ESPN Can't Stop Bleeding Subscribers

By Markets Fool.com


Image source: Rob Poetsch on Flickr.

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ESPN might be the worldwide leader in sports, but it's far from the most popular cable network. As it turns out, not everyone subscribes to cable for sports, and pay-TV providers have excluded ESPN's expensive networks from some of their entry-level packages.

Parent company Walt Disney reported that ESPN subscribers declined to 92 million at the end of fiscal 2015. That's down from 99 million at the end of fiscal 2013. And it doesn't look like the declines are slowing. Nielsen data indicates that ESPN had about 89.5 million subscribers at the end of May, down 1.5 million from its estimate in February. If this trend continues, ESPN will have just 87 million to 88 million subscribers by the end of Disney's fiscal year.

Why ESPN subscribers are so important to Disney

ESPN is by far the most expensive cable network for pay-TV operators to include in their service packages. The flagship network brings in as much as $7.21 per subscriber in affiliate fees, according to estimates from SNL Kagan.That's before you add on all the fees from its supplementary networks like ESPN2, ESPNews, and more.

Estimated subscription fees from ESPN's networks combined to account for more than half of Disney's total revenue from its cable networks division in fiscal 2015. What's more, cable networks is part of Disney's largest division, media networks, which accounted for 44% of revenue and 53% of operating income in fiscal 2015.

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Most of ESPN's contracts with pay-TV operators include a built-in fee ramp, which helps offset the decline in subscribers. Still, ESPN is forced to grow its advertising revenue to make up for the loss. Ad revenue is still growing, but at a moderate pace. Calendar-adjusted ad revenue at ESPN for Disney's second quarter was about 3%. It forecast 5% ad revenue growth this quarter.

More importantly, ESPN has some high-priced content rights that are going to start hitting its books. On top of the annual $1.9 billion it has in place with the NFL for Monday Night Football, its NBA contract increases more than $900 million next year to $1.4 billion annually for the next nine years. Additionally, ESPN's contract with the Big 10 expires next year, and it will likely have to renew for more than the current $100 million it currently pays. As sports rights continue to increase in price, ESPN's ability to keep subscribers becomes even more important to Disney's operating profits.

What management plans to do to stop the bleeding

During Disney's first-quarter earnings call CEO Bob Iger told investors that the majority of losses aren't coming from cord-cutters, but from cord-shavers. The skinny bundles offered by most pay-TV providers don't include ESPN since it's one of the biggest factors causing cable prices to increase.

During the second-quarter call, he gave analysts an update. He noted that over-the-top (OTT) pay-TV services like Sling TV and PlayStation Vue "did contribute incremental subs for ESPN this last quarter." He also mentioned that Disney has been in talks with both current and completely new distributors for its inclusion in less expensive network bundles. "All have expressed an avid interest in having ESPN and our other channels included in their initial offerings," Iger said. "And we are very, very encouraged by the discussions/negotiations that we are having."

Of course, the numbers are indicating that these efforts aren't enough to turn around ESPN's fortunes just yet.

If subscriber numbers continue to worsen, ESPN may opt to go over the top as several other premium cable networks have done recently. The company already has the infrastructure necessary to provide an OTT service, so the investment would be minimal. The only cost is the opportunity to sell other Disney networks in a bundle with ESPN. ESPN would also have a much tougher time increasing its rates for consumers than it does with pay-TV operators, who are used to regular price increases from most networks.

Speaking at an analysts' conference earlier this year, Iger said selling ESPN directly to consumers is "on the table." Still, it's likely ESPN would start offering an OTT service as a last resort if its other efforts with distributors fail to slow subscriber losses.

In the meantime, Disney investors should expect a continued slowdown in ESPN's revenue growth, and growth in sports rightscould even cut into the division's operating profits.

The article ESPN Can't Stop Bleeding Subscribers originally appeared on Fool.com.

Adam Levy has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.