. That was actually

growing faster in the first quarter. I think it was like 70%, something in the 70s. And then they had 994 million in trailing 12-month gross profit. That's growing 86% year over year. gross margin is at about 49% up from 32% three years ago. So if you've been tracking Roku since it's been public, obviously hardware revenue used to dominate the income statement. And since then platform revenue has really grown. That's what's created sort of that boost in gross margin. And then they have 198 million in trailing 12 month operating cashflow, and they're putting about 40 million into CapEx. So I think around 158 million in free cashflow, that's probably just sort of doing it off the top of my head, 7% to 8% free cash flow margins.

But they are pouring a ton of money into operating expenses. So I talked about the $40 million in CapEx over the last 12 months, plus they're doing $400 million roughly in research and development. So they're certainly investing heavily. It's obviously, it's the kind of platform that could have high margins if they cut the spending. But at this point, I see no reason why they shouldn't be investing back into the business. Yeah, yeah, for sure. For sure. Brad, you want to hit balance sheet? Yep. So balance sheet is pretty darn strong. They have roughly 2 billion in cash versus 1.1 billion quarter over quarter, not year over year. They did pocket about 990 million from an at the market equity offering. So keep that in mind. That's why the cash position really jumped. So good to know there. They have another half billion in receivables, just 100 million in payables. So now to 400 million there. They have $125 million in goodwill and just $80 million left in intangibles on the balance sheet.

So that's really not, I mean, that's not too alarming in terms of the size of future potential write-downs based on all the acquisitions they've been doing. They have essentially zero current debt, so zero current interest expense. They have $628 million in long-term debt and another $300 million in lease liabilities. They have another couple hundred million in revolvers. They did draw down $70 million of an existing revolver. an interest rate of LIBOR plus 1.75. And those interest rates are pretty typical of the debt that they're issuing. So very strong balance sheet, strong liquidity, no issues there. Yeah. I was just going to say, I'm honestly a fan of the at the money equity offerings,

especially if they're going to go after this sort of content spending war with some of the big players, the Disney's, the Apple TV's, the Netflix's of the world, they need cash to do it. But obviously, I don't think it requires that much CapEx as far as garnering ads. That's sort of just a tailwind that they benefit from. Well, 400 million R&D. Yeah, I mean, part of that, that's not all going towards ad spend or ad servicing. Yeah. But it's, I mean, why not raise the cash if you have the chance?

Yeah, definitely smart. Looks like a good balance sheet to me. Yeah, good balance sheet. definitely no concerns on that debt i mean yeah no concern on the debt and it's smart that they're paying the money but i mean they will discuss in the second half is that good for uh the current shareholders that that's more of a debate but let's hit the ad break and then we'll move into the second half of the show cox panoramic wi-fi includes advanced security to help protect all your connected devices you'll get real-time alerts oh like this one so you don't have to

worry about malware or when your kid downloads a song from a shady link and now all your computer can play is red color red color where are you all blocked thanks to advanced security included with cox panoramic wi-fi advanced security must be enabled in the panoramic wi-fi app restrictions apply all right welcome back next up we're gonna have anecdotal evidence pretty easy here uh i think we'll have some kick it off with Brad. Yeah. Our stories look pretty similar. So undergrad Roku was cheap. It was convenient. We used it. We got it over basic cable. There were some regrets because we liked to gamble on live sports, to be totally honest. And that wasn't a part of the product. I haven't used Roku in years. So for all I know, they could have some lives. I don't think

they do, but they could have some live sports rights. But yeah, anecdotal evidence, I enjoyed it. But if they could somehow figure out a way to incorporate live news and sports like Paramount Plus is doing and some of these other streaming services, I think that would be a real value creator. Yeah, it seems like the trend is moving in that direction, but it's pretty slow. There's kind of some friction or inertia from getting it over from the cable services. Ryan, do you have the anecdotal evidence yeah you said you looked at the roku channel recently uh yeah that's gonna be mine what uh did you see live channels on there i went this is what happened i went to the search bar search for a movie it said it's on the roku channel i watched it didn't even go to the roku

channel um that's kind of good anecdote yeah that's good i guess because i've been a doubter on it i i really am like why would i ever click on the second netflix and hbo but i did end up watching a movie there uh i'll say the experience sucked because there was a ton of ads that i hated uh and i i'm not gonna go there you would have loved it if you're a shareholder i it was i like netflix and hbo's model so much better yeah go ahead just generally so as a consumer, obviously I prefer subscription, but I've been a Roku user for about four years now. It's pretty much the go-to college TV since it's kind of one of the low cost providers. And I'd even argue there's a bit of a lock-in on the consumer side for me, at least where the

