By Reuben Gregg Brewer From Seeking Alpha

Summary

DIS rides on the back of ESPN.

But there’s something going on with ESPN that’s troubling.

Only it might be bigger than ESPN….

When most people think of Disney (NYSE:DIS), the image of a mouse comes to mind. But a football player might be a more appropriate image today. And that’s a big problem that could be getting bigger if recent trends in sports viewership prove to be more than a fluke.

The mouse house

Disney is, without a doubt, a house built by a mouse. And in that house lives a stable of iconic brands and images. The list includes Mickey Mouse and his fairyland pals, Marvel’s collection of super heroes, Star Wars, and… ESPN. Only one of these brands holds more sway than the others.

ESPN lives in Disney’s media network business unit, which is where the company’s ABC network and Disney cable channel also live. This division accounted for roughly 40% of revenues in the fiscal third quarter and through the first three quarters of the fiscal year. The $18 billion media networks brought in through the first three quarters was by far the largest contributor to the top line, followed by the company’s parks at roughly $12.6 billion.

Here’s the thing, these numbers get even more dramatic when you look at segment operating income, or basically how much each division contributes to the bottom line. The media network business accounted for just over 50% of the company’s operating income in the third quarter and just shy of that over the first three quarters of the fiscal year. In other words, the impact of the media networks business on the bottom line is even bigger than it is on the top line.

Which brings the story to sports. ESPN, Disney’s industry leading sports franchise, lives in the company’s cable network segment. It is, by far, the largest contributor to that business. And that business makes up roughly 70% of media networks’ revenues. Far more frightening, cable, led by ESPN, made up 85% of media networks’ operating income through the first three fiscal quarters and a full 90% in the fiscal third quarter. Basically, ESPN is really important to Disney’s financial health.

It’s doing well, right?

But here’s the thing, in the third quarter ESPN’s numbers were pretty good. The media networks saw revenue growth of 1%, which, according to the company, was, “…due to growth at ESPN, partially offset by a decrease at the Disney Channels, lower equity income from A&E and lower Freeform results.” So the rest of Disney’s media networks group was kind of soft, but ESPN held strong.

Or did it? Disney went on to explain, “The increase at ESPN was due to affiliate and advertising revenue growth, partially offset by higher programming costs. Affiliate revenue growth was due to contractual rate increases, partially offset by a decline in subscribers and an unfavorable impact from foreign currency translation.” The single most important thing to take away from that statement is the there has been a decline in subscribers. This isn’t a new issue, it’s been going on for a little bit now. And that’s the real problem that Disney faces.

There are a host of questions to ask before getting too upset. The first is how bad is the bleeding? The answer is not all that bad right now. Yes, ESPN is losing subscribers, but it still has enough to hold up the other segments of the media networks division. So the cash cow isn’t hemorrhaging. However, that doesn’t mean the company should ignore the problem.

The next question is what is Disney doing to fix this? The answer is that it’s investing in the future, most notably the investment in BAMTech that was announced at around the same time as third quarter earnings. BAMTech is baseball’s streaming division, which serves a number of big name customers with the technology to stream sporting events, including HBO. Disney is paying a billion dollars for a 33% stake, with the option to take a controlling interest in the future, assuming the investment works out.

BAMTech looks like a good move for Disney, since the technology gives it the ability to move from cable to internet delivery. Essentially, it addresses the cord cutter issue which appears to be at the heart of ESPN’s subscriber woes.

Bigger than a bread box

But what if the delivery method isn’t the only problem? What if the problem ESPN is facing isn’t just about how people consume sports, but with sports itself? That’s a third, more troubling question you should be asking yourself. And so far the answer doesn’t look so good.

For example, football saw viewership across all of its properties decline nearly 15% in September in its key demographic, 18 to 49 year olds. The big Sunday night game was off 12%, Monday was down 16%, and Thursday was off 15%. In other words, people just aren’t tuning in to football this year.

There are a number of things to help defend the decline. For example, a lot of football’s big names aren’t playing for various reasons. And then there’s the election this year, which has managed to make headlines like few others in recent history. So maybe this is a fluke, but maybe it isn’t…

It seems that 17% less people tuned in to watch the Olympics during prime time this year compared to the previous Olympics. And, by some estimates, viewership within the 18 to 49 age group was off by as much as 30%. Don’t forget that the Olympics included a nice headline grabbing scandal to help bring in the eyeballs. So, overall, it looks like people just weren’t as interested in this sports event as they had been in the past, either.

And that’s not the only other sports event that’s seeing declining viewership. Baseball’s All-Star Game, for example, has seen television viewership fall by around 50% since 1980. Although the World Series is the really big show in baseball, the fact that half as many people turn out to watch the sport’s best players compete head to head is telling. And what it says is people just don’t care about baseball as much as they once did.

But if that’s the case, then maybe people don’t care about the Olympics as they once did and that sports malaise could be encroaching on football, too. Which means that the whole premise behind ESPN, the largest sports focused network around, could be heading for a secular decline. That would be a big problem for Disney.

Time is on our side

There are a few positives here, though. For example, this could simply turn out to be a temporary lull. Moreover, these are slow moving shifts, no one is falling off of a cliff… at least not yet. But that doesn’t mean investors can ignore the outsize impact a shift away from sports would have on Disney’s top and bottom lines. To its credit, the company is trying to shift with the times to provide content to customers where and how they want to view it (BAMTech). However, if the problem is bigger than that, Disney could be in for a rough ride–there’s nothing it can do to fix ESPN if sports is the real problem.

If you own Disney, keep a close eye on ESPN. It’s a cash cow that Disney doesn’t want to see die. But that doesn’t mean it won’t.

Disclosure: I am/we are long DIS.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

For more on this story go to: http://seekingalpha.com/article/4012856-disney-sports-story-starting-falter? 

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