The Walt Disney Company (NYSE: DIS) is well known for its movies and theme parks. It consistently puts out the highest-grossing blockbusters. It took four of the top five spots for highest-grossing films last year, and it has two of the top three so far this year. Its theme parks typically see rising attendance numbers every year. This past year, attendance took a step back after Disney changed its ticketing policy to increase rates during peak periods. That translated into higher operating profits, which climbed 18% in the third quarter.
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However, Walt Disney doesn't make most of its money from either its film studio or theme parks. In fact, its biggest breadwinner is its television business. Media Networks accounted for nearly half of Disney's operating profit last year, and about 45% of operating profit in 2017 so far.
The biggest money maker is also the biggest risk
It's no secret cord-cutting is a major trend working against cable and media companies. Disney has experienced firsthand the impact of cord-cutting on its Media Networks business, particularly its cable networks.
Through the first nine months of 2017, revenue from Disney's cable networks is down 1%. Moreover, operating income fell 13%. Revenue has remained stable as Disney ramps up its affiliate fee per subscriber and it's able to command relatively strong advertising revenue. But its expenses increased substantially this year, particularly its content costs at ESPN, driving down operating income.
ESPN is by far the biggest money-maker for Disney's Cable Networks segment. Aside from losing millions of subscribers over the last few years, it's also seeing ballooning content costs. What's more, ESPN signed very long-term contracts for the rights to certain sports.
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While ESPN is bleeding subscribers, demand for the network appears to remain relatively strong. As mentioned, it's been able to raise its affiliate fee rates every year. What's more, the new breed of virtual pay-TV providers like Hulu and Sling TV, all made efforts to include ESPN in their base packages, further cementing the need for ESPN to sell a cable bundle -- no matter how skinny. Still, ESPN's dwindling subscriber count isn't something it was planning when it signed decade-long contracts with the NFL, MLB, and NBA, among others.
Giving the people what they want
Disney has announced plans to launch a stand-alone ESPN-branded over-the-top streaming service early next year. The service will offer access to over 10,000 events each year, capitalizing on ESPN's robust portfolio of content rights. While ESPN will stream MLB, NHL, and MLS games, it will reserve NFL and NBA games -- its most attractive content -- for cable subscribers.
The move has the potential to draw even more attention to its mobile app. ESPN's mobile app is a huge money-maker for ESPN, drawing millions of eyes to its digital properties every day. ESPN integrated its TV Everywhere app into its flagship app a few years ago. It plans to do the same with its upcoming streaming service.
Ultimately, ESPN envisions its app as a marketplace for sports content. It will make add-on subscriptions to MLB.TV, NHL. TV, and MLS Live (all powered by its majority-owned BAMTech) available in the app next year as well. Disney CEO Bob Iger said he envisions a future where customers can select the content they want to watch all through the ESPN app.
While cord-cutting is a big threat to Disney's biggest money-maker, the company is taking steps to mitigate the impact. Demand for its biggest network, ESPN, continues to rise, allowing it to keep raising rates and keep ad revenue fairly stable. While content costs are cutting into profits for now, the launch of its streaming service next year could help make the most of those rights as it brings in supplemental revenue.
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