Two 23% Growth Rates. Three Times the Gross Profit Gain

Roku had two businesses grow 23% in the third quarter. They looked a lot less alike one line down the income statement.

Advertising added $136.2 million in revenue and $113.9 million in gross profit from a year earlier. Subscriptions added $107.5 million in revenue but only about $35.5 million in gross profit.

Advertising delivered more than three times as much additional gross profit despite the identical revenue growth rates.

The advertising business now operates at a 63.2% gross margin, compared with 40.9% for subscriptions. Both are growing, but advertising is producing considerably more profit before corporate operating expenses.

Those numbers are particularly interesting with Fox’s now completed acquisition of Roku for approximately $22 billion in enterprise value. Fox is building its own subscription business while buying a company that makes substantial money helping other streaming services find customers.

Versant and People Inc. are confronting different versions of the same financial challenge. Both are finding new revenue as established businesses lose ground. The newer businesses have different operating costs, margins, and commercial dependencies, making their contribution to earnings harder to judge from revenue growth alone.

Cable’s $24 Million Hole

Versant’s third-quarter numbers put the replacement problem in pretty stark terms.

Linear distribution revenue fell $57 million to $935 million. Its comparable Platforms businesses added $33 million, growing 17.4% after excluding the effects of the SportsEngine divestiture and Full Swing acquisition.

That’s a $24 million gap between the two changes, before accounting for additional declines in advertising and content licensing.

Total revenue fell 4.2% to $1.59 billion. Adjusted EBITDA dropped 20.9% to $353 million.

Versant isn’t running out of cash. It generated $302 million in free cash flow during the quarter. But the cable business responsible for much of that cash is shrinking, and management needs the newer businesses to eventually replace the earnings going away.

Fandango offers one of the more interesting possibilities.

Ticketing drove the largest share of Platforms growth, with Fandango recording its strongest quarterly ticket sales since the pandemic. Versant is also expanding Fandango1, the software business serving movie theaters.

As Fandango moves further into theater operating software, it can sell services covering ticketing, concessions, payments, loyalty programs, and other daily operations.

A blockbuster movie can generate a terrific weekend of ticket sales. Theater software has the potential to generate ongoing service revenue between those releases, with transaction fees providing additional upside.

Selling an operating system also comes with costs. Theater integrations, customer support, software development, and payment services require investment. The business becomes more attractive when enough exhibitors sign contracts and keep using the products.

Versant doesn’t separately disclose Fandango1 revenue, installations, or margins.

Management can demonstrate ticketing growth and expanding software capabilities without showing how much profit the software operation generates independently of movie attendance.

Meanwhile, linear distribution still accounts for roughly 59% of total revenue. Versant has renewed enough carriage agreements to place 75% of its network subscribers under contracts extending into 2028 or later.

Those agreements provide some revenue visibility while the company builds.

The financial question is how much recurring gross profit Fandango1 and the other Platforms businesses can eventually produce, and how much investment they’ll require to get there.

A 17.4% growth rate looks encouraging. Replacing the earnings from a $935 million quarterly distribution business requires a much bigger financial contribution.

Fewer Clicks, Bigger Checks

People Inc. managed to grow digital revenue 2% in the third quarter even as core website sessions fell 26%. That’s a pretty good trick when Google keeps sending fewer readers your way.

Session-based digital revenue declined $10.6 million to $163.6 million. Non-session revenue increased $16 million to $125 million.

Licensing and other revenue did most of the heavy lifting, jumping 49% to $52.7 million.

As People collects more licensing revenue while search referrals collapse, Apple News+, Meta, and other syndication partners are becoming increasingly important to its business.

People is finding ways to get paid for content even when readers never visit its websites.

A website visit can generate advertising impressions, affiliate commissions, registrations, and subscription opportunities. A licensing agreement generates revenue through a separate commercial arrangement, potentially without requiring the publisher to acquire the end user.

That’s a pretty attractive option when Google referrals are disappearing.

But the financial arrangements vary.

Apple News compensates the publisher through revenue sharing tied to content consumption. People can also sell advertising within the Apple News experience. Meta has a multiyear content licensing agreement whose financial terms haven’t been disclosed.

