ESPN Is Not A Risk For Walt Disney Stock

  • Credit Suisse analyst Omar Sheikh has highlighted several ways in which ESPN can continue growing.
  • Walt Disney had earlier indicated that its programming costs would come down significantly during the current quarter.
  • There does not seem to be any major ESPN risk at the moment which is good for Disney stock.

With the vast majority of Wall Street analysts harping relentlessly about ESPN cord cutting woes, anything mildly bullish about Walt Disney's (NYSE:DIS) giant Media Networks certainly comes across as a breath of fresh air. Omar Sheikh from Credit Suisse is one of the few analysts on the Street who think that ESPN worries are overdone. Omar Sheikh says that any deceleration at ESPN can be overcome by strength in Walt Disney’s other revenue segments as well as some defensive sports channel strategies by Disney. Sheikh:

“First, DIS can reduce the likely significant usage of shared passwords for WatchESPN, where probably several million users consume the content without paying for it. Second, DIS can use its rights portfolio to create an unbundled product either with niche content aimed at "super-fans"; or for a fuller bundle of content to serve the casual sports fan."

Sheikh argues that Disney can implement the two strategies on its own or choose to do it with third-party partners such as Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL) or Verizon (NYSE:VZ).

Many investors have tended to gloss over such opportunities and simply assume that ESPN has only one way to go: down. Apart from the opportunities highlighted by Sheikh, Disney has a couple of other tricks up its sleeve. For instance, the company has consistently been hiking its affiliate fees to offset growing programming costs. The increase has usually been big enough to more than offset the loss of revenue due to churn. Although ESPN now sports affiliate fees that is more than three times its closest competitors, the strength of the channel gives it room to continue increasing affiliate fees without any real danger of losing its channel partners.

During its Q1 FY16 earnings, Walt Disney’s Media Networks recorded 8% revenue growth to $6,332. The segment’s operating income, however, fell 6% Y/Y to $1,412M, the only segment to post a bottom line contraction. The decline in operating income was mainly orchestrated by the timing of College Football Playoff bowl games from the usual second quarter to the first quarter. Walt Disney had already warned investors about this during its fourth quarter earnings call:

Earlier, I mentioned that the six New Year's Eve and New Year's Day college football playoff bowl games will air in fiscal Q1 this year compared to fiscal Q2 last year. As a result, the costs associated with these games will shift into Q1, so we expect total cable programming and production costs to be up high-teens in Q1 and to be down high-teens in Q2.

In fiscal 2016, ESPN does not have any major new sports rights contracts kicking in, so we expect total cable programming and production costs to be up low to mid-single-digits for the year.

So investors should look forward to seeing a significant uptick in Media Networks' operating income during the current quarter due to lower cable programming and production costs. Disney says that ESPN does not have any major sports right contracts kicking in during 2016 and therefore, expects cable programming costs to remain subdued during the year.

Regarding Sheikh’s sentiments about Walt Disney’s other revenue segments compensating for a slowdown in ESPN growth, we saw that happening during the company’s last earnings call when the company reported 13.8% Y/Y growth in revenue to $15.24B and 28% growth in earnings to $1.63 thanks to the stellar performance by Star Wars: The Force Awakens which powered Disney’s Studio Entertainment segment to $2,721M, good for a healthy 46% Y/Y growth while operating income jumped 86% to $1,014M.

And now it’s beginning to look like Disney’s Studio Entertainment division will remain hot for the rest of the year. Walt Disney’s newly-released animation movie Zootopia has already set the record at Disney Animation Studio with an opening domestic gross of $73.7M thus besting Frozen’s previous record of $67.4M. Global gross takings hit $232.5M.

It looks like Disney movies are just red-hot. The massive success of Disney movies this year will soon begin to be felt in the company’s Theme Parks division as well as the Consumer Products and Entertainment segment. Walt Disney's toy partners such as Hasbro (NASDAQ:HAS) have already posted impressive revenue growth during their latest earnings call courtesy of The Force. Zootopia will only accelerate this momentum.

In the final analysis, ESPN is not bereft of growth opportunities as Wall Street and many investors tend to imagine. These fears have been ongoing for several years now yet Disney’s Media Networks has continued to grow albeit at a slower pace. And, it’s these worries that have primarily been holding back Disney stock. It will probably take several more quarters before investors become convinced that ESPN is not on its death bed.

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