On Feb. 13, connected TV platform company Roku(NASDAQ: ROKU) shed hundreds of millions from its market capitalization following a report that retail giant Walmart(NYSE: WMT) is trying to buy TV manufacturer Vizio(NYSE: VZIO) for $2 billion. Based on the market's knee-jerk reaction to this news, investors are clearly worried about the competitive threat for Roku.
A week later, Walmart officially announced its deal to acquire Vizio for $2.3 billion. Roku stock dropped again on the news.
There may be good reason for investors' concern. Roku generates revenue in two main ways: device sales and platform revenue. On the hardware side of things, Roku sells smart TVs and accessories with streaming capabilities. Last year, Walmart was a top-three retailer for Roku's devices.
Walmart even sponsored some original Roku streaming video content in 2023, helping it generate ad revenue. Therefore, Walmart is a key partner for both of Roku's revenue streams.
If Walmart acquired Vizio to compete with Roku, then it stands to reason it won't play so nicely in the future. But Roku investors can relax as Walmart likely has a much bigger target in mind -- a longtime rival with a $1.75 trillion market cap.
What could Walmart be up to?
Walmart is likely much more interested in competing with e-commerce giant Amazon(NASDAQ: AMZN) than with Roku. In fact, this is what anonymous sources told The Wall Street Journal as well in relation to Walmart's acquisition.
Amazon has quietly become one of the most powerful digital advertising businesses in the world. In 2023, the company generated $47 billion in ad revenue. It grew this part of the business an impressive 26% year over year in the fourth quarter -- the best growth rate of any of its business segments.
The e-commerce giant is effective at advertising because it has a massive customer base, and it knows a lot about those customers. Every transaction on Amazon's marketplace provides the company with valuable data it can use to attract advertisers.
As the biggest retailer in the world, Walmart also has a large customer base, and it's working to better leverage its opportunity. In 2021, Walmart partnered with top demand-side advertising platform The Trade Desk to build Walmart's own demand-side capabilities. Then, in 2022, Walmart partnered with Roku to make streaming TV ads interactive and shoppable.
Therefore, it's no secret Walmart is working to become a force in digital advertising just like Amazon. That's how its interest in Vizio fits into the bigger picture. In Walmart's press release, management said that combining Vizio and Walmart's advertising businesses will "redefine the intersection of retail and entertainment."
For its part, Vizio has adopted a Roku-like strategy. Both Roku and Vizio sell physical hardware at a gross loss -- it costs more to make the devices than what they sell for. But this allows these companies to generate higher-margin revenue from operating system software.
Through the first three quarters of 2023, Vizio's device revenue of $753 million was down 31% year over year. However, its software revenue (what it calls Platform+) was up 24% to $424 million.
Device revenue still makes up the bulk of the top line for Vizio, so its decline has led to overall revenue slipping as well. However, the rising share of Platform+ revenue has boosted the company's gross profit margin.
Data by YCharts.
Given these numbers, Vizio is obviously all-in on its ad-focused platform business, and that's what Walmart wants so it can go toe-to-toe with Amazon.
A closing thought on Roku
It would go too far to say this news from Walmart is irrelevant for Roku's shareholders. Indeed, Walmart could opt to give greater visibility to its own TV brands once the deal is closed, which would hurt Roku's sales.
But is this outcome probable?
Recall that Walmart is a top-three retailer for Roku's devices. Well, Amazon is also among the top three, and it's been selling competing Amazon-branded smart TVs for years. Despite the resulting competition from Amazon, Roku just surpassed 80 million active accounts, making it the largest player in this space. Not only that, it just added 10 million new accounts in 2023, its second-best year ever. History suggest this news from Walmart won't be enough to dethrone Roku.
Roku continues to outshine competitors with much deeper pockets. In light of this track record, the recent drop in Roku's stock price could be an opportunity for long-term investors.
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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Jon Quast has positions in Roku. The Motley Fool has positions in and recommends Amazon, Roku, The Trade Desk, and Walmart. The Motley Fool has a disclosure policy.
