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We want to be clear here. Roku, Inc. (NASDAQ:ROKU) stock has been a very tough stock for longs. The losses are absolutely staggering over the last year. Now, we want to say that the company just reported a really strong Q3. It was quite good indeed, all things considered. So what is going on here? Shares are crashing more than 20% after hours. We received an ask to discuss these earnings and figured it was time to put something out on these earnings.
Bottom line? Roku’s quarter was fine, but the guidance was grim. Really terrible outlook for Q4, and that is why the stock is completely tanking. This follows a day where the markets cratered on yet another hike from the Fed and commentary from Chairman Powell that were as hawkish we can remember. Our take is that you need to avoid Roku stock, though long-term investors could speculate, but we think there are many better places to put your money. The subscriber numbers, player data, and other key trends are very telling. It is not good.
Roku Q3 top line results were strong
The company beat revenue estimates by a rather large degree. The company also reported earnings that were decent, all things considered, on the back of these revenues but expenses that were a bit higher than we would like to see. Revenues were up 12% from last year to $761 million. Very strong. But gross profit fell 2% to $457 million. This is a money-losing company, so big revenue beats are welcomed. While revenue did grow 18.5% from last year, the bottom line is that this is such a slow pace of growth, it is hard to defend the bullish thesis. Just horrible, even though it was better than we expected. Let us dig into the numbers.
Trends in new accounts and advertising revenue
Subscriber growth is critical for Roku, followed by expenses to attract accounts. We have to understand the trends here. It is great that Roku is the top selling TV operating system in the U.S. and is the number one TV streaming platform in the U.S., Canada, and Mexico by hours streamed, but the Street wants growth, a path to earnings, and strong outlooks. This quarter was strong, but the outlook is horrific. That is a fact. Active accounts were positive in Q2, as they added 2.3 million incremental active accounts to reach 65.4 million rising from 63.1 million last quarter and up from 56.4 million a year ago. That is strong.
But the current economic state is still causing advertisers to pause and reconsider spending. This is not good for Roku, which relies on this source of revenue. Both platform and player revenue fell from Q2. Ouch. Another indicator to watch is the stream hours. Stream hours were 21.9 billion. This was up 3.9 billion hours year-over-year, and to our surprise rose 1.2 billion hours from Q2. That was strong, but management in the release was not happy:
In Q3, we delivered meaningful growth in scale and engagement. We added 2.3 million incremental Active Accounts, and The Roku Channel’s Streaming Hours increased more than 90% year over year. Platform revenue grew 15% year over year, which was lower than our historical growth rates but positive given the difficult macro environment. Advertising spend on our platform continues to grow more slowly than our beginning-of-year forecast due to current weakness in the overall TV ad market and the ad scatter market in particular.
Advertising still grew. In fact, ad revenues were still up 15% year-over-year to $670 million. The problem is that this pace of growth has come to a snail’s pace, compared to the past. Overall ad spending is down in this economy though so in that context this was a strong result.
We are pleased with account growth, but the company sees reduced demand for its players because consumer discretionary spend is going to be down to finish 2022 and likely 2023.
Roku Q3 margins contract
A company like this growth is the name of the game, and you expect to see a strong gross profit even if net income continues to be negative. Account growth and player sales are critical and the growth there has stalled a bit, but you expect to see strong margins. Folks, margins were crushed in the quarter. Awful. Total gross margin was down to 46.9% in the quarter from 53.5% last year. Q3 platform gross margin was 55.8%, the worst it has been in over a year, and was down 920 basis points year-over-year. Q2 player margin was negative 19.2%, which improved from the sequential quarter. This was welcome news.
Profitability is softening
A year or so ago, it really seemed Roku would be sustainably profitable, at least that is the path it was on. Profitability has softened tremendously, and this is just horrible. We saw that the company lost $0.88 per share, although this was much better than expected since revenues were better than expected. Further, Q3 adjusted EBITDA was the lowest it has been in the past 4 quarters, coming in at negative $34 million. Just not good, guys.
The one positive is that they ended the quarter with nearly $2.0 billion of cash and short term investments with little in the way of long-term debt or liabilities. All is not lost, but it is not looking good when you consider the horrendous outlook.
Horrific outlook
The overall results were better than expected. The company is still growing revenue, but the pace of growth has stalled, margins are narrowing further, and as we saw, advertisers are just not spending, and operating expenses exploded higher. Management sees weakness continuing. As a result, guidance for Q4 is just terrible, which is why shares are tanking and we remain bearish.
So, a year ago they did a bunch of hiring and now they need to reduce headcount. Management said that it will take a “few more quarters for this operating expense growth rate to normalize.” So the company will continue to slow headcount and try to slow expenses. That’s good, but the outlook was horrible. They are looking for net revenue of about $800 million, total gross profit of roughly $325 million, and adjusted EBITDA of negative $135 million. So, adjusted EBITDA was positive a year ago and earlier this year. Then negative $12 million, then a loss of $34 million in Q3, and now forecasting a loss of $135 million on EBITDA.
Folks, this is an awful reduction and outlook. This pressure is not going away any time soon. Avoid the name.
Take home
Wise traders abandoned Roku a long time ago. Things are not good here. Trends are worsening. Profit potential has eroded horrifically. The stock could dead-cat bounce, but we will see massive tax-loss selling too. Little in the way to be excited about. Long-term investors could try to open here, but Roku is just a stock to stay away from.
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