For decades, ESPN has been the gift that keeps on giving for decades for its corporate parent, Walt Disney (DIS). However, the days of easy money for “The Worldwide Leader in Sports” are starting to come to an end — a potential anchor that threatens to weigh on Disney stock and its holders.
Don’t get me wrong; ESPN is still a cash cow. Credit Suisse analyst Michael Senno, who rates Disney stock as “outperform,” expects ESPN’s ad revenue to rise more than 6% in each of the next two fiscal years. Ratings, which have been soft, have stabilized in the September quarter and should be solid going forward, he said in a recent note to clients.
And what about the threat posed by 21st Century Fox’s (FOXA) Fox Sports 1 and others?
According to Senno, about 65% of ESPN’s ad revenue comes from live events and another 28% comes from its news show “SportsCenter,” which is the most vulnerable to Sports 1 competition.
“Overall, we believe that ESPN can continue to thrive in spite of competition and that recent concern about the network could be overdone,” Senno says.
However, while the analyst’s bullish view might be correct in the short run, ESPN’s long-term outlook remains uncertain at best. Broadcast rights costs are showing no signs of slowing. Meanwhile, ESPN’s rivals are increasingly eager to grab a piece of the sports programming pie for themselves.
Last year, ESPN and Fox were outbid by Comcast’s (CMCSA) NBC for rights to English Premier League soccer games, which has proven to be a surprise hit for the Peacock. NBC also bested ESPN and Time Warner’s (TWX) Turner Sports for the rights to NASCAR in a deal that starts in 2015. Thankfully, ESPN’s deals with other sports, such as the NFL, won’t expire for a few years
Competitors including Fox Sports 1 are helping drive up the costs of sports programming to near-astronomical levels. To make matters worse, some advertisers and pay television operators are starting to wonder whether the costs of sports programming are worth it.
Earlier this year, Blaise D’Sylvia — vice president for media, sports and entertainment marketing at Anheuser-Busch InBev (BUD) — predicted that within the next decade, sports leagues would be so strapped for cash that they would have to play shorter seasons. A statement like that, coming from a company whose brands have been synonymous with sports for decades, should raise red flags with investors over the long run.
Disney is confronting these issues head-on in its contract renewal talks with Dish Network (DISH). The two companies are also at odds over Dish’s AutoHop service, which allows viewers to bypass commercials. Investors are going to be paying close attention to these talks.
Charlie Ergen, the billionaire who controls the satellite provider, has been among the most vocal critics in the industry about increasing sports programming costs. As Bloomberg News noted, Ergen has threatened to drop ESPN over its fees and pass the savings onto customers.
Improbable as that seems, there is a method to Ergen’s madness.
With the exception of the National Football League, which is by far America’s most popular sport (sorry, baseball), the audience for most sports programming tends to be small, averaging less than 4% of all households. AT&T (T) and DirecTV (DTV) are refusing to carry Comcast’s CSN Houston channel, which broadcasts games from the NBA’s Rockets and baseball’s Astros. Neither company was seriously hurt by such a move. The Astros lost 111 games this season and are the second-worst team of all time (though still profitable, according to Forbes). The Rockets have fared better — they were eliminated in the first round of the playoffs last season — and acquired star Dwight Howard in free agency over the summer.
For investors, ESPN shouldn’t be the sole reason to buy or sell Disney stock, which has surged nearly 30% during the past year.
From a valuation standpoint, DIS doesn’t look quite so fresh. Disney stock trades at a price-to-earnings multiple of about 19 — that’s on the high end of the scale for the past five years, and also at a premium compared to peers such as Viacom (VIAB, 18.6), Time Warner (18) and 21st Century Fox (11).
However, it’s worth it exactly because ESPN is merely a piece of the puzzle.
Walt Disney World and Disneyland are among the top destinations in the U.S. for tourists from Europe and Asia. Meanwhile, the company’s cruise ships will win business away from Carnival (CCL), which has been struggling to repair the damage by a series of well-publicized mishaps. While Wall Street has focused on the disappointing box-office performance of The Lone Ranger, Disney has box-office gold in the form of its Marvel and Star Wars properties.
That’s the beauty of Disney stock — even if ESPN begins to falter, it has several other divisions waiting to prop it up.
As of this writing, Jonathan Berr did not hold a position in any of the aforementioned securities. Follow him on Twitter at @jdberr and at Berr’s World.
