As Streaming Heads into Possible Recession, Did Wall Street Wrongly Beat Roku Shares?

by Arthur · August 1, 2022

Conversations on Wall Street and similar economics-focused circles have reached an almost Talmudic level of obscurity and technical complexity: Are we in a recession after two quarters of negative GDP growth? Will Last Week’s Fed Rate Hike Kill Inflation? Will it trigger that recession? What will the next rate hike do? What does it mean that we keep adding hundreds of thousands of new jobs?

No one is even sure if we actually know we’re in a recession until we’re pretty much out of it. Nowhere was that more evident than this week, where tech giants Alphabet, Apple, Microsoft and Amazon (all of which have significant ad-based or streaming units) collectively reported a 24% drop in quarterly profits, and still saw their share prices jump. Even Netflix shares are up more than 30% in the past month after a bad first half.

Meanwhile, Roku also missed the mark, seeing its shares hammered, falling 29%, after a long, brutal decline over the past year.

Pivotal Research principal and senior analyst Jeff Wlodarczak cracked that Roku could be “Broku” after reporting “frankly terrible guidance for 2Q and 3Q as it looks like our main concern about the company suddenly hit them like a freight train.”

That’s despite what should be a big season for video ad sales for the biggest U.S. streaming platform, especially with midterm election spending and the imminent arrival of both Disney Plus and Netflix’s ad-supported tiers, with the tens of millions of customers likely to use both parts.

Roku even reported that it had more than $1 billion in Upfront ad commitments, a record for the company as it continues to build out its Roku Channel ad-supported service.

And eMarketer projects that ad-supported streaming audiences overall will grow 9% this year, to 140 million. More importantly, they will attract a growing share of viewing time and revenue, which is projected to increase by 33% to nearly $19 billion by 2022.

At least in theory, everyone should be having a good time on Roku, especially when people start looking for something free to watch.

Except, no. Wolfe Research analyst Peter Supino was one of many to turn what seemed like good news into bad, downgrading Roku stock to partially “underperform” because of all the new ad-supported inventory on highly sought-after platforms that it wants.

Supino’s argument is basic supply and demand; more supply pushes prices down. And “instead of expanding the pie,” all the high-end newcomers could simply “push dollars away from non-premium categories,” especially if overall ad spending doesn’t continue to grow.

Also read: Roku backs up 10% as Wall Street shrugs off silly narratives

Analysts, who have traditionally struggled to understand Roku’s business, piled on. A number of them dropped the company’s stock price targets to somewhere less than even today’s $65. Just a year ago, these shares were approaching $450.

So two questions are presented: Are the analysts right about Roku’s prospects in a downturn? And are these concerns relevant to prospects for everyone else in the sector, especially smaller companies?

Citing Roku’s own investor letter, Wells Fargo media analyst Steven Cahall said the problem is a suddenly seized spread market. Marketers are now worried that the possibly looming recession will lead to much less consumption, so they are spending much less to reach these consumers.

Unlike cable TV, connected TVs are “less sticky,” Cahall suggested. Basically, customers are less invested, especially lower-end shows, and thus less likely to watch it consistently. Plus, they have a lot more options these days.

“This is a shock to the stock because (connected TV) was thought to be a secular growing ad channel and therefore should have proved less volatile and/or gained share in a recessionary environment,” Cahall wrote.

So maybe he’s right. Perhaps Roku is semi-secretly a mess, given its American focus and the challenging transition from dongle maker to OEM interface licensor. Sell the stock while you can. But what does this mean for other providers of “non-premium ad programming?

The odd thing here is that being recession-proof was supposed to be one of the big advantages of the ad-supported Roku Channel and its several major competitors.

The industry’s received wisdom is that in times of economic stress, cheaper content like that shown on the Roku Channel, Amazon’s Freevee, Pluto TV, Tubi, STIRR and the rest tend to be watched more, as people cancel premium channels to save money. People still need to fill time, and can’t afford to go out, so ad-supported TV should thrive.

Of course, this theory hasn’t really been tested in the Streaming Wars era.

We had 12 years of rapidly growing markets, where the Streaming Wars coalesced as broadcast and cable distribution began their cord-cutting collapse. The rapid transformation to streaming was supercharged by the pandemic’s first months of shutdown, then settled into a seemingly permanently higher level of consumption.

Now, as we circle around a possible bona fide economic downturn (maybe), we’ll see if the received wisdom of previous eras has any basis in this one.

Are people really looking at less “non-premium” when they feel the pinch of inflation, higher credit card payments, more expensive car/home loans and brutal gas prices?

If they see more while advertisers spend less, how long will this mismatch continue? If people don’t buy anythingno point in buying ads, especially if they are not seen, because no one is watching.

But if the eyeballs turn more and more to the Roku Channel, Freevee, Tubi, Pluto TV, et almakes brands and marketers a particularly dumb mistake, just as they’re starting to shift billions of dollars to streaming from legacy outlets.

We’re about to embark on the first true test of what happens to the streaming industry when the economy is bad. It should be fascinating to watch, although I bet many more will be tuning into the Roku Channel, Tubi, Freevee, etc., in the coming months. Chalk this up to another case of Wall Street overreacting to a business it still doesn’t fully understand.

One final note: for all the gloom in Roku’s quarterly report, the company did Note that the growth in the number of active users of the platform accelerated again in the 2nd quarter. As my beloved editor said, it is the metric that counts.