SINGAPORE (Sept 16): Where might investors find more value in technology? In software or hardware? In a creator of original content or an aggregator? Conventional wisdom is that software, particularly one offered on a subscription basis, where sellers rely primarily on recurring revenues, offers far better value than hardware. Moreover, creating content is seen as a more valuable proposition than aggregating content.

 One company that has turned generally accepted theory on its head by successfully aggregating a plethora of content in the aftermath of “cord cutting” — or cable TV subscribers abandoning expensive 100 to 250-plus channel “bundles” to buy cheaper, more focused over-the-top streaming packages — is hardware upstart Roku, maker of set-top boxes and streaming stick hardware that facilitates over-the-top video streaming.

Investors are betting that content aggregation will create more value over time than content creation. Look no further than the stock prices of top movie and TV content creators and Roku over the past two years for evidence. Despite a 14% plunge over the past week, Roku is among the best-performing tech stocks this year — up 388% since January compared with 24% for video content behemoth The Walt Disney Co and 8% for streaming giant Netflix, which is repositioning itself as a premium original content provider. Roku stock is up more than 960% since its IPO in September 2017, whereas Disney, which is poised to launch its Disney+ streaming service on Nov 12, is up 38% and Netflix has risen 55% over the same period.

Ironically, the idea for Roku, codenamed “Griffin”, was originally conceived within Netflix. Indeed, its founder and CEO Anthony Wood, a serial entrepreneur, was vice-president of internet TV at Netflix until the streaming pioneer jettisoned the production of streaming devices in 2009 because it did not want to compete head-on with Apple, which was making similar hardware. Netflix, which had transformed itself from a mail-based DVD-rental library into a streaming platform, incorporated a new firm called Roku to build a device, becoming its first investor. Roku’s headquarters in the Silicon Valley town of Los Gatos are right next door to Netflix’s, which still subleases the building to it. Netflix these days makes up just a quarter of the total hours streamed on Roku devices.

Not a Fitbit or GoPro

Wood had initially positioned the company as a neutral hardware maker that would facilitate the entire streaming industry. During a gold rush, often the best investment is to buy the makers of picks and shovels. When everyone’s digging, you can be sure that there is an awful lot of shovels, picks and pans being peddled to all sorts of prospectors. But the tech industry has seen hardware players come in and grow exponentially only to be disrupted by behemoths with a large ecosystem. Gadget maker GoPro and fitness wearable maker Fitbit turned out to be a mere flash in the pan. GoPro stock is down 97% from its peak; Fitbit, which was disrupted by AppleWatch, is down 93%.

Aware of the hardware curse, Wood had an epiphany: What if Roku aggregated the content as well? So, he repositioned the device maker to take advantage of the secular shift in TV consumption from cable to streaming by betting that being an aggregator would give him a piece of the TV advertising market because streaming pioneers such as Netflix were building their business on subscription revenues.

Last year, the US TV ad market raked in US$70 billion, or more than US$250 per viewer. But TV advertising is undergoing a dramatic transformation, as cord cutting is forcing advertisers to move spending away from terrestrial TV to internet-based New Media. Yet, despite their best efforts, search giant Google and social media behemoth Facebook, which were quick to capture the bulk of print advertising, have yet to attract anything more than marginal TV ad dollars. YouTube ads are considered low-end inventory while Facebook does not have enough long-form videos to serve advertising. Roku, on the other hand, provides ad formats that are reminiscent of traditional TV while targeting and measuring with the latest digital tools.

In the April-to-June 2019 quarter, Roku’s active accounts jumped 39% to 30.5 million while revenues soared 59% to US$250.1 million ($345 million). Its total streaming hours skyrocketed 72% in the quarter, which helped platform revenues grow 86% and hardware revenues rise 24%. Platform revenues now make up 67% of Roku’s total revenues. Some of the more bullish forecasts of Roku estimate that it could double its account base from 30.5 million now to 60 million and its annual revenue per user from US$21 currently to US$40 over the next three years and grow to US$80 per user by 2025. Roku is trying to emulate the template of Google and Facebook, the two dominant players in the global ad market.

