We previously mentioned that during Disney‘s (NYSE:DIS) Q1 fiscal 2013 earnings announcement, the focus will be on the impact of rating pressures on media networks against the growth in licensing and affiliate fees. While media networks such as ABC and ESPN were affected by softer ratings, the growth in affiliate fee and ad pricing more than made up for it. Overall, Disney’s media networks revenues increased by 7% in Q1 fiscal 2013 compared to the same period a year ago.  The growth was not just concentrated within cable networks, which has usually been the case in recent times, but also encompassed Disney’s broadcasting business.
On the other hand, revenues and EBITDA (earnings before interest, taxes, depreciation and amortization) were down for Disney’s filmed entertainment unit. But that’s fine given that this business constitutes just about 10% to Disney’s value. As far as parks & resorts business is concerned, the revenues and EBITDA were higher driven by better per capita guest spending and healthy attendance. This business is benefiting from gradual improvement in the U.S. economy.
Let’s turn our attention back to media networks which constitute roughly 70% of Disney’s value.
Affiliate & Licensing Fee Growth With Ratings Pressure
The growth in media networks revenues can be primarily attributed to the growth in the affiliate fee, which increased by 9% in the quarter.  On the other hand, advertising revenues grew by just 2%.  The media networks business can be divided into two parts – cable networks and broadcasting.
The cable networks business is primarily dominated by ESPN, followed by Disney Channel and others. Accounting for the first quarter of fiscal 2013, we estimate that ESPN will bring close to $11 billion in revenues for Disney in 2012. These include revenues from primary ESPN channel as well as its other sister channels such as ESPN2, ESPNU, ESPNEWS, ESPN Classic and ESPN Deportes. ESPN has close to 100 million subscribers in the U.S., which speaks of the huge demand as well as bundling strategies that pay-TV service providers adopt.
The bulk of the affiliate fee growth can be attributed to contractual rate increases across Disney’s cablel networks, especially ESPN. The network is still dominant in sports programming with several long-term contracts for major sporting events. As a result, it is able to negotiate a healthy annual growth in carriage fees. That said, ESPN has been facing some ratings pressure recently, which is weighing on ad growth. We believe the decline in ESPN’s ratings can be attributed to Summer Olympics, which was broadcasted on NBC and garnered high viewership. However, Disney’s management has stated that ESPN has seen a good rebound in ratings for Q2 fiscal 2013 so far.
As far as broadcasting business is concerned, the ad revenues grew driven by increased political ad spending and rate increases, partially offset by lower ratings.
What Happens Next?
Disney will continue to depend heavily on ESPN for foreseeable future. We believe that ESPN’s business is more or less stable in the near term. Although there is growing competition from NBC and Fox, they can not challenge ESPN unless they outbid the network for sporting events rights. For that to happen, ESPN’s contracts have to expire.
Therefore, in near to medium term, Disney’s revenue growth is secure in our view. Additionally, there is ample scope of international expansion given the right content and marketing. Sports programming is gaining popularity all over the world and Disney has opportunity to syndicate more shows internationally. To do this well the company will need to keep its programming costs in check in order to maintain margins. Sports programming costs rose in the recently concluded quarter driving down Disney’s cable networks EBITDA. The company can not simply pass on the increased costs to its customers due to long-term contracts that are negotiated in advance as well as the fact that the pay-TV companies are becoming increasingly resistant to carriage fee hikes.
There exists a risk that a shift to DVR viewing, change in Nielsen’s rating measurement and change in viewing habits will affect live primetime viewership. As entertainment options grow, viewers are likely to spread their leisure time across different devices and services and that might continue to put pressure on ratings. Disney has done well with ESPN and the Disney Channel and can mitigate ratings pressure with growth in fee per subscriber, increased licensing of content, syndication to international markets and more investment in programming, which will result in a virtuous cycle.
We are in process of updating our price estimate for Disney in light of recent earnings.
Our price estimate for Disney stands at $54.60, roughly in line with the market price.Notes: