On Tuesday, cable channels showcased their commercial viability during "Upfront Week," a time when cable networks receive half of their advertising sales commitments for the year. For ESPN (NYSE:DIS), this year proved to be less rewarding than years past when ESPN dominated these showcases. Falling subscription numbers, millennials moving away from cable services, and the rise of alternative sports news services has ESPN and ad buyers worried, though the Disney subsidiary remains a powerful force.
ESPN's presentation focused on what good could be found among the news, emphasizing a continued ability to dominate live sports. It noted that viewers from the WatchESPN application will be counted starting in 2017 numbers, helping to curb concerns about decreases in overall viewership. ESPN also reported a 74% year-to-year increase in online viewing of its embattled signature offering, SportsCenter.
However, ESPN subscribers are still down 7 million over the last two years including 3 million last year, bringing the network's total down to 92 million at year end. This is equally troubling for ESPN's parent company, Disney, as ESPN is a crucial component to the success of its $6.8 billion cable division.
Fox Sports reported in 2015 that ESPN charged a subscription fee to cable companies of $6.61 a month, which it collects on over 90 million subscribers. Despite this seemingly large amount of income, the network continues to lose steam, as the variable gain from each additional subscriber is becoming increasingly small compared to the skyrocketing fixed costs of exclusive television deals for various sports, conferences, leagues and tournaments. This is even more alarming considering subscriber fees are almost double the revenue generated from advertising at ESPN. The continuing drop in subscribers have an outsized impact on ESPN's (and Disney's) bottom line. The effect from this can be seen in the shareholder return of Disney, which has dropped in the last year. On May 14, 2015 the shareholder return from a January 3, 2012 investment was at 198.7% while on May 16, 2016 Disney closed at 176.04%. In Exhibit 1 you can see how different this is than the few years of steady growth prior to 2015.
Exhibit: Total Shareholder Return Disney
Source: Enlight Research
A question always swirling around ESPN is if and when they will go "over the top directly to consumers like HBO and CBS have done," according to Bloomberg analyst Paul Sweeney. Sweeney believes this hasn't happened yet because Disney has decided they have more to lose by leaving the traditional cable bundle than other television providers - largely because by leaving they could destroy the concept of the "cable bundle" of which Disney has several other major channels. There is likely concern that even if ESPN could support its own standalone user base, Disney's other channels could not, ultimately hurting its bottom line more than helping. Disney CEO Bob Iger has consistently said there are no plans for ESPN to go "over the top," and at Upfront Week, ESPN Inc. President John Skipper "offered only an emphatic and decisive 'no'" in regards to this alternative option.
As a way to fight back against continuing subscriber loss, ESPN formally announced two new initiatives yesterday, both online platforms. The first is Live Connect, a way for advertisers to deliver focused banner ads on the ESPN website using data gained from fan-use of the site. It also launched "The Undefeated," a sports-content site focused on African-American perspectives. While digital advertising has a long way to go to compete with subscription and advertising revenue from television, it could help provide ESPN a stronger base for additional shifts to online streaming.
This is in stark contrast to ESPN's current foray into the world outside of cable television, WatchESPN. As WatchESPN still requires a cable subscription, it really only serves as a way for existing customers to watch their same cable subscription beyond the couch, resulting in no real addition to ESPN's current subscriber numbers. Nevertheless, ESPN will be including WatchESPN subscriber numbers in its 2017 reporting, and it will be interesting to see how their inclusion shapes the network's Nielsen data. It will also be interesting to see how ad buyers receive and act upon ESPN's presentation at Upfront, and how the network's new platform and targeted advertising service influence digital advertising revenue.
Those are all side items to the main issue of ESPN's profitability, though. The real question is how the network will contend with decreasing subscriber numbers in a world of increasing fixed costs for distribution contracts? Will we ever see a standalone ESPN subscription service? Perhaps the increasing popularity of skinny bundles, such as the cheaper-than-traditional cable Sling Television service (which already includes ESPN) will provide Disney an opportunity to release ESPN from its reliance on traditional cable subscribers while still maintaining its hardline stance against "over the top" programming.
Though faced with challenges, ESPN is staying innovative and producing quality content while retaining a dominant position in live sports entertainment. With the level of importance ESPN plays into Disney's success, this will be an intriguing dynamic to watch going forward.
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Research support by Enlight analyst Davis Fussell.
Disclosure: I/we 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.