The Case For Disney Dumping ESPN

Subscribers are in free fall, costs are skyrocketing, and pro sports leagues are at risk of losing a huge revenue stream

Illustration: Tara Jacoby
Dec 07, 2016 at 11:34 AM ET

The chorus of financial analysts calling on Disney to spin off ESPN and its other media network properties is growing. On Monday, RBC Capital Markets analyst Steven Cahall joined up by attributing Disney’s lagging stock price to ESPN’s mortally wounded business model, a common charge that’s led to a rash of financial firms downgrading Disney’s stock over the last year.

While Disney’s movie studios and theme parks have boomed ever since the company acquired Marvel Entertainment and LucasFilm LTD in 2009 and 2012, respectively, ESPN has been hemorrhaging millions of subscribers over the same time period. Given that the synergies between the two businesses seem limited at best, analysts and shareholders alike are wondering aloud why Disney is still keeping the self-proclaimed worldwide leader in sports around.

One of the more thorough cases for dumping ESPN came in September from The Edge, a financial firm that specializes in spinoffs, which outlined the network’s two primary issues: falling subscribers and the rising cost to secure broadcasting rights for pro and college sports games.

ESPN’s primary revenue stream is the subscriber affiliate fee it charges viewers for each of its channels. Because cable companies offer channels in bundles, millions of people are forced to pay for ESPN even if they don’t watch it. But with streaming services like Netflix disrupting the cable industry, people have either downgraded to “skinny bundles” that don’t include ESPN or they’ve dumped their cable TV subscriptions all together. The result is that ESPN has lost more than 11 million subscribers in five years, according to Nielsen, and the rate at which it’s losing subscribers is accelerating.

ESPN has countered its loss in subscribers by raising its industry-high affiliate fee, which has kept revenue steady even as the channel has shed subscribers, but as The Edge notes, this is a short-term fix that’s likely not even sustainable in the medium term.

With live sports still being seen as the one sure bet in television, the cost to secure broadcasting rights to pro and college sports games has ballooned, a problem that’s exacerbated for ESPN by the entry of FS1 and NBCSN. A Vocativ analysis earlier this year estimated that ESPN paid $2.8 billion for broadcasting rights in 2012 and $5.5 billion in 2016, almost double in just four years.

The short version of ESPN’s problem: Fewer subscribers means less subscriber revenue. Fewer subscribers means less advertising revenue. Higher costs means less profit and less profit makes for unhappy shareholders, which is why even Liberty Media’s John Malone, a media tycoon who’s helped shape the industry for decades, is predicting that Disney will ultimately part ways with ESPN.

“If I had to guess, what you will see is a split of Disney with ESPN spun off and, probably, ESPN could be owned and protected by a distributor in the US,” Malone told CNBC in November.

But ESPN’s problems don’t just affect Disney. Pro and college sports leagues who depend on cable networks to buy broadcasting rights and air games will take a hit, too, as The Edge points out in a section of their report called “Ballooning sports rights cost–a bubble waiting to pop?”

“We view the entire sporting value chain to be at risk,” The Edge writes. “As viewers stop paying for ever-increasing cable rates, carrier companies would no longer be able to afford buying broadcast rights from big sports channels such as ESPN, which in turn would put pressure on per subscriber affiliate fee of ESPN, a double whammy for the company as its subscriber base is shrinking. This would affect sport organizers such as NFL’s ability to hike fees, something they have been doing over the past decades, thereby impacting sport team revenues and player salaries.”

How exposed your favorite sport is to this risk depends on how much it relies on cable networks to air games and collect revenue, and the most exposed sports may be college football and basketball, particularly second-tier college conferences that have organized around the sole purpose of sucking money out of ESPN et al. When that money goes away, so too might the football program at Yee Haw State University in Nowheresville, Red State. If the effects aren’t that dramatic, it might at least keep more than a few coaches from becoming multimillionaires.

Once that money is gone, it’s probably not coming back. Cable TV’s channel bundle that ESPN got fat on is fragmenting into numerous standalone streaming services. In hopes of launching a standalone streaming service for ESPN, Disney acquired a stake in BAMTech, a joint venture that launched streaming services for MLB and the NHL.

A standalone service might help stall ESPN’s bleeding, but as newspapers that try to sell digital subscriptions can tell you, the streaming service is unlikely to match what ESPN was getting prior to the collapse of the cable TV model. As The Edge notes, that service will have to cost much more than ESPN was charging in the cable bundle. MoffettNathanson estimates the service would have to cost $36.30 per month. Meanwhile, a Beta Research survey indicated viewers valued an ESPN streaming service at $1.45. Have fun bridging that gap.

If Disney does spinoff ESPN, what happens next is anyone’s guess. Might it exist as a standalone company? Would an existing media company such as Time Warner buy ESPN in hopes of creating some sort of streaming bundle? Would Netflix or Amazon buy ESPN as a way of breaking into live events? Would a social media platform such as Facebook or Twitter want to double down on streaming video by buying ESPN? The answer is a huge unknown, but Disney seems to be in a spot where figuring it out makes the most sense for the company’s future.