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3 Reasons Roku Shouldn’t Sell Itself to Netflix

Rumors have popped up on Wall Street in the past couple of weeks that streaming service Netflix may make a bid to acquire streaming platform Roku (NASDAQ: ROKU). The rumor was also spreading within Roku, and the company has suspended employee trading of its stock, a procedure that sometimes comes before important news is made public.

Investors will have to wait and see whether there’s fire where the smoke is, but it seems plausible now that Roku’s market cap has shrunk to $10 billion, a digestible price tag for Netflix. But selling out isn’t always the most rewarding move over the long term. Here are three reasons why Roku should remain on its own.

1. Who needs whom?

Netflix’s market cap is roughly seven times larger than Roku’s, and the company enjoys its reputation as the streaming industry’s pioneer. But Netflix’s years of insisting on hewing solely to a subscription model may have caught it flatfooted.

Its subscriber growth has notably slowed since the peak of COVID-19. Year over year, subscriber growth fell into the single digits in Q2 2021, where it has remained ever since. Meanwhile, the rise of a host of competing services is putting pricing pressure on Netflix.

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

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

Acquiring Roku would provide Netflix with the adtech partner it needs, and bringing it in-house would make it more profitable, giving Netflix all of Roku’s user data in the process.

The benefits are clear for Netflix, but what would Roku gain? Aside from a premium on its current share price, Roku’s leadership as a streaming video gatekeeper is a compelling long-term investment thesis.

2. Netflix could have trouble swallowing Roku

Roku won’t come cheap. Netflix would have to pay a healthy premium to get shareholders to agree to sell. But how high can Netflix afford to go? The chart below illustrates how the constant need for fresh content has kept the business cash-flow neutral, forcing it to borrow more money.

NFLX Cash and Short Term Investments (Quarterly) data by YCharts

To swing an acquisition, Netflix would have to either borrow — potentially putting financial strain on its ability to spend on content — or hold a secondary stock offering at a time when its share price is down 75% from its high.

3. Buying high and selling low?

Roku’s shareholders could wonder the same thing. That company’s stock has fallen by more than 80% from its peak. Would Roku be willing to sell itself at what would likely be a price far below its market cap from just a year ago?

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

ROKU PS Ratio data by YCharts

Netflix’s desire to move into ad-supported streaming makes a potential acquisition of Roku appealing for it. However, the situation isn’t as straightforward for Roku. Shareholders of acquired companies sell for the money, and the current market makes a fat payday unlikely for Roku’s investors.

It may turn out that Roku and Netflix will work together on ads to some degree — there have already been rumors to that effect. However, a formal acquisition doesn’t seem to make sense for Roku right now.

Justin Pope has positions in Roku. The Motley Fool has positions in and recommends Netflix and Roku. The Motley Fool has a disclosure policy.

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