U.S. Markets close in 5 hrs 6 mins

Roku Shares Hit With 2 Downgrades

Evan Niu, CFA, The Motley Fool

So far in 2019, shares of streaming TV platform Roku (NASDAQ: ROKU) have staged a massive comeback, gaining 131% year to date through yesterday's close. The stock is now nearly back to where it was before the broad market turmoil in the fourth quarter. To be clear, Roku has given investors a lot to be optimistic about in recent months. Core operating metrics like active accounts, hours streamed, and average revenue per user (ARPU) all continue to march into record territory, and Roku expects to hit $1 billion in revenue this year, a significant milestone for the company.

But the market could be getting ahead of itself.

The Roku Channel on a TV

Image source: Roku.

A tale of two downgrades

Roku was hit with two separate downgrades today, thanks to Loop Capital and Macquarie, with analysts at both firms pointing to stretched valuation at current levels.

Loop Capital dropped its rating on Roku shares from hold to sell, while keeping a $45 price target. Analyst Alan Gould argues that the stock has reached "excessive valuation" levels and believes Roku could suffer from intensifying competition on the horizon. The streaming wars are heating up, with a multitude of traditional telecom and media giants bringing over-the-top (OTT) services to market this year. That could help Roku's hardware business, even while putting competitive pressure on the platform segment.

Gould also notes that there has been an uptick in insider selling, which doesn't inspire a lot of confidence. For example, regulatory filings show CEO Anthony Wood converted and sold 35,000 shares earlier this month as part of a pre-arranged Rule 10b5-1 trading plan at prices between $66.81 and $69.82. Roku also filed a mixed shelf offering this week for an unspecified number of shares, suggesting some dilution is in store.

Separately, Macquarie downgraded its rating on Roku to neutral, similarly pointing to "a full valuation" at current levels. Beyond the upcoming onslaught of traditional companies jumping into the streaming space, Macquarie is also concerned about Apple's upcoming video-streaming service, which will be unveiled in less than two weeks. That service could garner 100 million subscribers within a few years of launch, according to estimates from Wedbush.

Macquarie is also concerned that Roku's ad business could get hurt, as the media giants are now collaborating on a new consortium led by TV manufacturer Vizio called Project OAR, which stands for "Open Addressable Ready." The goal is to create an open standardized advertising platform for the industry's ongoing shift to streaming, facilitating targeted ads akin to how online ad networks are able to target eyeballs with uncanny accuracy. That initiative was just announced this week and isn't expected to officially launch until next year, but it could eventually threaten to undermine Roku's proprietary ad platform and poach advertisers.

Roku's platform segment is largely driven by advertising, with revenue sharing of subscription and a-la-carte purchases representing a smaller portion of that business. Much of Roku's ARPU gains -- which are calculated as total platform revenue divided by active accounts on a trailing-12-month (TTM) basis -- are attributable to growth in advertising revenue. ARPU hit a record $17.95 in 2018.

Roku is facing many potential headwinds going forward, and intensifying competition combined with a lofty valuation is a recipe for a pullback.

More From The Motley Fool

Evan Niu, CFA owns shares of AAPL. The Motley Fool owns shares of and recommends AAPL. The Motley Fool has the following options: long January 2020 $150 calls on AAPL and short January 2020 $155 calls on AAPL. The Motley Fool has a disclosure policy.