One relationship can generate additional revenue as consumption increases. Another may provide a different mix of guaranteed payments and usage-related compensation.

Either way, the publisher still has to produce the content that makes those agreements worth signing.

And the costs of running the broader digital business haven’t disappeared.

People’s digital adjusted EBITDA declined 2% to $72 million during the quarter, even as digital revenue increased 2%. Management attributed the adjusted EBITDA decline primarily to higher selling and marketing expenses, compensation, and software licensing and maintenance costs.

Digital operating income, meanwhile, increased 27% to $48.7 million. That improvement benefited from prior-year severance expenses and lower amortization costs.

Both figures deserve attention. The operating-income comparison improved considerably, while the company’s adjusted measure of ongoing digital profitability slipped slightly.

People doesn’t disclose licensing margins separately, so there’s no basis for assuming those agreements caused the adjusted EBITDA decline. The company is still investing in marketing, software, and the editorial operation supporting its brands.

The licensing business is helping absorb the loss of website-driven revenue. Maintaining profitability will depend on how much those agreements contribute after the costs of producing, packaging, and distributing the content.

There’s also the renewal issue.

Management expects licensing growth to moderate as existing agreements reach their anniversaries. The initial contribution from a new deal can create an impressive year-over-year comparison. Subsequent growth depends on consumption, contractual terms, new partners, and the company’s ability to negotiate better economics.

People has found additional buyers for its content. The next test is how much earnings growth those relationships can support once the initial revenue gains become part of the comparison.

The $19.99 Churn Test

Fox has managed something that plenty of media companies would love to accomplish.

Lachlan Murdoch told investors that approximately 97% of new Fox One subscribers don’t have a traditional cable subscription.

Those additions have been sufficient to offset declines in Fox’s traditional subscriber base, returning the company to positive subscriber growth over the trailing 12 months.

Fox is finding paying customers beyond the cable bundle while preserving much of the existing distribution business.

Distribution revenue within Fox’s Cable Network Programming segment increased 10% to $1.2 billion in its fiscal first quarter, supported by higher rates and subscriber growth that included Fox One.

The segment includes both traditional distribution and Fox One, so that growth shouldn’t be mistaken for a 10% increase in legacy cable affiliate fees alone.

Still, Fox One’s incremental subscriber gains are encouraging.

The service costs $19.99 a month, giving Fox access to households that weren’t generating traditional cable distribution revenue.

But management hasn’t disclosed Fox One’s paid subscriber base, acquisition costs, churn rate, or average net revenue per subscriber.

Murdoch also acknowledged that the subscriber base will fluctuate with the sports calendar.

Fox can attract customers for major games and tournaments. The financial return depends on how many paid months those customers generate, what Fox spends bringing them in, and how much of the subscription payment it keeps.

Fox News offers a potential retention benefit by giving sports-acquired customers something to watch between major events. Management says those customers are engaging with news programming.

The company hasn’t quantified the effect on retention or profitability.

Distribution relationships add another variable.

A Fox One customer subscribing directly may generate different economics from someone signing up through an aggregator that participates in the subscription revenue.

That arrangement can still be attractive if the partner delivers subscribers more efficiently than Fox could acquire them on its own. The economics depend on customer-acquisition costs, partner fees, and how long those subscriptions last.

Fox has demonstrated that it can reach a largely new paying audience without heavily cannibalizing cable subscriptions.

What remains undisclosed is how much recurring profit that audience produces.

And Fox’s acquisition of Roku is about to make the comparison between subscription and advertising economics considerably more interesting.

Ads Pay the Bills

Roku’s third-quarter results show where most of its incremental platform gross profit is coming from.

Advertising generated approximately 76% of the company’s $149.3 million year-over-year increase in platform gross profit.

Video advertising impressions increased 33%, even as average price per impression declined 7%. Roku sold considerably more inventory, while a shift toward higher-margin advertising products helped improve profitability.

Advertising gross profit increased 33% to $459.4 million.

