A couple of weeks ago, in my new newsletter, I wrote that you should "short ESPN."
I outlined why I thought that the recent cost-cutting measures taken by ESPN head John Skipper to axe prominent media stars such as Bill Simmons, Keith Olbermann and Colin Cowherd belied a more serious internal dilemma at the Disney-owned (DIS) company. This wasn't about some moralistic high-ground being taken or cozying up with NFL commissioner Roger Goodell; it was about protecting the mother ship from revenues that were hitting a wall and future costs ballooning because of signed TV rights deals with various sports leagues.
Tuesday, Disney earnings disappointed, mostly because ESPN ad sales disappointed, extra affiliate revenue fees ESPN gained from transmitting the SEC Network covered up affiliate fee revenue losses at ESPN, and the company took down its guidance for ESPN subscriber growth from high single digits to mid-single digits for the next few years.
Disney's stock was down about 9% in afternoon trading. When ESPN accounts for half of Disney's operating income, subscriber growth hitting the wall is going to send a chill down the spines of investors. And, of course, it's not just Disney being hit on cord-cutting fears:
- Time Warner (TWX) was down about 9%
- 21st Century Fox (FOXA) was down around 7%
- Discover Communications (DISCA) fell more than 9%
- Viacom (VIA) lost about 7.5%
Wall Street can be prone to over-reaction, but that magnitude of a reaction suggests that there is a real basis for concern.
But Ben Thompson at Stratechery says that ESPN will be fine. His argument -- like Disney CEO Robert Iger's last night on the earnings call -- is that ESPN has locked up TV rights to some of the most important sports events for the next decade. The bundle works now. But ESPN could go direct at any time and make just as much if not more money from selling Over The Top, or OTT, (via the Internet). So why worry?
There is some truth to this argument. ESPN makes about $9.2 billion from affiliate revenue fees, according to some rough math I did. It has about 95 million subscribers. If 20% of those subs pay $30 per month for content, it would bring in $6.8 billion in annual revenue. Where's the problem?
But this would be like arguing that the New York Times (NYT) would be fine when the Web came of age. In February 2000, the New York Times traded at $48 per share, or nearly 4x as much as it does currently. It still exists today, but a lot of us get our news from Facebook (FB) or Buzzfeed, which obviously didn't exist in 2000.
Incumbents are not well positioned to take advantage of new, sudden shifts in the business model, let alone a two-way shift in business models delivered via a different technology.
Tower Records could have signed an exclusive 10-year deal to sell Guns N' Roses, The Beatles and Backstreet Boys in 2002, but you couldn't conclude that Tower Records would be fine at the end of that exclusive agreement -- or that its stock (if it had traded in the public markets) would be worth as much.
Just because ESPN has a great set of content locked up now doesn't mean that Wall Street won't put the stock through the wringer for the next five years as it goes through fits and starts about if and when the company should go OTT and bite the hands of all its cable company partners. "Should we do it now and risk Verizon (VZ) and Comcast (CMCSA) will kick us off overnight?" will be the discussion in Burbank, not Bristol.
ESPN will likely wait as long as it can before truly going over the top, trying to maximize affiliate fees while saving their digital offering. It reminds me of Blockbuster competing against Netflix (NFLX). And why wouldn't Netflix take a run at bidding at sports as much as various content offerings? Or starting a second Netflix channel with sports offering ("The Deuce"). Why let Disney gobble up that $30 a month when Netflix has so much credibility now?
What about Google's (GOOGL) YouTube making a huge play for TV rights? Or some completely new player?
While all this drama goes on, investors will wonder: Why do I need to own Disney's stock now? In 10 years, Disney's stock might be a lot higher. But Wall Street worries about where the stock's going to trade in the next few weeks. They can always wait to buy a stock when the dust settles.
Or you could have paid $44 for the New York Times' stock in 2000.
Correction: A previous version of this article incorrectly represented estimates for the number of ESPN subscribers and its annual revenue.