The Threat To Disney's Profit Train Is Sports

| About: The Walt (DIS)

Want to know the real reason Disney (NYSE:DIS) paid $4 billion for Lucasfilm in the hope it can turn the Star Wars franchise into more hits?

It's because there's a cash cow in the back called ESPN. And the cow is about to get thinner.

The earnings warning on the cash cow may be motivating a speculative move on the part of Disney that may or may not pay off. The stock currently remains below the price it was at when the Lucasfilm deal was announced, over fear of earnings dilution on an $86 billion market cap.

I think the LucasFilm deal will pay off big for Disney, but I do think some caution is justified on earnings going forward because of risks to the sports franchise. I'll discuss them below. See whether or not you agree.

ESPN isn't just a single channel any more. There's ESPN2, ESPNews, ESPNClassic, and ESPNU. Each gets valuable cable real estate. And there's ESPN3, an Internet-only "channel" that charges ISPs $5/month per subscriber for access permission. All these sources of cash flow have let ESPN become the big dog in acquiring sports rights around the globe.

But the industry is on to the game, and it's getting into it. Fox (NASDAQ:NWS) has cobbled together its own collection of regional channels under the Fox name, and is competing for rights. Comcast's (NASDAQ:CMCSA) NBC Universal unit has turned the former OLN - previously home to bicycling and rodeo - into the NBC Sports channel and just bought exclusive U.S. rights to the English Premier League for an eye-popping $250 million. Even CBS (NYSE:CBS) has its own sports-only channel, which it has been using to go after collegiate leagues.

How "bad" is it? I went to Rice University, not a hotbed of sports then or now. (But I think our chemistry department can beat up your chemistry department.) Their football team barely draws a congregation to its old stadium, let alone a crowd, and its league, called Conference USA, has become a laggard. Yet I saw almost all their games this year (or I could have - some were truly execrable) on basic cable, mostly through Fox and CBS. (They wound up going 6-6 and they're headed for a minor bowl game.)

Point is, cable programmers are bidding heavily on all sorts of things, and showing them to people, even games few can be expected to see.

How bad is this for Disney and ESPN? In addition to its U.S. challengers, the network will also have to compete for rights with Al Jazeera, which has launched its own sports channels, called BE IN, recently. If you wanted to see the U.S. Mens' fight back against Antigua a few months ago, you were out of luck unless your cable channel had BE IN.

All this points to margin compression for ESPN, and less earnings growth for DIS, unless a way can be found to improve results elsewhere. Hence Lucasfilm, which is a fairly speculative play. But it's one the company had to make.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.