After booming IPO, Roku says streaming boxes aren’t the future

The company that started as a secret Netflix Inc.












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 project to build hardware that could stream media to televisions no longer thinks those gadgets are the key to its Wall Street success.

Roku Inc.












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 made its debut Thursday after raking in at least $219 million in an initial public offering that valued the company at roughly $1.3 billion, and shares zoomed nearly 68% higher than the $14 IPO price to close at $23.50. The blockbuster first-day performance suggests investors have taken to the company even after it failed to raise private capital at a $1.5 billion valuation earlier this year.

Roku is largely known for its line of TV streaming sticks and devices, but executives say that the future lies in money generated from what people use the gadgets for: consuming content. Roku is staking its growth on its dedicated TV and streaming device operating system, described as “platform” revenue in company filings with the Securities and Exchange Commission that showed sales growth of 91% in the first six months of 2017 from the previous year.

“What’s important in the evolution of the company is the platform business is becoming a greater and greater portion of Roku,” Chief Financial Officer Steven Louden told MarketWatch in a telephone interview Thursday. “It’s now 80% of our gross profit and I think it’s great proof-point for investors about really what the Roku business model is about.”

Don’t miss: Roku IPO: Five things to know about the streaming-device company.

The company generates revenue from its streaming operating system in three ways: It sells ads, which make up about two-thirds of the current platform sales, and has revenue-sharing agreements for content and subscriptions purchased via its operating system, according to Louden. A final 5% comes from licensing the technology to others.

“[Licensing fees are] probably the place that has the most significant revenue recognition around it,” Louden said. “Our licensing fees—we have multiyear deals with TV brands as well as service operators through our Roku Power program. We actually have almost $70 million in deferred revenue on the balance sheet, which is a lot of value.”

As the software side of the business grows at a near triple-digit clip, hardware sales dipped 2% to $117.3 million in the first six months of 2017 compared with last year. But Roku doesn’t see what it calls “player” revenue as a profit driver, Louden says, but rather a way to attract new customers to its platform.

“We focus on overall profit growth at Roku,” he said. “We are making a strategic trade off between the player segment and the platform segment because we are not trying to maximize for player revenue.…We look at the player segment as a customer-acquisition path as opposed to thinking like a hardware company and needing to maximize revenue on that.”

Roku’s focus on the software ecosystem echoes the sentiments of other hardware startups that have made it to Wall Street, like GoPro Inc.












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 and Fitbit Inc.












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 It is a path that Apple Inc.












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 has shown to be possible, as the iPhone maker’s software and services revenues have continued to grow even as sales growth for its hardware has stalled.

IPO experts are closely watching the company’s non-device revenue and give credit to executives for recognizing that hardware was not the path to Roku’s most promising future.

“What [executives] were able to do was recognize their hardware business model was not a long-term smashing success and manage to change, and not to have a giant dip in the process moving from the hardware to the platform and have some decent margins along the way,” said Barrett Daniels, Chief Executive of Nextstep, a San Francisco company that helps private firms go public. “The good part of the business is really growing.”

Daniels says he was pleasantly surprised by the company’s S-1 filing because, unlike some other recent tech IPOs such as Snap Inc.












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 , executives didn’t give themselves massive stock grants, their financials appear to be “well-managed” and the company went public at the right time.

“Unlike Evan Spiegel at Snap—large stock grants are actually pretty common—the executives don’t seem to be robbing the place. I think they’ve done a very responsible job.”

See also: Six things to know about the Snap IPO

Roku’s debut comes at time when the market for IPOs appears to be improving. The total number of IPOs this year has already surpassed the total number of deals completed for all of 2016. What’s different about Roku’s IPO is that investors in the private companies look to have missed an opportunity, passing on a chance to invest at a $1.5 billion valuation.

“Public investors seem to be the smart ones,” Daniels said. “They were able to recognize good fundamentals and good future prospects. Private market investors are the dumb ones, meaning they had a chance to invest in this six months ago and they passed. I think this is a new sort of world we’re living in.”

Roku’s IPO also arrives at a good time for technology companies, as the SPDR Technology Select Sector exchange-traded fund












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 has rallied 5.2% over the past three months, while the S&P 500 index












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 has gained 2.8%.

Roku












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 sold at least 9 million shares in the IPO for $126 million, and selling stockholders Menlo Ventures and Sky Ventures Ltd. combined to sell 6.7 million shares. Underwriters have access to 2.35 million more shares, which would be split between the company and selling stockholders if they are sold.

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