navigation is so intuitive and you get so used to the operating system that when I've gone back, my parents have like a fire stick and navigation is a lot more difficult. It's a little frustrating. it's often messy i've had a lot of kind of hiccups with the fire stick i don't even know about chrome cast or apple tv but i just prefer the roku design which it's probably an operating system i'll stick with yeah as long as i watch tv yeah i think that yeah that could be the case or is it really just that the tvs are cheap like i knew it was cheap i knew it worked so in the you know like and i was back in college. And now when I have my own apartment, I'm like, all right, $200 TV, decent size. Yeah. That's way cheaper than everything else. I use that, uh, that I feel

like that's more important, but either way, the TV itself is more expensive than taking a fire stick though. Uh, sure, sure. Yeah, for sure. Uh, so I guess there, I mean, maybe I'm overthinking it, but I think having such a basic platform kind of helps. Yeah. I don't know. Maybe I'm a doubter. Maybe I'm a doubter of how much shareholder value that can create, but it's definitely nice. Nice for sure. Future growth opportunities, Brad, what did you have here? So DataZoo, I think it's, so actually I think it's DataZoo if it's Xoo or something, I'm sorry, but that acquisition is very compelling to me and I am biased because I own, oh, go ahead. And is that, that's the demand side platform, right?

Yeah, they changed the name to OneView. Yep, yep. So I'm biased because TradeDesk, I mean, it's one of my largest positions. That's the de facto demand side platform right now. So I love the business model. But I love it because the unit economics are mouthwatering and the growth is pretty darn consistent. So we're talking about this gross margin kind of going very impressively from 32 to 49%. And I think if they can kind of internalize some of this programmatic outsourcing, that could be a really, really strong growth tailwind and margin tailwind going forward. Yeah, that makes sense.

it can definitely help expand margins and it helps them build well then they'll probably never get to the uh sorry the google level walled garden it can help them build more of a walled garden which is very advantageous so yeah i'll get into mine and this isn't necessarily something they control so i guess it's not like they're pushing the future growth opportunity here but the ott media push and the content spend that's going on is a big tailwind for them um and they benefit from it in a lot of ways so we talked about the ad supported we talked about the subscription signups um but then there's also like we just saw apple tv plus is now uh putting itself uh on the roku remote button or whatever uh yeah pushing that but the the direct uh the one click

to those you know those four i don't know people know if they have the remote but it's just a a little direct to that channel thing on the remote yeah so i just uh the roku remote real estate i think is valuable especially i forget what the installed base is now i'm guessing it's like 50 million in between 50 and 60 days um and it got over touted i think there was an overreaction in the market when they saw that apple tv was signing up for it and i think it's about a dollar per customer for this advertisement that was according to a 2019 report um the idea here is that they can add multiple buttons uh it's kind of like the home bar for an iphone hopefully if the installed base gets large enough and that that's very valuable real estate and

hopefully they can have price and power there yeah yeah i mean yeah the stock went up five billion which is a bit ridiculous to do that in the news it's definitely accretive but if you say like all right they have 100 million say they get 100 million accounts all new remotes because it's not it's only new remotes a lot of people are not going to get a new remote so say they have 100 million accounts four dollars per i mean that's 400 million dollars but and it's not very recurring so i i mean it's nice i don't know five billion dollar market cap boost is certainly an overreaction but i think it's back down five billion today yeah that's just yeah that's just the market we're in uh i'll hit mine and this is kind of more we maybe discuss their original

strategy, which they've done recently. So they acquired this old house. That's something I know about, but apparently it's the biggest home improvement show out there. I forgot what channel it's on. They got the rights and I think just the ownership of that for a hundred million dollars, and it's going to go onto the Roku channel. So I bet it's just a way to acquire customers to the Roku channel. It's a part of their original strategies to get demand for advertising there. And they're doing that with that Quibi content they kind of bought on the cheap and this is nice it kind of shows what kind of business model they're going for over there but i think it's a bit of a it's a bit of a step back because i think at first they're

like we're just going to set up the advertising and it's going to be like youtube the content will be built for us but then they're like oh shoot like all right netflix is ad free hbo is ad free disney plus is ad free i think i'm pretty sure on disney plus yeah yeah it is and they're like, all right, well, there might not, you know, we may have to build the content out ourselves. I mean, what do you guys think about that? Is that going to hurt their returns on invested capital? Because I don't know, they're going to have to spend a lot more than just this whole house to get to get the returns here on the ad set. Or do you, Brad? Yeah, it reminds me almost of Fubo, which is really struggling in the gross profit margin department because they don't really

