Anyone who has read my work lately knows that I have been increasingly bearish on ESPN and the traditional cable bundle, and thus by extension on Disney (NYSE:DIS) as a whole since ESPN is the largest share of its earnings. Disney says ESPN's subscriber losses are slowing, down to 2M in FY2016 from 3M the year before, and 4M the year before that. But that does not include Disney's massive loss in October subscribers, so losses may be accelerating again.
I will not rehash the old debate again, at least not today. I say Disney is in trouble, others say it's doing fine. But if I'm right, how play the long side of this equation?
Four years ago, I came across this Deadline article concerning the economic value of the various major content companies in American Pay-TV. I am well aware a lot has changed in the last four years. I don't offer the article as a perfect snapshot of today's market. Nevertheless, while its specific numbers are probably long out of date, there is still something valuable we can take away from it.
The article itself was merely a summary of work done by analyst Barton Crockett. Crockett had just done a major survey of pay-TV customers to find out how much they valued the various channels in the cable bundle. Nothing special there, there have been literally hundreds of such surveys, both before and after Netflix (NASDAQ:NFLX) came along.
The interesting thing about Crockett's work was what he did next. Most surveys stopped there. How much do you like each channel and what would you be willing to pay for it? Crockett went further and asked two additional questions. First, he asked, in the existing bundle system, what channels absence would cause you to cancel your whole Pay-TV service? That is, how much would the absence of each channel reduce total bundle membership? From this he extrapolated a brand value for each channel, and by grouping channels by owner he extrapolated one for each content company.
Second, he also asked those channels themselves how much affiliate fees they got from the existing bundle system. And finally, he divided the existing Pay-TV cash flows by the "loyalty share" of each content company to calculate whether they were overpaid or underpaid by the existing system. He excluded premium channels since, as add-ons, they were already in a sort of ala carte system.
Better Off Alone
The results were more than a little astonishing. It quickly became clear that Crockett's most important takeaway was not the specifics of exactly how well or poorly each company would do if the bundle went away. The most important finding was the imbalance between winners and losers in the current system. In surveying consumers about their desire to pay for the various pieces of eleven major content companies, he found only three companies which would lose out in an ala carte system: Disney was the big one, as we would all expect. TimeWarner (NYSE:TWX) and 20th Century Fox (NASDAQ:FOX) were also on the short end, although their losses were projected to be less than half of what Disney's were.
The other eight companies all achieved various degrees of benefit under an ala carte system. Viacom's (NASDAQ:VIAB) (NYSE:VIA) benefit was the smallest, as it only barely broke above even. But even that is rather significant. Viacom is one of the purest cable channel plays out there, a company one would expect to have a lot invested in the success of the existing bundle. And yet since it lacks both a broadcasting powerhouse and sports content - unlike Disney - it has been forced to accept so many sub-par payment deals that it is now more or less indifferent to the bundle's fate.
Meanwhile other, more focused cable companies like A+E Networks, Discovery Communications (NASDAQ:DISCA) and Scripps Networks (NYSE:SNI) all fare substantially better under an ala carte system. Crockett's numbers four years ago actually showed that their earnings could increase as much as 150%! Nor was that the biggest number. CBS (NYSE:CBS) was the biggest winner of all even before counting whatever gains Showtime might get, with the non-premium company segment alone projected to raise earnings 400%!
AMC Networks (NASDAQ:AMCX) had to settle for a meager 80% boost. Even NBCUniversal was projected to gain 66%. Of course, being owned by Comcast (NASDAQ:CMCSA) might cause some issues with getting NBCUniversal execs on board with ala carte - in fact that was one of the reasons consumer groups cited to try to block the merger - but so far Comcast has played nice with Internet based TV groups, as its consent order from the FCC requires it to.
How Dated Is This?
Sadly, no one else has done a similar survey since, at least as far as I can tell. Various companies do run quarterly surveys of consumer willingness to purchase various channels ala carte. But as I have pointed out before, those surveys often distort results by failing to incorporate into their questions the pricing differentials between the various channels. Lining up ESPN and A+E and simply asking which one consumers prefer is a somewhat slanted question, since one would cost $15 or more a month in an ala carte system and the other would cost only $1. Crockett's work actually incorporated pricing differentials.
There is also at least some evidence that Crockett's work might not be so out of date. AT&T (NYSE:T) just recently launched their new DIRECTV Now service, a new digital TV service offering a traditional linear package of TV channels. The service is one of if not the most comprehensive available, with almost every major content provider included. CBS, however, is reportedly the only network to refuse to join, suggesting that it still thinks it is uniquely disadvantaged by the traditional bundle scheme relative to its content's value. Like Viacom, CBS doesn't really have a sports-focused cable channel, although its flagship broadcast channel does show a lot of sports including the NFL and the NCAA. Nevertheless, they seem to feel that their content is being underpaid to prop up ESPN's expensive sports contracts - and Crockett's work suggests that they're right.
I have researched over the past few days the earnings reports of the other content companies. While some do show real growth, not a single one shows the kind of explosive earnings growth to suggest that the gross disparities Crockett identified in their compensation has been addressed in any substantial part. For CBS, for example, the biggest victim of the current system, even now advertising remains the single biggest revenue category for the whole company. That is followed by syndication and distribution. Subscription fees are the smallest category, compared to ESPN where subscription fees are 80% of revenue. Perhaps this is why CBS has been the first to launch an independent streaming service, CBS All Access, to monetize this content more effectively. It thinks it can get a better deal without having to carry ESPN. I wouldn't be surprised if Crockett's numbers are more or less accurate still today.
Despite the somewhat dated data, I believe Crockett's work might still be the best guide available to how to play the long side of the cable bundle's demise. CBS is a clear favorite here, with maybe Discovery and Scripps as other candidates although they have less than half the upside of CBS according to Crockett. I would not invest in Comcast, as I expect that the boost to NBCUniversal will be more than offset by the hit to its core cable business.
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.