ESPN is Disney’s (NYSE:DIS) flagship channel and constitutes close to 40% of the company’s value. This implies that its business is worth around $40 billion based on our estimated $102 billion valuation estimate for Disney. How does ESPN generate so much value?
We estimate that the network brought 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 is the case for many of the big cable networks. However, ESPN’s true value lies in the high fee per subscriber that it charges for its sports programming. This amount has increased from an estimated $3.65 in 2008 to $5.05 in 2012. The historical growth has resulted from multi-year programming contracts that specify annual fee increase, sustained high demand for sports programming, rising sports programming costs and ESPN’s market leading position. Going forward, growth in the subscription fee is likely to slow due to pressure from pay-TV service providers and expected competition from NBC and Fox, who are planning to launch nationwide sports networks to compete with ESPN.
High Demand & Costs For Sports Programming
ESPN charges a high fee per subscriber by tapping the demand for sports programming in the U.S. This demand is evident from the fact that other sports networks such as Fox Sports are also able to charge substantially higher fee per subscriber as compared to the regular cable networks such as Nickelodeon, MTV, TNT, TBS and The Disney Channel. According to Nielsen, after staying stable for a while, the proportion of prime time audience watching sports programming has increased substantially in the past few years. The chart below demonstrates that from 9.4% for 2008-09 season, the figure went up to 19.4% for 2009-10 season, and further increased to 20% for 2010-11 season. ESPN will benefit from this trend, and will be able to sustain growth in its fee per subscriber, despite the fact that it is already quite high.
However, the growing demand for sports programming is not the sole reason why ESPN charges a higher fee. The sports programming costs are also high and rising. In order to cover these costs and yet maintain healthy margins of close to 45%, the network has to charge a fee of more than $5 per subscriber.
At the end of 2011, the NFL was in the process of negotiating new agreements with various broadcast networks that would increase their costs by as much as 60%.  The sports programming costs are likely to continue to increase in the future, and ESPN will need to increase its subscription fee in order to avoid taking a hit on its margins.
Multi-Year Agreements & Historical Trends Suggest Future Growth
Cable networks have shown robust and sustained growth across the industry and ESPN is no different. Like other cable networks, ESPN enters into multi-year agreements with pay-TV service providers such as Comcast (NASDAQ:CMCSA), DirecTV (NASDAQ:DTV) and others. Such agreements specify an annual increase in subscription fee, therefore guaranteeing future revenue growth even if the subscriber base remains stagnant. ESPN’s fee per subscriber has grown at an average annual rate of 9% over the past five years, implying an average annual increase of 36 cents per subscriber.
However, for the next six to seven years, we have assumed the average annual increase to be half of this at around 18 cents per subscriber. We feel that the competition from rival networks and pressure from pay-TV service providers will not allow the historical growth rate to continue.
Competition From NBC And Fox, And Pressure From Pay-TV Companies Could Weigh On ESPN’s Future Growth
ESPN’s success has encouraged other media companies to make a significant push into sports programming. It is going to be hard for the competitors to emulate ESPN’s success, given that it has bagged long term rights for many major sporting events. However, there will be good competition for the second spot.
Fox and NBC are vying for this this position. News Corp’s (NASDAQ:NWS) Fox Sports is a regional sports network. Regional sports networks are involved in broadcasting college and professional sports of local teams on regional level, and in addition to Fox, NBC is another major player. Both Fox and NBC are also trying to get ahead in the race to build a national sports network to compete with ESPN. However, given that NBC was able to bag rights for Olympics and recently outbid Fox for English Premier League Soccer, it appears that Fox is lagging behind.  Recently, Fox also announced that it is getting close to launching a national sports network, which may help its sports ambitions.
The essence is that ESPN will find itself in the company of rivals who will bid against it, and potentially acquire programming rights to some of the most watched sporting events. ESPN’s appeal could diminish and so will its ability to increase the fee per subscriber as customers might look for alternative options in Fox and NBC.
In addition to this, pay-TV subscribers are getting increasingly strict about controlling the rising programming costs. ESPN is currently bundled in almost every pay-TV package, but some of the cable operators are contemplating dropping ESPN from some low-tiered programming packages. ESPN will need to balance its subscription fee growth against the possibility of a declining subscriber base due to the efforts of the pay-TV service providers.
The Significance For Disney
We estimate that ESPN constitutes close to 40% of Disney’s value. A notable portion of this is dependent on the growth in ESPN’s subscription fee. If ESPN maintains its market leadership and continues to increase its subscription fee at the historical rate of 35-38 cents per subscriber, there could be more than 5% upside to our price estimate for Disney.
We believe that the downside risks yet are less likely as our forecast is already conservative, keeping in mind the factors that can mitigate the growth.
Our price estimate for Disney stands at $56.50, roughly in line with the market price.Notes:
- Cable-TV Honchos Cry Foul Over Soaring Cost of ESPN, The Wall Street Journal, Dec 6 2011 [↩]
- NBC wins $250m rights to broadcast English Premier League in US, Oct 19 2012 [↩]