Disney (DIS) is reportedly gearing up for more layoffs at ESPN, and that only underscores how important the sports network is to its bottom line and, by extension, DIS stock.
As we saw in last month’s share-price rout, Disney’s disproportionate reliance on the juggernaut that is ESPN makes the media company especially sensitive to the secular trend known as cord cutting.
True, pretty much every media company got whacked in August after DIS said ESPN lost subscribers in the latest quarter, but DIS stock led the charge by falling 22% in a little less than three weeks.
The reality is that the current cable TV model is coming apart. Between entertainment delivered online and customers clamoring for a la carte subscriptions, the future of the media and cable industries have probably never been this uncertain.
More worrisome, cord cutting is a growing trend that is here to stay.
Millennials in particular are eschewing subscriptions to cable TV services in favor of entertainment delivered online. As a cohort bigger than the baby boomers, there’s little wonder why media companies are nervous and cable companies are finding merger partners as fast as they can.
The youngest millennials are only about 15 years old and the industry knows that some percentage 0f this younger generation — and an accelerating one at that — will never become cable TV subscribers. Even the oldest millennials are only about 35, and more likely to ditch cable in favor of online, on-demand programming.
A Problem for ESPN Is a Problem for DIS
The market overreacted to the news that ESPN lost a modest number of subscribers — it overreacts to everything — but it’s right to factor in the risk that EPSN could lose more subscribers in the future. ESPN is too important to DIS not to.
ESPN’s overwhelming strength comes thanks to its reliance on live programming. Viewers are less likely to record live sports and then skip through the commercials. That’s why it can charge distributors the highest prices by a wide margin.
Market researcher SNL Kagan estimates that ESPN will book an average monthly affiliate fee of $6.55 this year. That absolutely dwarfs the competition. TNT, which is the second-most expensive network, comes with an estimated average monthly affiliate fee of less than $2.
As a result, ESPN accounts for most of the operating income in the company’s most important segment and about half of DIS’s total operating profits.
Here’s the breakdown of segment operating income for the most recent quarter:
- Cable Networks: $2.1 billion
- Parks and Resorts: $922 million
- Studio Entertainment: $472 million
- Consumer Products: $348 million
- Interactive: $0
- Total Segment Operating Income: $4.12 billion
Most of that income from cable comes courtesy of ESPN. The market is right to worry about anything that threatens it. The market pays for growth, and that’s a lot harder for DIS to achieve if ESPN doesn’t deliver.
It’s not like this is the first time ESPN dumped employees to boost profitability.
ESPN is a fantastic asset. But it’s also highly captive to the secular industry trend of cord cutting and so-called skinny bundles.
Disney is diversified, to be sure, but ESPN faces long-term risks that can’t be ignored when it comes to valuing DIS stock.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.
