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After Three-Fold Rally, Roku Stock Is Overvalued

Thomas Niel

Shares in Roku (NASDAQ: ROKU) have had a successful run year-to-date. Roku stock is up three-fold, from approximately $32 a pop in January to over $103 today. Despite competition from larger peers Amazon (NASDAQ: AMZN), Alphabet (NASDAQ: GOOG, NASDAQ:GOOGL), and Netflix (NASDAQ: NFLX), investors are confident in the company’s long-term success.

After a dramatic surge, ROKU stock is simply overvalued

Source: Shutterstock

But with the Roku stock price reaching frothy valuation levels, future upside is likely limited. Read on to see why now is not the time to dive in.

The Roku Platform Continues to Grow

Based on Q1 2019 results, Roku continues to grow as a leading streaming platform. The number of active accounts is up 40% year-over-year, with 29.1 million active accounts in the first quarter of 2019. That compares favorably to the 20.8 million accounts in Q1 2018. Streaming hours have jumped 74% year-over-year, and average revenue per user has climbed 27%.

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With this subscriber growth, quarterly sales have climbed 51% YOY, from $61.5 million to $206.7 million. However, due to the increased expansion of its infrastructure, the company continues to post operating losses.

Losses from operations were $10.7 million, compared to a $6.9 million operating loss in Q1 2018. The company’s 2019 guidance projects net revenues between $1.03 billion and $1.05 billion. However, management estimates a $65 million to $75 million net loss in 2019, with adjusted EBITDA estimated around breakeven ($10 million to $20 million).

With ROKU continuing to invest in growth, it will be years before it becomes a “cash cow.” But today’s performance is not the story. Besides the potential catalyst of formidable market share in the next five to ten years, investors believe the company to be an irresistible takeover candidate for deep-pocketed competitors.

Is Roku Stock Still a Takeover Candidate?

Due to its small size compared to peers, several analysts consistently consider Roku stock a takeover candidate.

As InvestorPlace contributor Bret Kenwell discussed back in March, Alphabet is the most logical buyer. Kenwell pointed out that 70% of streaming users have a ROKU device. In contrast, only 16% of streamers own Chromecast, Alphabet’s streaming media adapter.

Acquiring the company would be a quick and easy way for Google to jolt ahead of Amazon and Apple (NASDAQ:AAPL). While the potential acquisition price is high, building out organically would cost money, and more importantly, time.

Microsoft (NASDAQ: MSFT) is another logical buyer. Microsoft has an existing streaming platform (Microsoft Movies & TV), but only Xbox users largely advantage this service. Buying Roku would get Microsoft’s streaming and VOD service into more homes. That would give the software giant an opportunity to catch up to Amazon and Apple.

And a slew of other potential acquirers abounds. Last October, InvestorPlace contributor Will Ashworth gave a full list of potential buyers. These include telecom companies such as AT&T (NYSE: T) and Verizon (NYSE: VZ), as well as content behemoths such as Disney (NYSE: DIS). Even Facebook (NASDAQ: FB) is a potential buyer.

But takeover rumors are just that: rumors. Buying shares on takeover talk rarely pans out to big returns.

An important caveat is valuation. When the Roku stock price was a third of what it is today, the company was more digestible. But at the current valuation, even a large competitor must weigh the opportunity cost of developing their own platform versus bulking up via a costly acquisition.

Valuation: Roku Stock Price Getting Frothy

Given that Roku’s biggest peers are subsidiaries of tech giants, the company’s main publicly traded peer is Netflix. Looking at the company’s enterprise value-to-sales (EV/sales) metric, Roku stock is the more expensive of the two. Specifically, that’s 14.2 versus 10.5 for NFLX.

The company also trades at a massive EV/sales premium to larger peers AMZN (EV/sales of 4.2), AAPL (EV/sales of 3.74) and GOOG (EV/sales of 4.86).

It is important to note this is not an apples-to-apples comparison. As the only “pure play” of its kind, the company could be worth the premium. But with high expectations baked into the share price, the stock may no longer be a strong opportunity.

Despite a Strong Business, Roku Stock Is Not a Buy

Despite having less prestige than its FAANG competitors, Roku continues to grow as a major streaming platform. With advertising revenue moving from television to streaming, the company could win big long-term.

But despite strong forward-looking prospects, ROKU stock is not a buy at these levels. Investors buying shares today are paying a substantial premium to gain exposure to the streaming trend.

On the other hand, a big tech or media company could buy ROKU as an efficient pathway to eyeballs. With Alphabet, Microsoft, and others lacking significant market share in the streaming space, buying them out would make them more formidable competitors to Amazon and Apple.

At the current Roku stock price, the company is not a buy. Waiting until a material pullback is the smart move. In late 2018, shares tumbled from roughly $75 a share to below $30, before rallying back to over $100. In the event of another big decline, ROKU could be a solid opportunity.

As of this writing, Thomas Niel did not own a position in any of the aforementioned securities.

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