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Why Roku Stock May Surge Sky-High

Chris Lau

After Roku (NASDAQ: ROKU) disclosed in an SEC filing that it would sell up to 1 million shares of ROKU stock, the market bid the shares higher. Investors interpreted the company’s decision to raise cash as a positive development because Roku will have more capital with which to grow.

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Roku may very well become the next big technology and media titan. And with its low stock float, this independent streaming firm could eventually become a takeover target. After Roku stock price jumped in recent weeks, what should investors expect from Roku stock going forward?

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Roku Is a Potential Takeover Target

Roku is the last of the independent streaming services. After Disney (NYSE: DIS) bought Hulu from its co-owner, AT&T(NYSE: T), another telecom or studio giant may want to buy Roku.   Such companies may be interested in buying ROKU because of the rapid growth of its user base.

In the first quarter, Roku had around 30 million ad-supported and paid subscribers. That’s five times smaller than Netflix’s (NASDAQ: NFLX) 150 million subscribers. But Netflix reported subscription growth of just 2.7 million, compared to the 5 million expected, so investors may look elsewhere for user growth.

Amazon.com’s Prime Day Is a Positive Catalyst for Roku Stock

When Amazon.com (NASDAQ: AMZN) slashed prices of a 32” LED Roku TV to just $99, Walmart (NYSE: WMT) followed suit with deals on  55” 4K TVs . The affordable 32” TVs and Roku sticks that are selling for just $24 will lift Roku’s viewership. At these low prices, consumers are more likely to own several Roku devices. Given how widespread the company’s devices have become, marketers will definitely benefit from buying ads on Roku.

It’s  very easy to use Roku’s devices to launch other streaming services such as Hulu, Prime Video and Netflix. As a result, Roku’s devices  may become  consumers’ favorite  means of centralizing the home theater experience. Additionally, the company’s ad displays are not obtrusive. By keeping isers’ experience clean and simple, Roku offers the best of both worlds: friendly advertising and a subscription option.

Roku’s Growth Opportunities

The Roku Channel provides Roku with a tremendous growth opportunity. Roku Channel has over 30 partners, including AT&T’s (NYSE:T) HBO. And in the last 18 – 24 months, Roku has added plenty of content to get its audience more engaged. Less than two years old, the Roku Channel is already a top-five channel as measured by reach. At that pace of growth, expect Roku’s core content  to attract even more viewers in the months and years ahead.

Roku has international growth ambitions, too. It thinks it can eventually penetrate 1 billion broadband households. As higher brand awareness and affordability entice TV owners to buy Roku-enabled TVs, its user base will continue to increase.

By achieving break-even EBITDA sooner than expected,  the company can provide ROKU stock with a positive catalyst. To get there, Roku is focused first on becoming the top smart-TV operating system. Advertising and subscription will drive its revenues. Investors should be confident that Roku will maintain its lead as the top  streaming platform. Google’s Android TV shipped well before Roku, but its market share is well below Roku’s. Even though streaming device suppliers will try to dethrone Roku, the company will keep its lead. It will do so by offering the best system.

Advertising to Boost ROKU Stock

Each year,  $70 billion is spent on TV ads. And the majority of Roku’s revenue comes from video ad impressions and will only grow. As Roku’s audience grows, more marketers will buy ads on its platform. Since viewership is moving from cable and over-the-air TV to platforms like Roku, expect Roku stock to be boosted by sustained ad revenue growth.

The Valuation of Roku Stock and the Bottom Line on ROKU

Roku could continue growing its revenue by 50% or more annually. Conservatively assuming its revenue rises just 25% annually, a 5-year DCF Revenue Exit model suggests the stock is roughly fairly valued. Conversely, Roku stock is trading above analysts’ average price target of $89.

Roku stock may trade at stretched valuations, and ROKU is vulnerable to profit-taking after its huge gains. But when the company reports its results in August, strong subscription growth will send the stock higher. That will squeeze out those shorting Roku stock, forcing them to finally close their short positions which currently account for 10% of the total float.

As of this writing, the author did not hold a position in any of the aforementioned securities.

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