The Magical World of ESPN

Let’s face it: cable is in trouble and ESPN is no exception. In fact, as of 2016, subscribership fell 27% from 2012 as reported by Nielsen Ratings. Once dubbed the ‘Crown Jewel’ of Disney’s bottom line, ESPN might be known as the hail marry attempt of financial statement turnarounds A common misconception names ESPN making up 42% of Disney’s operating earnings. However, Disney’s cable network segment includes ESPN, all the Disney channels and Freeform (formerly ABC Family). This cable segment constitutes the 42% margin of operating income. Now, to be fair ESPN contributes the biggest revenue source within this segment, which gives cause for concern when subscribership falls 27% in four years.

ESPN’s model, albeit simple, remains flawed. They pay upfront for sports broadcasting contracts and then air the games over the life of the contract. Their profit comes from cable subscribers and ad revenue. There are two problems with this business model. First, increased competition from other cable subscribers, such as NBC, a Comcast company, to buy up these sports contracts. ESPN’s average contract will terminate by 2023, which opens the door for competitors. The contracts up for grabs include Sunday Night Football, a specified number of NHL games, and the English Premier League Soccer. Secondly, consumer preference. Consumers who leave cable for online streaming destroy ESPN’s profit model. For every one cable or satellite subscriber that cuts the cord, ESPN loses on average $7.00 per month..

The cracks in ESPN started to become evidently clear in Disney’s first quarter results for 2017. For the second quarter in a row the cable segment earnings came in negative. Management thinks that the recent poor earnings were disappointing but feels if they stay the course, ESPN cable will continue to earn roughly $8-11 billion annually. As John Kosner, the network’s head of digital and print media, put it in a Bloomberg article, “Everything we do supports the pay television business.” However, shareholders don’t care about past performance. They want to see revenue steadily increase and if it drops, they sell. To management’s point: $8-11 billion in revenue is nothing to sneer at, but don’t forget about those pesky sport contract costs. It is projected that, “programming costs will top $8 billion in 2017,” per media researcher Kagan.. You should always look at operating income alongside revenue to see the after cost profit.

As a shareholder, you always have three options: buy or buy more of the company, trim your position back to reduce exposure and/or lock in gains/losses, or sell out completely. This same principal can be said of management as well. Management can either divest a segment of their business they no longer wish to hold either because of accumulating losses or due to the segment growing strong enough to stand alone, trim their position by cutting back resources and costs, or invest more into the business segment typically in the form of research and development or mergers and acquisitions. Disney clearly decided to do the latter. In 2016, Disney acquired a minority stake in BAMTech, which provides direct-to-consumer streaming services. The goal for Disney will be to transfer their cable customer base to online. Disney will rely on BAMTech to make this happen, and in the meantime, will continue to buy sports contracts to secure their position as the number one sports cable provider. It certainly feels as if Disney stands on the 10-yard line with seconds to go in the fourth quarter with only one play left. They have already decided they are running the ball up the middle, but have they underestimated the defensive line?

By | 2017-10-31T11:12:37+00:00 May 26th, 2017|Categories: Market Thoughts|0 Comments

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