have this gigantic brand following and they do have to spend money on content and live sports rights. So yeah, I think Roku is in a far better position to do it just because they've had so much more success and they've got cash on the balance sheet. But it is a little, it's not a red flag, but a yellow flag, as we say sometimes. Do you know how these expenses are getting categorized? I can't imagine it's CapEx because there was only like 40 million in CapEx. Yeah. So I, it was just an acquisition. So it's going to be, this is under, you know, business acquisitions under cashflow from investing activities. So I just consider it, it's not going to be considered CapEx,

but I would consider it CapEx because it's under that. And then that's where that goodwill is coming from, from them. But yeah, I don't know. What are your thoughts, Ryan, on this? Is that. No, I, I think it's probably in their best interest. if they get a large enough library of content to do a paid service as opposed to advertising because I think the trend of subscription of everything is here to stay.

I think people prefer that. It's such a worse experience when everything's bogged down with advertisements. But that's their whole business. That's a lot of their business. I mean, you don't necessarily know that, but... It's a good chunk. I can say that.

it's uh probably not advertising from the roku channel no not yet yeah no no there will be ad supported channels that may that stay so if you talk about abc something like that live sports i think you can keep advertisements on but you kind of got him for the x it uh i would say i would not i'm not a viewer of the roku channel right now and ads are part of the reason why yeah i mean i guess we'll get into highlights and all that's here the rope channels stay low life for me who knows maybe they'll really execute uh but let's get to highlights and lowlights brad what do you have uh highlights would be going back to what ryan kind of just hit on with with apple tv deciding to um add the button to the roku channel so that kind of ties

into my low light as well roku is competing with the richest companies in the world all of the richest companies in the world um competition is extremely fierce and they have handled it admirably so far i mean this reminds me a little bit i know you guys love spotify and and when apple music was announced i was one of the people who said oh that that's spotify can't compete apple's way richer and and they'll they'll just they'll win but spotify has completely proved me wrong over the last several years and roku is proving me wrong now so the low light is that competitive landscape but really so far so good for how they've been able to handle it yeah they've Definitely. It's similar of how they had the big tech competitors to Spotify and they were able to

out-execute them just because they were focusing on that niche. But they have competition from other, I think they have competition from other places too. Ryan, what are your highlights on the list? Highlights for me, I am a big fan of Anthony Wood. I'd put him in my top four or five CEOs in the world right now. And he's a big reason why this industry exists. If you listen to interviews from him uh in like 2016 2017 everything he's talked about has kind of come to fruition he reminds me a lot of a hastings figure which is i guess unsurprising that a little less charismatic than hastings man yeah but smarter smart uh but they they are friends i'm pretty sure um and then uh they have 38 of the smart tvs sold in the u.s uh as roku tvs and then i think

they're seeing similar dominance in canada yeah and they're going mexico and brazil now too so yeah big international all around owning i mean owning that stack and there are probably some scale benefits here as well having that massive install base leads obviously to uh better economics but the low light then is being the end-to-end provider leads to some concerns over i don't want to say monopolistic power but you're going to see pushback on a 20 take rate i mean It's kind of like the Apple issue, which if you have Roku channel content that you're giving away for free, I guess they're doing advertisements on it. But then you're charging everyone 20%. It's a little difficult to get around.

It's going to be far in the future. There's nowhere. And good thing their competitors are so big that no one will probably care. And yeah, it's also the people they're competing with don't really have any room to point fingers about monopolies. So, I guess that's a benefit to them. Also, yeah, as far as concerns over other hardware providers, I think those are in the past. Those are definitely in the past. I mean, the big questions you have to ask now, and it's really why they're multiple, totally expanded over the last three years.

I mean, the big question now is how much advertising spending can they get, you know, with the negotiations with people like Netflix, who has the more leveraging power. I would love a lawsuit to come out just so I can figure out if Netflix gives them any money. That's a huge question I have, and I don't know if we're ever going to know that. But all hit highlights for me, I mean, all around just quality of business, market leader, great margins, long runway for growth. Management has a phenomenal track record of making all the right moves at the right time. There's just a ton to like here. but low lights i'm worried and this might just be anecdotal in my head and it might not matter but i'm just worried about where the ad dollars are flowing and then share dilution the small

low lights but uh those are some things i've been concerned about just looking at brad and i think the low light that we're all thinking of is the low light that breaks our low light rule isn't it i mean yeah multiple expansion that that has happened over the last three years how how real as that um and so far so good but but yeah i don't want to break the rules so never mind we'll get that in probably the bear case but let's do bull case first brad what are your thoughts of how does robu's business need to evolve for for the stock to succeed over the long term yep i think the bull case here is that it can become or it can continue to be not not become the spotify of of this video streaming landscape of it doesn't really make sense that they can significantly underspend

