Saga Partners, a fundamental, long-term, value investment management firm, published its fourth-quarter 2020 Investor Letter – a copy of which can be seen here. A net return of 24.5% was recorded by the fund for the Q4 of 2020, outperforming its S&P 500 benchmark that delivered a 12.1% return. You can view the fund’s top 5 holdings to have a peek at their top bets for 2021.
Saga Partners, in their Q4 2020 Investor Letter, said that Roku, Inc. (NASDAQ: ROKU) is one of the most attractive opportunities they currently own. Roku, Inc. is a TV entertainment streaming platform company that currently has a $56.8 billion market cap. For the past 3 months, ROKU delivered an impressive 92.28% return and settled at $469.70 per share at the closing of February 16th.
Here is what Saga Partners has to say about Roku, Inc. in their Q4 2020 investor letter:
“Roku has been on my radar since its 2017 IPO given our significant investment in The Trade Desk. While I admired the company from afar, I never was comfortable with how it would successfully compete with the tech giants, particularly Amazon’s Fire TV, Google’s Chromecast, Apple TV, and to a lesser extent, the large TV manufacturers (OEMs) such as Samsung and LG trying to build their own TV operating systems. I also did not quite grasp Roku’s competitive position in the advertising value chain relative to the Trade Desk. Would Roku, being another middleman in the advertising/content value chain, be able to earn attractive profits with The Trade Desk in the power position?
I watched from the sidelines as Roku’s market share in streaming devices and TV operating systems continued rise. Roku has since increasingly become the default operating systems for TV and the largest aggregator of third-party TV streaming content in North America based on streaming hours with its 51 million active accounts. It has the largest market share of smart TVs in North America with 38% in the US and 31% in Canada. 49% of all programmatic connected TV ads go to Roku devices. When COVID opened the floodgates for the inevitable consumer and advertiser adoption of connected TV, I sharpened my pencil to better understand the dynamics that seemed to continue to play in Roku’s favor.
Roku is winning market share from Google for a few reasons. Google has not made strong inroads in TV operating systems with OEMs for the same reason that Microsoft could not transition its dominance in the personal computer operating system to the mobile phone operating system. They were trying to reconfigure an operating system that was built for a completely different product, thereby making it less effective than if starting from scratch. Google’s Android TV is primarily a phone platform that was stripped down to create a TV version. TV manufacturing is very price competitive. Google’s stripped-down mobile operating system for a TV has a higher cost structure and puts them at a price disadvantage to Roku which has been purpose built for TV from the ground up. The lower cost of materials required to run the Roku OS enables TV brand license partners to build more competitively priced products.
Amazon and Apple have also faced difficulties. Amazon has been successful in selling Fire Sticks but has not gained a lot of traction in licensing their TV operating system to OEMs. This is largely because retailers (most notably Walmart a significant seller of TVs) view Amazon as a direct competitor and do not want to carry Amazon consumer electronic products. The Apple TV is now a distant fourth in terms of streaming player unit sales. Apple has traditionally been resistant to licensing their operating system and has gone to market with a premium hardware product and therefore has not made a lot of inroads in TV.
Most TV OEMs are beginning to license an operating system from a company such as Roku. However, there are TV OEMs such as Samsung and LG trying to build their own TV OS. Despite having sizeable TV sale market shares both have been facing consumer adoption headwinds. One reason is that TV OEMs historical core competency has been designing and manufacturing tangible products. Like what happened with mobile phone OEMs when the Android mobile operating system came out, it’s difficult for an OEM to also focus on writing software to build a proprietary OS that competes with a company whose only focus is licensing its software. Additionally, there is a benefit to being TV OEM agnostic and therefore being available on any potential TV.
Roku is experiencing the operating system virtuous cycle; as Roku enters more households, it collects more data on viewers which helps advertisers target viewers, drawing in more content that can access users and monetize via ads better on Roku, which provides more content and better viewer experience, repeat. Increasingly, people will prefer TVs that come with a Roku OS because they will have the best consumer experience which then motivates more OEMs to license the Roku OS.
Whoever controls the TV operating system is going to be in a powerful position in the TV value chain. Before streaming, the legacy cable operator was in that power position, controlling distribution and the direct-to-consumer relationship. With the power of the Internet, Roku increasingly looks like the dominant company that is aggregating consumer demand, controlling the direct-to-consumer relationships, and displacing the legacy cable company position in the value chain.
Connected TV is a much better experience for both consumers and advertisers. Viewers can watch what they want when they want, and advertisers are better able to target viewers with the data Roku can collect. While cable operators monetize by collecting money each month from the consumer and then slicing it up among different content providers, Roku monetizes by taking a piece of the advertising, transactions, and subscriptions that occur over their platform.
The next question was what Roku’s relationship would eventually look like relative to a potentially powerful player like The Trade Desk. As I’ve discussed many times in the past, The Trade Desk will eventually be the ultimate aggregator of advertising demand, helping allocate ad dollars across the global supply of ad inventory. They own the customer relationship (the advertiser) and are able to aggregate the highly fragmented supply of ad inventory around the world. The Trade Desk helps advertisers make the best return on their ad dollar based on their specific needs.
In the advertising sense, Roku will technically be a supplier of inventory as they help content owners monetize via advertising. As it becomes increasingly evident that Roku is winning as the TV operating system, they will still be in a power position for any advertiser that wants to monetize via TV, which has historically been a significant share of total ad dollars.
This may be a controversial comment for all the Netflix bulls out there, but I expect that at end state, content owners will increasingly be commoditized, Roku will be a powerful aggregator of TV viewers, and The Trade Desk will be an even more powerful aggregator of total advertising dollars. There’s still a lot of steps before this dynamic unfolds and I will be watching closely. Companies like Netflix and Disney will likely continue to be powerful content owners because of the supply side economies of scale, but I suspect will lose their direct-to-consumer advantage. Subscription content services like Netflix will eventually try to monetize their content via advertising as paid subscription growth slows which they will then have to share with whoever owns the TV operating system direct-to-consumer relationship. No single company, not even Netflix, will be able to control/own the entire world’s supply of TV content; and viewers will want help filtering all of the increasingly accessible content on demand.
The Trade Desk will be in the power position to allocate ad dollars to Roku based on the attractive ROI to advertise on TV. Advertisers will still go straight to The Trade Desk because only The Trade Desk will be able to compare the entire universe of available ad inventory on their platform. Advertisers will want to know what the ROI is on Spotify vs. Google vs. Roku vs. any other place to advertise in the world. Roku will never turn down demand from the Trade Desk since it will likely be a material amount of ad spend. If advertisers only want to advertise on TV, they will be able to bypass The Trade Desk and go straight to Roku; however, they will likely earn lower ROIs on their spend since similar ads can be sent outside of TV and only the Trade Desk will be able to provide the data/analytics on the most effective places to show those ads. Owning demand is a powerful place to be in the internet economy.”
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