Subscriptions generated $237.7 million in gross profit, up 18%, as subscription costs rose faster than revenue. Roku attributed the margin compression primarily to a greater mix of Premium Subscriptions.

As advertising accounts for most of Roku’s incremental platform profit, the company is demonstrating how differently the two revenue streams behave.

Advertising can grow through additional impressions, better ad products, and greater advertiser demand. Subscriptions depend on customer payments and commercial arrangements with the services Roku helps distribute.

The company also recorded a $48.6 million gross loss in Devices, driven primarily by elevated memory costs. That’s another reminder that putting Roku’s operating system into households comes with expenses before those households generate advertising or subscription revenue.

And Roku doesn’t need to own the programming being watched to participate in the revenue.

Its Sports Experience generated more than one million subscription sign-ups during the World Cup across services including Peacock, Paramount+, Fox One, and ViX.

Meanwhile, more than 80% of Roku’s in-stream video advertising impressions were delivered programmatically during the third quarter. Media and entertainment companies are also spending more to promote their content and services through Roku’s advertising products.

Roku can collect advertising revenue from one streaming company, earn subscription revenue by helping another find customers, and generate viewing through The Roku Channel.

Those relationships work across competing services.

That makes Fox’s acquisition particularly interesting.

Fox agreed in June to acquire Roku in a transaction valued at approximately $22 billion in enterprise value. The companies have received their required shareholder approvals and foreign regulatory approvals, while U.S. antitrust clearance remains outstanding.

Fox would gain Roku’s operating system, advertising business, subscription marketplace, and distribution relationships alongside its existing sports, news, and streaming operations.

It would also inherit a commercial incentive that can conflict with the natural instinct to promote its own programming.

Roku makes money when other streaming services advertise, distribute subscriptions, and attract viewers through its operating system.

Fox One, Tubi, and Fox’s other properties give the combined company plenty of programming to promote. But Roku’s strongest incremental gross profit currently comes from advertising, including demand generated by companies competing for the same viewers.

Fox and Roku have committed to operating Roku as an open, partner-friendly platform after the acquisition.

Roku’s earnings show the financial logic behind that commitment. A business collecting advertising and distribution revenue from the broader streaming market has good reasons to keep those commercial relationships healthy, even when its parent company owns competing services.

The Streaming Wars Take

An internal Fox One promotion on Roku’s Home Screen should carry an economic cost, even if Fox never sends itself an invoice.

That screen has commercial value.

Roku can sell advertising placement to another streaming service, help a partner acquire a paying subscriber, or direct viewers toward Fox One. Each option generates different revenue and carries different costs.

Once Fox owns Roku, promoting Fox One won’t automatically produce the best financial return simply because the subscription belongs to the same company.

A paid advertising placement from Peacock or Paramount+ can generate revenue without Fox having to finance the programming those companies are promoting.

A new Fox One subscriber can generate recurring subscription revenue, but Fox must account for acquisition expenses, distribution fees, the cost of serving that customer, and how long the subscription lasts.

Those returns need to be compared with the advertising and distribution revenue Fox could earn by promoting somebody else’s service.

Roku’s third-quarter results make the opportunity cost unusually visible.

Advertising produced more than three times the incremental gross profit of subscriptions, despite identical revenue growth rates. The subscription business remains valuable, but the advertising operation is currently generating much more of Roku’s additional platform gross profit.

That creates an interesting tension for the combined company.

Fox has a strong incentive to put its own programming in front of Roku households. It also has a financial interest in keeping competing services spending money on Roku advertising and distribution.

Favoring Fox programming without a corresponding profit benefit could sacrifice attractive advertising revenue while making the company’s relationships with other streaming services harder to maintain.

The promised open marketplace has commercial value. Those competing services are paying customers, and some of their spending supports Roku’s highest-margin business.

There will be times when promoting Fox One produces the stronger return. There may also be times when sending a household toward Peacock or Paramount+ generates more profit for Fox.

That’s the decision Fox will have to make once it owns both the programming and the distribution business.

At a $22 billion enterprise valuation, the company can’t afford to confuse promoting its own products with maximizing the return on the business it bought.

Sometimes the most profitable customer is the competitor writing the check.