Disney’s ESPN Will Continue Its Growth Trajectory Despite Subscriber Losses

Disney’s (NYSE:DIS) ESPN is planning to cut around 350 jobs amid subscriber losses and rising programming costs. ^[1] The network has been able to grow its subscription fees in the past few years but has seen subscriber losses, primarily due to higher bundle costs. ESPN is a very important segment for Disney, accounting for around 30% of Disney’s stock value, in our view. The network has been spending heavily to acquire programming rights and has periodically passed on some of the increased costs to pay-TV operators. This, in turn, has led to higher bundle costs and many subscribers have left the network, trimming ESPN’s subscriber base. Nevertheless, its ratings have remained high in the recent past, which, in turn, has boosted its advertising revenues. However, subscription revenues are a more stable source of income as compared to advertising, which can sometimes be fickle to anticipate given the reliance on television ratings. This is one of the reasons why Disney’s stock plunged after its Q2 earnings conference call in August, where it stated that its cable networks won’t meet company forecasts as a result of subscriber losses and currency issues. On that note, we discuss below the trends at ESPN, our forecasts and factors that will drive growth for the sports giant.

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ESPN Has Lost 5 Million Subscribers Since 2010

EPSN’s subscriber base has contracted from around 100 million subscribers in 2010 to 95 million in 2014. ^[2] As such, the network’s penetration among U.S. pay-TV households has dropped from over 95% to around 89% during the same period. This can be attributed to a combination of increased bundle prices and growth of digital video platforms. While higher bundle pricing has led many subscribers to drop ESPN (also referred to as cord shaving), the rise of digital platforms such as Hulu and Netflix have encouraged cord cutting. This is evident from a recent study that indicated that the number of cord cutters in North America is growing. Last year, over 8% of pay-TV subscribers decided to drop their connections. Also, 45% of the pay-TV subscribers reduced their services (cord shaving) during the same period. ^[3]

We believe this trend is likely to continue in the coming years and expect the network’s penetration among U.S. pay-TV households to come down to 85%, resulting in a subscriber base of around 97 million by the end of our forecast period (towards 2022). We expect a decrease in penetration due to rising sports programming fees, which might prompt pay-TV companies to drop ESPN from lower-priced programming packages. Furthermore, the rise of alternative video platforms, such as Netflix and Hulu, are encouraging customers to cut the cord. Having said that, demand for ESPN will not allow any significant decrease in its penetration.

ESPN Has Still Managed To Grow Its Subscription Fees

Despite the subscription losses, ESPN has managed to pass on some of the increased costs to pay-TV operators. Monthly subscription fee has increased from $4.40 in 2010 to $6.05 in 2014, according to our estimates. This is also the reason why subscription revenues have grown from $5.25 billion to over $7 billion during the same period. We expect this trajectory to continue in the coming years and estimate subscription fees to be around $9 towards the end of our forecast period. This will translate into subscription revenues of over $10 billion by 2022. We expect an increase in subscriber fees due to rising costs and demand for ESPN. Although ESPN accounts for a big portion of sports programming fees for pay-TV providers, these costs have been rising across the board leading to fee increases. Also, there is immense demand for sports programming and ESPN has acquired long-term rights for most of the popular sports programming. In fact, ESPN has committed to $44 billion in programming rights second only to 21st Century Fox’s $48.6 billion commitments. ^[1] Accordingly, it should be able to continue to increase its subscription prices in the coming years.

Ad Revenues Has Seen Steady Growth And Is Likely To Continue This Trajectory

ESPN’s ad revenues have grown from $2.75 billion in 2010 to $3.8 billion in calendar year 2014. ESPN’s effective ad pricing has contributed to this growth. Advertising can be linked to television ratings and it has been doing well for the network in the recent past. Looking at 2014 ratings, ESPN was the most watched cable network, with a 3% uptick in ratings in 18-49 demographics, and this led to a 5% jump in advertising revenues. ^[4] Overall sports viewership is growing and this is great news for ESPN. The network has been the leader in sports programming and will remain so for the foreseeable future, given that it has renewed most of its programming deals for the long term, including NFL. Accordingly, we estimate advertising revenues to continue to grow to over $5 billion by 2022. This translates into revenues of over $15 billion for ESPN and an estimated EBITDA margin of 47% will translate into EBITDA of around $7.4 billion. It must be noted that this is just the ESPN network. The contribution will be even higher if we include ESPN’s sister channels, including ESPN2.

Overall, we acknowledge that ESPN’s subscriber base has declined, but at the same time we believe that demand for sports programming will drive ESPN’s growth in the coming years. This growth will not only come from increased subscriber fees but also from increased viewership, which will boost the network’s advertising revenues. The network’s EBITDA margins are on the higher side and it should be able to maintain them given the appeal of its programming. Having said that, we do expect a slight decline in penetration levels among U.S. pay-TV households, but any significant decline is unlikely.

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1. Disney’s ESPN Said Planning to Eliminate as Many as 350 Jobs, Bloomberg, Oct 21, 2015 [↩] [↩]
2. Disney’s SEC Filings [↩]
3. New Study Shows A Rise In Cord Cutting – 8.2 Percent Ditched Pay TV In 2014, Up 1.3% YoY, Tech Crunch, Jun 23, 2015 [↩]
4. ESPN No. 1 in Cable Ratings for 2014, Variety, Jan 2, 2015 [↩]