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3 Reasons Why Roku Shouldn’t Sell Itself to Netflix

Over the past couple of weeks, there have been rumors on Wall Street that the streaming service Netflix may apply to acquire a streaming platform Roku (ROCU -3.71%). Word has also spread within Roku, and the company has suspended employee trading of its shares, a procedure that sometimes happens before major news is made public.

Investors will have to wait and see if there’s fire where there’s smoke, but that now seems plausible as Roku’s market cap has shrunk to $10 billion, which is a reasonable price for Netflix. But selling isn’t always the most profitable move in the long run. Here are three reasons why Roku should stay on its own.

1. Who needs who?

Netflix’s market capitalization is about seven times that of Roku’s, and the company has a reputation as a trailblazer in the streaming industry. But the years of Netflix insisting on a purely subscription model may have taken it by surprise.

Subscriber growth has slowed noticeably since the peak of COVID-19. Year after year, subscriber growth fell to single digits in the second quarter of 2021 and has remained at that level ever since. Meanwhile, the rise of a host of competing services is putting price pressure on Netflix.

Roku, on the other hand, has been slowly building its advertising business since acquiring ad platform dataxu in 2019. Its ad-supported service The Roku Channel has become one of the top five streaming services among Roku users in terms of reach and engagement. .

Netflix co-CEO Reed Hastings openly stated in the Q1 2022 earnings report that in terms of offering an ad-supported tier, he would prefer to outsource all behind-the-scenes advertising technology so that Netflix can continue to focus on creating content.

Acquiring Roku will give Netflix the ad technology partner it needs, and hosting it internally will make it more profitable, giving Netflix all of Roku’s user data in the process.

The benefits for Netflix are clear, but what will Roku get? Beyond the premium to the current share price, Roku’s leadership as a video streaming gatekeeper is a compelling long-term investment thesis.

2. Netflix may have trouble swallowing Roku

Roku won’t be cheap. Netflix will have to pay a hefty premium to get shareholders to agree to the sale. But how high can Netflix afford to go? The chart below shows how the constant need for fresh content keeps a business’s cash flow neutral, forcing them to borrow more money.

NFLX Cash and Short Term Investments (Quarterly) Chart

NFLX Cash and Short-Term Investments (Quarterly) data on YCharts

To make the takeover, Netflix would either have to borrow, which could put financial pressure on its ability to spend on content, or conduct a secondary offering at a time when its share price has fallen 75% from its peak.

3. Buy high and sell low?

Roku shareholders may be asking the same question. The company’s shares are down over 80% from their peak. Will Roku be willing to sell itself for a price likely to be well below its market cap just a year ago?

You can see below that Roku is arguably as cheap as ever in terms of price-to-sales ratio. I’m not sure I see a clear incentive to sell at these levels given Roku’s business has more subscribers than ever and its advertising business is growing.

ROKU PS Power Factor Table

PS ratio ROKU data on YCharts

Netflix’s push to transition to ad-supported streaming makes the potential acquisition of Roku attractive. However, for Roku, the situation is not so simple. Shareholders of acquired companies are selling them for cash, and the current market makes a big payday for Roku investors unlikely.

It may turn out that Roku and Netflix will work together on ads to some extent – this has already been rumored. However, a formal acquisition doesn’t make sense for Roku right now.

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