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Buy Trade Desk, Sell Roku Stock: Pair Trading Idea

New York Ad Week 2016 - Day 1

D Deepasupil/Getty Images Entertainment

Introduction

Stocks The Trade Desk (NASDAQ: TTD) and Roku Inc. (NASDAQ: ROCU) are trading amid a broader tech selloff that began in November 2021. While both companies are generally considered key beneficiaries of a century-long trend towards CTV advertising, these alleged twins’ business fundamentals suggest that Trade Desk stock is likely to outperform Roku if markets overcome fears of inflation, rate hikes and an economic slowdown.

Roku vs. Trade Desk is back
YCharts Data

Tailwinds of a similar industry

Trade Desk and Roku are the main beneficiaries of CTV advertising. According to GroupM, total U.S. TV advertising spending will grow modestly over the next few years (from $71 billion in 2022 to just $72 billion in 2024), but the dynamics of its sub-categories will change. One of them is traditional television advertising, which is expected to drop from $59 billion to $55 billion between 2022 and 2024. the same period.

Not too long ago, Netflix also announced its intention to venture into advertising (analysis here), which could potentially open up more opportunities in the CTV space. In line with this macro trend, Trade Desk serves as a one-stop-shop for advertisers to manage their CTV campaigns, while Roku is a streaming platform that helps advertisers reach a huge user base.

But different business models

The fundamentals of Roku’s business are very much tied to consumers, as marketers see value in reaching 61 million households. This makes Roku a walled garden similar to Snap (SNAP) and Meta (META), where user growth is an important metric for the investment community. However, in a post-COVID environment, Roku is likely to face hurdles in expanding its user base as much of consumer demand for streaming has been shifted during the pandemic, with new accounts dependent on sales of smart TVs preloaded with Roku OS. .

On the retail front, the latest results from Walmart (WMT), Target (TGT) and Best Buy (BBY) point to a slowdown in discretionary spending thanks to a strong 2021 driven by stimulus checks. In March TSMC (TSM) warned slowdown in demand for smartphones and PCs. On June 16, Samsung (OTC:SSNLF), the world’s leading TV and smartphone manufacturer, reportedly asked suppliers to suspend shipment electronic components in response to growing inventories. These events are likely to influence the growth of the Roku account in the future.

On the other hand, Trade Desk operates as an advertising platform, working primarily with advertising agencies (eg WPP, Publicis and Omnicom). The business model is not dependent on hardware sales and does not need a large user base to attract advertising budgets as it is not a walled garden. Instead, the Independent Demand Platform (DSP) charges a percentage (19%-20%) of total customer ad spending across channels such as mobile, media, audio, and CTV.

In terms of platform neutrality, Trade Desk has no user data or proprietary content that could potentially lead to a conflict of interest with publishers and advertisers. In contrast, Roku is heavily investing in The Roku Channel (TRC), which competes with other video-on-demand (AVOD) offerings such as Peacock and Tubi. Roku owns 100% of TRC’s ad inventory and receives a certain percentage of inventory from other AVOD publishers, similar to Amazon receiving a percentage from third-party sellers on every sale, offering its own private label products that compete with them. Also, if Roku is somehow acquired by Netflix, it would be hard to imagine Netflix-owned Roku asking for ad inventory from other AVOD players like Disney+ and Hulu (analysis here).

And different income forecasts

It is clear that investors are no longer rewarded for risk in losing growth stories in a challenging macro environment driven by inflation and monetary tightening. This is where profitability matters. As a leading independent DSP, Trade Desk has managed to maintain a very attractive margin profile and is expected to have adjusted EPS of ~$1 in 2022 and $1.18 in 2023.

Although Roku is a leader in the streaming industry, its gross margins are pitted against a money-losing player business, where management believes it’s best to sell streaming sticks at a loss to manage user accounts, which affects its advertising business, which has gross profit ~ 60%. . Historically, Roku has not been a very profitable business, with negative operating income for 4 of the last 5 years. With management targeting an adjusted EBITDA margin of 4% for 2022, EPS for the year will again be in negative territory.

Roku Financials vs. Trade Desk
YCharts Data

Hence the different ratings.

In terms of relative valuation, Trade Desk trades at a significant premium over Roku with a forward EV/sale of 12.8x. However, digging further, Trade Desk looks relatively more reasonable with 33x EV/EBITDA and 47x P/E, compared to Roku’s 54x EV/EBITDA and no P/E given the lack of net income. While EV/Sales has historically been a popular metric among growth investors, I believe markets are increasingly trying to value stocks based on earnings rather than sales as the investment landscape shifts from abundance to scarcity.

Roku score vs Trade Desk
YCharts Data

Risks

The most obvious risk to the long side of the deal is that Trade Desk is performing underwhelming either due to lower-than-expected CTV ad growth or a significant slowdown in the broader ad landscape, impacting ad budgets across the board. channels and possibly trade. Table stakes. In the short term, Roku stock is indeed in oversold territory and buyers may find the valuation very undemanding, at least in terms of EV/sales. Also, Roku could actually be acquired by another company (like Netflix) that would immediately raise the stock as arbitrageurs take advantage of the situation.

bottom line

Trade Desk and Roku’s revenue is expected to grow over 30% in 2022 as the structural shift towards CTV remains largely unchanged despite the current macroeconomic headwinds. Following Snap’s recent outlook, Trade Desk has reiterated its guidance for Q2 2022, while Roku did not provide an update. However, the underlying principles of both companies differ significantly and have resulted in discrepancies in financial results and estimates. If investors believe in Trade Desk’s long-term outlook, Roku could be an effective hedge against short-term volatility. When the market returns to normal, I believe Trade Desk shares will likely outperform Roku.

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