- Part of Wall Street has continued sounding the alarm regarding Walt Disney's rising ESPN programming costs.
- The analysts contend that not even the stellar performance by The Force will be enough to counter these rising costs.
- How bad is the problem really?
Most Walt Disney (NYSE:DIS) investors are celebrating after Star Wars: The Force Awakens debuted during the weekend and set new box office records. Investors are expecting the movie to be a catalyst for Disney stock price. I discussed how The Force topped the previous record for opening weekend US takings set by Jurassic Park in 2009, but said that it had not broken the record for global takings in this article here. But that now has changed after analysts bumped up the figure for US gross takings by The Force from $238M to $248M, effectively meaning The Force has surpassed Jurassic Park on both US and global gross takings for the opening weekend, and now holds the record for both categories at $248M and $529M compared to Jurassic Park’s 208M and 524.9M. (Investors should keep an eye on those opening weekend figures since they have been bumped up twice in just a day and could still go higher).
But apparently not everybody is as starry-eyed about those killer results. Disney stock finished the day 1% lower after Jeffries’ John Janedis reiterated his Hold rating on Disney stock with a $112 price target (5% above current price). Interestingly, Mr. Janedis is fretting over the same thing that BTIG’s Rich Greenfield pointed as the reason he downgraded Disney stock last week: rising ESPN programming costs. Mr. Greenfield did not give investors the benefit of solid figures to help them visualize how bad the situation is, but luckily Mr. Janedis has done that in this piece of commentary:
"Step ups in ESPN's sports rights will be $750M in F17, followed by another $280M increase in F18.”
In my previous Disney article explained the problem of rising ESPN programming costs as something that is not new since programming costs have gradually risen from ~$3.0B in FY 2011 to ~$4.55B in FY 2015 (Disney’s FY 2015 ended in September 30), or a 52% increase over four years. ESPN programming costs have therefore grown at ~11% per annum.
Source: Wall Street Journal
Janedis has not talked about any increases in the Disney’s current fiscal years (FY 2016) so we presume costs will stay flat in the current fiscal year. I previously pointed out that Disney has been offsetting increasing ESPN programming costs by increasing its affiliate fees. Disney will increase its affiliate fees per subscriber per month from $6.82 during the last fiscal year to $7.20 in the current fiscal year.
AC Nielsen estimates that ESPN subscribers fell from 99 million in 2013 to 92 million in 2015. That works out to 3.6% annual decline. At this rate, ESPN subscribers will have fallen to 85.5M by 2017. Assuming Disney increases its affiliate fees by 10% again in 2017, then the company will recognize affiliate revenue of $8.13B in FY 2017 compared to $7.53B in FY 2015.
Meanwhile, Disney’s programming costs could rise from $4.55B in FY 2015 to $5.3B in FY 2017, according to Janedis. The net effect will be that ESPN’s affiliate fees will increase by $600M but will be accompanied by a $750M increase in programming costs, meaning ESPN’s operating income will fall by only 150M during the period.
Investors should remembers that we have not accounted for cable advertising revenue which makes up a significant part of ESPN revenue for Walt Disney.
Domestic cable affiliate revenue was up 17% in the quarter and up 8% excluding the benefit of the 53rd week. Ad revenue at ESPN was up 5% in the quarter. Two factors affected the comparability of ESPN's ad growth in the quarter, the 53rd week and the absence of the Men's World Cup. We estimate that ESPN's ad revenue was up 9% when you exclude the net impact of these two factors.
There is therefore a good chance that ESPN net revenue will actually continue growing over the next 2-year period even as programming costs keep rising and ESPN continues losing subscribers.
Can Stars Wars Offset Cable Weakness?
Ultimately Star Wars will be judged by investors on the basis of whether or not it’s able to offset the company’s weakness in cable. The Force is estimated to bring in net revenue of $9B (ticket sales + ancillaries) in 2016 alone, a record in the movie industry. But the good news for Disney investors is that the Walt Disney plans to release at least six years of annual sequels to the movie. This is great because the company has a very good track record when it comes to creating successful sequels. The six sequels might not reach the magnitude of success by The Force, but will likely not be far behind.
Ultimately I believe that The Force and other upcoming Star Wars sequels will be more than enough to offset rising ESPN programming costs and subscriber loss. This makes Disney stock a good long-term play.