Description

Vizio is a competitor to Roku, a business which most of you probably know pretty well. Both are players in connected TV (“CTV”), where the revenue model is based on selling advertising to the viewer. Ad inventory in CTV began in the form of home screen banner ads, but has expanded to placement ads for search and discovery, to VOD and OTT subscription transactions from which the CTV platform operator takes a cut, and increasingly, to free ad-supported TV (“FAST”). FAST consists of content that the CTV platform operator itself has either purchased, or more commonly, licensed, with normal commercial breaks with the ad revenue going to the CTV platform (and the content licensor).  

CTV is growing by leaps and bounds as more and more viewers cut the cord, and also because it is a very effective form of advertising. A CTV  operator knows who the viewer is based on the email address (and, soon, credit card information) used for account registration. The CTV also knows exactly what the viewer is watching thanks to automated content recognition software, as well as whether the viewer is still actively watching the TV based on remote control usage. Further, the CTV knows the viewer’s shopping and location history through third party data sources, and has a record of which ads a viewer has seen, giving advertisers the option to “re-target” them with follow-up ads on the CTV or on their mobile devices. Because CTV is so much more targeted than linear TV, advertisers pay 2-7x as much per impression.

The largest CTV operator by far is Roku. However, Roku faces a big problem: its lack of a hardware TV business has left it open to disintermediation, specifically by Google. Television OEMs once paid Roku a fee for the right to install the Roku OS on their TVs, but the industry has woken up to how valuable a CTV user is, and so competition (mainly from Google so far) has flipped this dynamic on its head, and now Roku is being forced to pay the OEMs for OS placement, pitting it against Google in a bidding war for market share that is already hurting its margins.

Conversely, the big TV companies (Vizio, Samsung, LG, CTL) have a direct line to the consumer/viewer via their established brands and retail presence. They cannot be disintermediated except by dongles, whose popularity is dying.

The shift in economics from selling TV sets to selling ads to CTV users is dramatic. In the US, a television manufacturer typically makes just $15 in gross profit when they sell a television set — a 5% gross margin on an average wholesale price of $300. That $15 gets earned once and then the manufacturer may not get another chance to sell to that same consumer for six or seven years (the average life of a TV set). But when selling a connected TV, the manufacturer gets the initial hardware gross profit, plus the opportunity to sell advertising to the viewer for the life of the CTV set. Roku generates about $45 per user (and growing) in advertising revenue annually. That $45 of ad revenue comes at a 50% gross margin, and recurs every year for as long as the TV is in use. What was once a business that generated $15 in gross profits per user one time every six to seven years, now generates much more than that each year for those six to seven years.

There are also still a lot of opportunities to grow the CTV ad pie, with the biggest and most immediate being interactive ads. Imagine a draftkings over/under ad at halftime of the superbowl, or a Domino’s pizza offer. Since the user’s information is already stored in their CTV user profile – including name, address, and credit card info – replying “yes” to one of these ads can be as simple as the click of a button. These ads will convert at a very high rate and will offer direct purchase attribution, meaning they will go for extremely high CPMs.

So overall, we really like the CTV business model, which benefits from recurring, high-margin revenue, as well as massive secular tailwinds. We like Vizio in particular for the following reasons:

1. Vizio is growing its CTV platform revenue at about 2x the rate of Roku, because it is starting from such a lower base. Specifically, Vizio currently earns $25 in annual ARPU, compared to almost $45 for Roku. The difference exists because Roku started earlier in CTV so has a larger base of advertising customers, and because Roku also implemented payment functionality earlier. But Vizio is now rolling out payment functionality, and has invested heavily in its ad sales team in the last two years, so the ARPU gap — which has already narrowed by a third in the last two years — should continue to shrink quickly, if not eventually disappear completely.
   
   We would also point out that Roku could close the gap overnight by acquiring Vizio and porting its users over to Roku’s ad and payment networks.
   
   

2. Equivalent valuation to Roku despite twice the CTV platform growth rate. Currently VZIO trades 2.7x EV/CTV platform revenue, while Roku is at 2.2x after a huge fall in its stock price. Yet, as described above, Vizio has a much better growth outlook going forward due to the large but very close-able ARPU gap to Roku. And, Vizio has far lower risk of disintermediation.
   
   

3. Already CF positive, with a clear path to operating leverage and high EBITDA margins a few years out. Unlike Roku, which has run itself like a tech company via massive cash burn and huge investments in R&D and content, Vizio has been run with the corporate DNA of the penny-pinching TV industry, where profits margins are measured in the decimals. It has been cash flow positive every year and generating great operating leverage as CTV revenue grows far faster than the associated expenses of software R&D and ad sales. We think the company could be generating ~$100M of EBIT in approximately 3 years – at which point VZIO’s ARPU would only be where Roku’s is today.
   
   

4. The Vizio opportunity exists for obvious reasons: illiquidity, and perception as a TV hardware business.
   
   Illiquidity: Vizio’s founder and CEO William Wang took the company public so employees could have a liquid market for their stock in the company. But, even at twice the current share price, he was not enthused about selling more of Vizio than necessary to achieve this purpose, so he only floated a quarter of the company’s shares publicly. He still owns 40%, and Vizio’s manufacturing partners and executives collectively own another 32%. That doesn’t leave much stock for everyone else.
   
   Perception as a TV business: Most of Vizio’s brand awareness – and financial history – is that of a TV set manufacturer. A terrible business in other words. But as we discussed above the transition to CTV has remade the economics of the business, something which will be apparent to anyone who looks at the hardware and software sides of the business separately.
   
   Moreover, Vizio’s consolidated profit growth this year has been suppressed by a decline in TV set margin, which has masked the underlying growth of the CTV platform business (~40%+ for 2022). However, we think the decline in TV set margins, which is being driven by competition for the CTV user, has a lower bound because some margin must remain for the TV manufacturer itself, and most of the large players (Samsung, LG, etc.) manufacture their own TVs. The major retailers don’t like declining prices either, as it reduces their total dollar volume of sales.
   
   

5. Strong financial position: Vizio has $300M+ of net cash and generates consistent positive cash flow.
   
   

6. Attractive acquisition target. As mentioned above, we think Vizio would be a great purchase for Roku. Not only would Vizio’s TV’s business be an obvious way for Roku to prevent itself from continuing to be disintermediated, but Roku would benefit from a massive revenue step-up from Vizio’s users as it converted them to its more established advertising and payments platforms.
   
   Vizio could also make sense for other players trying to get into CTV. Google does have a history of buying established hardware brands to use as beachheads for its platform ambitions: Nest, HTC, and FitBit come to mind. Amazon is also trying to get into the industry, as are Comcast and Charter via a joint venture(!).

As mentioned above, we think Vizio could approach $100M of EBIT by 2025 or so. We would also expect the EBIT still to be growing at a very strong double digit clip at that point, and for Vizio to have accumulated another $200-300M of FCF over the period, lowering the EV to something like $1.1B. We leave it to you to decide what Vizio’s EBIT would be worth in that scenario, but we don’t think it's 11x.

There is a lot of concern right now about a cyclical downturn in advertising, especially in the scatter market. We don’t have much of an opinion other than we think it’ll happen. But CTV itself is such a strong secular trend, and still at such an early stage, that we’re not too concerned about short-term bumps.

Catalyst

Continuing to differentiate itself from Roku, especially by outgrowing Roku in an advertising downturn; strong earnings leverage and FCF generation as revenue grows. Potentially M&A.