Apple and have a far more fragile balance sheet and far less consumer data. And yet they are producing a superior product and having zero problems taking market share from this $2 trillion company. So it is possible. And if it's possible for anyone, it's possible for Spotify and roku so so that that's the bull case that that all this competition is more complementary than than cannibalistic and and they can really just continue being a market leader in this field yeah ryan yeah bull case for me is that their control over uh the eyeballs or aggregating demand leads to them having a lot of negotiating leverage and then different pricing power in different areas obviously there's a lot of different avenues for optionality with regards

to platform revenue um and then if the cord cut in trend and the content spend on ctv persists they're going to be beneficiaries of that um that's that's sort of the bull case is that everything continues to go well in their favor and the game marketer and this uh as far as industry tailwinds doesn't stop yeah i don't think it will um but i'll hit my bull case and maybe i'll get more into the way you got to be thinking about with the valuation so uh just kind of getting summing up to the big numbers i mean you have to expect arpu which now sits uh we don't have the numbers promised it's in between 30 and 40 dollars uh per user uh that is average revenue per user i think you have to expect it to at least hit

hundred dollars and likely 150 200 for the current share price to be viable and you know we got a huge boost here to like all-time highs so we're going off of a high multiple here might just be a timing issue what's that now the arpu i think it's in between thirty dollars and forty dollars and i don't think that is impossible because that's over a 12-month period but it's certainly a big growth from here so just to go through some numbers if they get to 100 million active accounts and ARPU gets to $100. That's $10 billion in revenue. Now, the market cap right now is like $58 billion EB. Enterprise value is about $56 billion. But we've alluded, you're probably looking towards $60 and the $60 billion range. If you're expecting good returns over the long term,

you've got to think, all right, this thing can get to $100 billion market cap, $120 billion market cap, something like that. So off $10 billion in revenue, if they can grow accounts at a pretty strong rate and ARPU can expand rapidly like it has. So I'm not saying it won't. You're at about a 10X revenue multiple. Off of that, how much cash are they going to generate? I don't know. Those are the numbers you got to put in your head and you think you got to expect lots and lots of growth from both sides, from total accounts and average revenue per user. Yeah. And if you're, one sec, Brad, if you're a shareholder, you kind of have to be real with yourself. The bull case isn't what it used to be. I mean,

it's been a 14-bagger in two and a half years. And I would argue that it was definitely a fat pitch in 2019 and an obvious one. Everything's obvious in hindsight. Well, we own shares. Everything's obvious in hindsight, but yes, I think it was. I think you and I both own shares in the $30 range. Obviously, we sold, so I guess Yes, we're kind of the losers here, but the return, it's not going to be a 14-bagger from here. So, obviously, temporary expectations. Yeah, Brad, what would you know? Oh, yeah.

On the multiple expansion front, it's important to note that the sales multiple can get cut into half. It can get cut into thirds, and it probably will. And the stock can still do pretty darn well if they get to these ambitious lofty goals that Brett was kind of outlining. So, yeah, I think, what is it, like, 27 or 28 times sales right now? Yeah. I think getting down to 10 to 12 times sales is inevitable, and I don't think that's going to prevent success for Roku shareholders if this company continues to do its thing. And that maturity, just 10 to 12 times sales, you've got to expect margins, gross margins and cash flow margins to expand a lot from here. If that's optimistic.

Yeah. And just like scenario planning here, let's say they reached like margin profile of an Apple, which is like an operating cashflow or free cashflow margin multiple or margins. It would, what do they trade at? What's their sales multiple? Yeah. Right. It's very unlikely that this trades at a terminal sales multiple of north of 20. I'd say it's impossible. Yeah. But bear case, we've hit on it a bit, but anything else, Brad, you want to add here?

I would echo impossible that this is above 20 times sales in a decade, which is a very long time. And again, doesn't mean this stock isn't going to succeed, but just good to talk about that, I think. But on the bear case, and the fact that Roku is shifting aggressively to software and ad revenues makes this a little less concerning. But promotions like YouTube just handing out free TVs to make or to kind of build their user base there, it just it makes people more aware of how similar some of these products are. And Ryan was talking about how the operating system is more intuitive and is more user-friendly than some of these other competitors. But it really seems like in the long-term future, 90 plus percent of these revenues are going to be software.

