Even a cursory glance at Disney's (DIS) latest earnings report from a novice can see a company hitting on all cylinders right now. Total revenue was up 4% year over year, with net income up 24% translating to $1.01 per share, up 31%, in the 2nd quarter of 2012. This occurred in what was a challenging quarter for much of the entertainment industry. The latest estimates hold that content distributors, from cable to satellite, lost as many as 450,000 subscribers in the 2nd quarter ending June 30th, which would be the worst quarter, even for the normally difficult 2nd quarter, in the industry's history. It represents a drop of 0.5% overall.
The worrying thing for cable companies has to be that the demographic they most want to capture; 18-34 year old males are the ones making the decisions to not pay. 25% unemployment in that age bracket is finally taking its toll on the industry. They simply cannot afford a $100+ entertainment bill without a job or are back living with their parents.
Total Domination in Sports
That Disney's revenue in their Media Networks division posted a rise in revenue of 3% in an environment wherein subscribers dropped that much is a testament to their quality of their media brands, specifically ESPN and The Disney Channel. ESPN is, by far, the most expensive service in cable and they account for 45% of Disney's total revenues. Ratings for both properties are still strong enough to give Disney pricing leverage for subscription fees, and ESPN is charging $5.15 per household, up from $4.69 last year, a 10% increase. And that's just for the so-called MotherShip. To that $5.15 tack on a few more dollar s for ESPN2, ESPNNews, ESPN Soft Focus Classic, etc.
And most people don't watch ESPN, so, Disney's revenue per viewer is likely somewhere between 8-10 times that. And we wonder why there is no a la carte cable in the U.S.?
But ESPN can get away with it, for while the rest of cable ad rates are slouching slowly towards oblivion, ESPN's rose 15%, though total operating revenue as flat for the quarter. Scheduled TV has been on the decline for years and the only real draw left is content which is improved by watching it live, namely sports. Creative content is too risky and advertisers have been refusing to support a model that cannot reliably draw eyeballs anymore. Only sports still has that allure, because sporting events have to be scheduled, by their nature and it is the unknown of the story to be told that makes drives people to their flat-screen TVs.
The Fight to Show ESPN
ESPN is something that Apple (AAPL) is looking to get a piece of to help sell Apple TVs and which Microsoft (MSFT) already serves up for their Xbox Live subscribers, as long as they are cable subscribers. But, the current set up is small potatoes compared to the big issue, namely the breakdown of the MVPD (Multi-Channel Video Programming Distributor) rules in force by the FCC, which prohibits platforms like Apple TV or Roku to carry specific channels because they do not qualify as an MVPD and therefore cannot get competitive pricing.
The threat to cable operators that internet streaming platforms like Apple TV and Xbox live represent are obvious and the outcome inevitable. The wire coming to your house is just a big IP pipeline and it doesn't matter what device it terminates into: a set-top cable box, DSL modem or $60 router from Amazon. The cable companies are not content to sell just bandwidth, but want to charge for the content distribution as well, but that's where this is all headed eventually. The MVPD rules keep the status quo in place and the ESPN subscriber fees flowing to Disney.
Future Content Shock
Apple is playing coy about getting into the TV hardware business because they know that with this rule still in place they have nothing compelling to offer until the content creation system becomes more atomized and companies like Disney have to compete with 1000 small houses focused on producing niche content that isn't sold through the cable networks. Netflix (NASDAQ:NFLX) is attempting to break the MVPD-enforced barricade by going into content creation directly. First they are trying to resurrect cancelled TV shows, with season 4 of Arrested Development going into production last month for a spring release. If successful and capable of driving new subscriptions to their services this would serve as the beginning of a new era. So, for Apple, the choice is becoming clear: either join Netflix in becoming a content creator directly or wait for the regulatory scheme to collapse under the weight of ESPN's insane revenues in a grinding stagflationary recession.
For Disney it would require a shift in distribution model but it shouldn't affect their future plans. If the Disney channel is the highest rated kid's network on cable why wouldn't Disney be able to sell a la carte subscriptions to it through Xbox live or Apple TV? It is the staggering revenues generated by ESPN that continues to keep this industry from evolving a new pricing model. If another 450,000 drop their cable subs for a mobile data package in this quarter the future will be clear.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.