Roku plans to shake up how customers watch video, and it could help the company earn more ad dollars

Key Points
  • Roku is talking to more media companies about putting their content directly on its streaming app, in exchange for a larger share of advertising revenue.
  • Media companies, who are getting less ad revenue from TV as well as smaller deals from cable companies, are willing to make the deals to find another distribution channel. It also allows them to reach cord-cutters. 
Roku plummets despite EPS beat
Roku plummets despite EPS beat

As audiences increasingly cut the cord, Roku is seizing its opportunity as an ad-friendly streaming video platform.

Roku is in current talks with media companies to include their content in its app instead of leaving it in their own separate apps, according to five advertising, technology and media executives who had talked with the company. In exchange, Roku will lead advertising sales on their shows and take a larger share of the revenue.

Roku executives have all expressed plans to expand its The Roku Channel streaming app into "a house channel," similar to how Apple's TV app works today, three of the sources said.

Other apps will still be allowed on the platform, but would not be featured as prominently as they are today. One proposed plan would make the Roku-owned free service the home screen, where people would be able to access partner content without switching from app to app, according to two of the executives. Roku would recommend shows and movies based on user data and pre-set categories. No sense of timing was given, but they were told the changes were a "core focus" for Roku's future plans, three of the sources said.

A spokesperson for Roku said it does not comment on specific partner relationships or rumors or speculation.

With 22 million active accounts as of June, a Roku device or Roku-enabled smart TV is the main way that U.S. households stream TV shows and movies. It's also a method marketers can use to reach those viewers. The company has also vastly expanded its own app, The Roku Channel, making it available non-Roku devices like desktop computers via the internet and on mobile phones.

Wedbush Securities upgraded Roku last week to a buy due to its dominant position in OTT advertising and potential for international expansion. The company reports earnings on Wednesday.

Roku is also facing stiff competition from other device makers with deeper pockets like Google's Chromecast, Apple TV and Amazon Fire TV. Amazon's streaming video advertising business is just starting up, but the company has also talked to media buyers about expanding its ad-supported video options, CNBC previously reported. Google has a live streaming TV service, YouTube TV, which it argues offers advertisers the exact TV audience they want to reach. And Apple is aggressively purchasing its own shows and movies for an upcoming service, although has indicated to media companies it will not be ad-supported.

For users, the changes could make it easier to find shows to watch without having to switch from app to app.

But it's really Roku who stands to gain the most. Roku's platform revenue reached $90.3 million last quarter, growing 96 percent year over year. Its average revenue per user (ARPU) reached $16.60. EMarketer projects Roku will generate $293 million in ad revenue in 2018, noting money floating to over-the-top (OTT) streaming video companies is going to continue to rise as TV ad spending declines.

"With Google and Facebook, you have the ability to place the ads, but you don't have the same type of content, something where users will spend 30 [minutes] to an hour undisturbed," said Raghu Kodige, chief product officer for TV data company Alphonso.

Apps that appear on Roku's platform have to let Roku sell up to 30 percent of their ad inventory and give up as much as 20 percent of one-time purchases (like movies). Larger, more popular streaming services have more negotiation power and may pay the company little to no fees.

If media companies agree to put their shows and movies on Roku's own service, the company is proposing it will handle sales and get 55 percent of the ad revenue, according to one industry executive. Ads would range from traditional 30-second ad breaks, display banner ads and sponsorship opportunities around themed video playlists. For example, a collection of road trip movies could get interest from an auto advertiser.

Media companies may be willing to sign on. They are already getting less money for their channels from cable companies, so they are more open to deals with companies like Roku because it's one way to increase revenue, according to one media executive. Roku also reaches the audience who don't have cable or satellite subscriptions, another executive noted. But whether the larger media companies will agree to give up 55 percent of the ad revenue remains to be seen, a source added. It will also increase competition for the apps that remain separate from Roku's streaming services.

Roku shares dropped as much as 12 percent after hours on Wednesday as the company reported Q3 earnings. The company beat expectations on revenue and earnings and raised guidance, but came in slightly below expectations on platform revenue and average revenue per user.

Roku CEO on earnings beat, growing ad revenue
Roku CEO on earnings beat, growing ad revenue