And that's just a reality at this point. Yeah, yeah, for sure. Ryan? My bear case is, I mean, obviously multiple compression is a part of it, but they've done international expansion or they've tried to if that's if it's poorly adopted abroad that could be a potential low light um third risk there yeah but in canada and mexico they seem to be doing well um and then i guess market crowding in in terms of content spending i think the hardware stuff is obviously behind us but uh let's say the roku channel investments produce crappy returns that's a lot of wasted money um so coupling that with some multiple compression uh there's uh your rate of return might be a little lower that people are hoping yeah yeah roku channel stuff

it worries me uh as someone that doesn't know the business that well anymore but it does worry me i'll get some for me i think the decline in ad support of tv is a bear case so not necessarily total ad dollar spend um you know they reference that 70 billion dollars it's huge and they might be able to expand that with the targeting capabilities that they have compared to what people have on cable. But, you know, user time, not user, just people's time spent on television is declining as a percent of their entertainment. And if that continues, that is a risk. You know, I think the dominant of YouTube advertising, Facebook advertising, Instagram advertising, TikTok, video advertising, that is a lot of dollars going there that aren't going to real

And it might be less zero sum than I think, but those trends have to be an investor's mind. I kind of like, why, I don't know, like, why are you, you have to ask yourself, why would I want real estate instead of Google? Like, I don't know. Or Trade Desk. Yeah. Or Trade Desk.

I mean, or Facebook or whatever. Yeah. You have to ask. That's kind of, that's something I would consider as the bear case. i saw jerry capital who i uh tend to think highly of mentioned something on twitter about this about uh tv viewing hours dropping but if i'm not mistaken roku streaming hours per user has continued to grow frequently yeah yeah i mean but that's in a niche i mean we're just talking globally he's right it is declining that's percentage of entertainment spent uh time spent

if you kind of get what i mean there you know it's going to phones it's going to computers maybe you know but as an oculus might be a left tail risk here yeah uh that seems a bit far-fetched in my opinion i don't know i'm just saying it's a left tail risk i don't know it might be tiny all right more or less interested brad uh i this is tough so less interested and i have to follow that up by saying this is my second favorite company in the streaming landscape, in the programmatic TV landscape, I just prefer Trade Desk. And it's because of some of these things we were talking about. It's because Trade Desk can aggregate all of this programmatic ad demand across podcasts, across video games, across every

single other channel, across Oculus, everything. And we don't really know how content is going to be consumed in five, 10 years. So in terms of a long-term bet, the lack of platform bias, the lack of channel bias that the trade desk kind of provides is something that I prefer. And DataZoo, honestly, is my favorite part of Roku. I know it's not called that anymore. But so just I really like Roku and I love trade desk. So I'll own the trade desk. Yeah, that's interesting. You bring that up. They mentioned on either a conference call or just one of those investor conference transcripts I was reading last night that one view is not restricted to the Roku platform. So that could be, you know, that could help them out as well. I don't know how

important that is but ryan what are your thoughts i am less interested which sucks because it's a business i really like i really like management um but i have a hard time rationalizing the risk reward here uh given at the current price yeah yeah less interested pretty easy to sum it up valuations or multiples just way too high for that risk love the business but uh there's just there's a lot of risk here but it's exciting it'll it'll be definitely interesting to see how they play out even if we don't own it there's something that it's just a business that's fun to follow um all right stop for next week brad it is your turn you've given us hints before i think i have it predicted but we'll see if we'll see if i'm right yeah um it's a company i'm very

excited about it's ipo-ing in a few weeks i think it's going to be my newest position but have a lot lot more digging to do it is called duo lingo and that is going to be our stock for next week so very excited to cover that it's a language learning app um they're expanding into english and and math and and proficiency proficiency exams so um it'll be fun to dig into for sure nice uh education and where language stuff are they uh domestic company do you know yeah so they're in the they're in very early innings of expansion into Europe and Asia and Latin America. So that'll be a good teaser for future growth opportunities next week. All right. Yeah, should be fun. Excited to talk Duolingo. All right, let's get the disclosures out of the way. Remember, Ryan,

or excuse me, all of us are not financial advisors. Gosh, I'm forgetting it. What is it? We're not financial advisors. Anything we say on the show is not formal advice or recommendation. There we go. Ryan and I are general partners at Arch Capital. Arch Capital clients may hold securities in position to discuss on this podcast. Thank you all for listening. We'll see you next time.