Roku Is Thinking Outside Its Box

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Roku (NASDAQ:ROKU) unveiled the Roku Channel about six months ago, offering a limited library of ad-supported streaming video content. Management has said the early results of the Roku Channel have been much better than expected, and it led to the company’s revenue outperformance in the fourth quarter. Management thinks the Roku Channel is so great that it could be the seed of an entirely new home screen for Roku’s devices.

Management is also pitching the Roku Channel to publishers as an alternative to distribution via Netflix (NASDAQ:NFLX). Instead of selling content rights and locking them up with Netflix, publishers can have more control over their content and a bigger stake in their success by publishing through the Roku Channel.

But Netflix is available on just about any internet-connected device you can think of. Roku Channel is only on Roku devices. But starting this summer, the Roku Channel will be available on Samsung smart TVs, the company announced, and that could be just the start.

The Roku homescreen on a TV.

Image source: Roku.

Roku doesn’t want to sell you a device

Roku’s management has made it very clear that its player segment is simply a means to an end. “Our primary focus in selling players is to increase active accounts; we are not focused on maximizing hardware revenue and hardware gross profit,” management wrote in its fourth-quarter letter to shareholders. In fact, Roku’s player sales decreased year over year in the fourth quarter, with gross margin shrinking to 9.5% for the segment.

Roku’s main focus is on its platform business, which includes advertisements and revenue-sharing agreements for distributing paid apps through the Roku Channel Store. That segment is increasingly tilting toward advertising, which accounted for 75% of segment revenue in the fourth quarter thanks in part to the Roku Channel.

As such, Roku has put a bigger focus on licensing its operating system to more device makers. Management has said there are more advertising opportunities when it controls the television OS instead of sitting on a device.

Expanding the Roku Channel to non-Roku Powered devices is an extension of that licensing focus. It gets one of Roku’s fastest growing sources of revenue to a wider audience, which should enable it to sell more advertising.

Roku Channel needs to be on every device to compete

While Roku has built up quite a user base of 19.3 million active accounts, it still pales in comparison to the reach of Netflix’s 117 million subscribers. And not all of those 19.3 million accounts watch the Roku Channel.

As a result, Netflix is in a position to offer a lot more money than Roku for the streaming rights to content. Netflix expects to spend between $7.5 billion and $8 billion on content this year; Roku’s platform revenue totalled $225 million last year.

The more distribution Roku Channel has, the more viewers it can court, and the more likely it is to attract better content. Roku is hoping to create a virtuous cycle and turn the Roku Channel into a legitimate competitor to other streaming video on demand platforms with much deeper pockets by offering more control to publishers.

Getting on Samsung smart TVs is a great first step outside of Roku’s own devices. Samsung accounted for about one-third of all smart TVs in U.S. households as of last year. But Roku should be looking to expand to more devices in the future in order to build out the content catalog on the Roku Channel.

Adam Levy has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Netflix. The Motley Fool has a disclosure policy.