Dominating with scale

To dominate the TV ad market, all that TV content aggregators such as Roku need is to acquire scale. Like Google and Facebook, Roku collects data from its customers, which allows advertisers to more effectively target their campaigns. As its ad revenues grow, Roku is able to provide more free ad-supported video content, which in turn attracts more viewers. Its growing platform allows users to personalise their content selection with cable-TV replacement offerings and other streaming services that suit their needs and budget. Roku hosts more than 5,000 third-party streaming apps. Ad-supported channels available on the Roku platform include CBS News, Crackle, The CW Television Network and Vice as well as subscription channels such as HBO Now, Hulu and Netflix and traditional pay-TV replacement services such as DirecTV Now, Sling TV and Sony PlayStation Vue.

Unlike Netflix, which is expected to spend US$15 billion on content this year, and Disney, which has budgeted US$22 billion, Roku does not spend anything on original content. Neither does it charge heavily for monthly subscriptions. It makes money from negotiated revenue-sharing agreements with streaming services such as Netflix and upcoming services such as Disney+. On top of that, there are revenues from advertising.

Roku is clearly winning the smart-TV war, says James Wang, an analyst at ARK Invest, a tech-focused asset management firm in New York. More than a third of all smart TVs sold in the US run on Roku’s operating system (OS). According to eMarketer, Roku has a 44% share of the US internet-TV device market, versus Amazon Fire TV’s 33%, Google Chromecast’s 16%, and Apple TV’s 13%. Apple recently launched its own tvOS. That means more smart TVs will come with Apple tvOS built in. But as Apple learnt in its battle to dominate the PC operating system arena, where its Mac OS was pitted against Microsoft’s Windows, or in smartphones, where it fights Google’s Android, operating system wars are notoriously hard to win. “Little Roku has bested both Google and Amazon in the battle for the control of smart TVs,” notes Wang.

Instead of merely making set-top boxes and sticks or just licensing TV makers such as Sony Corp, Samsung Electronics Co and LG Electronics to sell smart TVs that have its devices built-in, Roku focused on replacing the cable, or pay-TV, bundle. “Few TV vendors have the software chops to create a modern connected TV OS,” says ARK’s Wang. “By focusing purely on Roku OS and practically giving it away, Roku has attracted TV manufacturers and increased its installed base.” Now, it has more than 30 million active accounts streaming more than 3½ hours of content per day on average, making it one of the most engaging streaming video platforms in the US.

Competition galore

Until now, Roku has had the field to itself, but competition is coming. Amazon’s Fire TV recently announced a deal that would allow third-party ad firms to sell ads on its service. Amazon is also chasing Roku in Europe, where it will introduce its Fire TV device to new markets, and expand its footprint in existing markets such as the UK and Germany. Amazon, which has an extensive library of original programming, wants to become the set-top box or the gateway in the post-cord-cutting era.

On Sept 10, as Apple unveiled the pricing of its own streaming services, Netflix and Disney shares fell, but hardest hit was Roku, whose stock plunged 8% in the days after the announcement. Roku basically sells hardware at cost, while its “platform” last year had a near 71% gross margin, notes tech strategist and blogger Ben Thompson. “Apple TV Channels is a means to buy subscriptions to other streaming services, which makes a lot of money for Roku and Amazon” as well, he says. Apple and Amazon see themselves as aggregators of content, however, which helps them build their respective ecosystems.

Roku sees itself as a neutral platform on which anyone with content can sell their service. Apple’s new Apple TV+ service, to be launched in November, as well as Amazon’s TV programming will be available on the Roku platform, for which Roku will get a cut. Disney, along with Comcast Corp, CBS Corp, AT&T’s HBO and other Warner channels that will begin streaming next year, expects to be on Roku as well.

As more streaming providers arrive on its platform, Roku will rake in more revenues. For now, think of Roku, Amazon and Apple as “frenemies”. At some point, however, the competition is likely to become so fierce that Amazon and Apple could pull their apps from Roku’s platform, though in the current environment, that is unthinkable because they will be accused of choking the platform to death. Eventually, there will be a shakeout among content creators but, more likely than not, neutral platform providers such as Roku will survive — indeed, even thrive.

Assif Shameen is a technology writer based in North America