Disney (DIS +7.60%) gained control of ESPN through its acquisition of Capital Cities Communications in 1996. Over the following two decades, ESPN became the crown jewel of its cable business, which generated 30% of Disney's sales and over half of its operating income last quarter.
However, Disney's cable business has lost some of its luster in recent years due to cord-cutters leaving for streaming services. Between fiscal 2011 and 2015, Disney's ESPN subscribers fell from 99 million to 92 million, which was surprising since live sports broadcasts seem to be protected against streaming rivals. Similar declines hit Disney's other domestic channels, although it gained overseas viewers at both ESPN and its core Disney channels.
Image source: ESPN.
Last quarter, Disney's cable networks revenue fell 2%, but operating income rose 12% as lower programming costs and higher affiliate revenue offset declines in advertising revenue and subscribers. That's worrisome, because programming costs and affiliate revenues fluctuate seasonally, while revenue from ads and subscribers are core pillars of growth.
The bears believe that ESPN will eventually be crushed by rising costs for sports programming and subscriber declines. The bulls believe that ESPN's multiplatform digital expansion across its website, app, and streaming platforms will keep its brand relevant, lock in subscribers, and boost its negotiating clout with major sports leagues. But another option has only been occasionally considered -- what if Disney spun off ESPN via an IPO?
Why would Disney spin off ESPN?
Spinning off ESPN would greatly reduce the weight of its cable networks business on Disney's top and bottom lines. Investors could then focus on Disney's parks and resorts and studio entertainment businesses, which both have more tailwinds and fewer headwinds than the cable division.
The downsized media networks business could then focus on integrating its film-based properties, like Marvel, Star Wars, and Pixar, into programs on ABC and the Disney Channels. ESPN programs, on the other hand, can't extend Disney's core film and theme park franchises.
If Disney spins off ESPN, the network could use its own stock to fund acquisitions instead of waiting for permission from its parent company. These acquisitions could include apps, games, and websites to expand its digital presence. If Disney still wants to stay invested in ESPN, it can retain a controlling share after the IPO.
How much would ESPN be worth?
ESPN's exact value is hard to pin down, since Disney doesn't report the network's operating results separately. In 2014, Wunderlich Securities analyst Matthew Harrigan estimated that the network was worth $50 billion, up from an estimated value of $40 billion in 2012. Hearst Corporation still owns 20% of ESPN, so that estimate values its stake at about $10 billion, while Disney's majority stake would be worth $40 billion -- slightly more than 20% of its current enterprise value.
At first glance, a stand-alone cable sports network could be a tough sell. Shares of MSG Networks (NYSE: MSGN), which owns a diverse portfolio of sports teams and sports networks, have slid more than 20% in 2016 due to slow sales growth and an earnings miss in February. However, ESPN could attract investors by diversifying its portfolio, bringing in fresh talent to lead its digital initiatives, and offer a higher dividend than Disney's current 1.4% yield.
ESPN's Android TV app. Image source: ESPN.
There's also the possibility that Disney's media rivals might try to buy ESPN if it went public. Fox (FOXA +0.00%) has been challenging ESPN in live sports for years, and Comcast's (CMCSA 0.17%) NBC Sports Network would get much bigger by absorbing ESPN. Dalian Wanda, Disney's rapidly growing Chinese rival, might make a bid to expand its portfolio of U.S. entertainment properties, which already includes AMC Entertainment and Legendary Pictures.
Any company that bought ESPN would also gain much more clout in price negotiations with sports leagues and associations. But it's unclear if any of these media giants would be willing to pay over $50 billion for the network.
Will a spinoff ever happen?
Ten years ago, Disney shot down speculation that it should spin off ESPN. But over the past decade, bidding wars for sports broadcast rights have intensified and cord-cutters have disrupted the business of cable bundles. I doubt Disney will divest such a huge part of its core business anytime soon, but it might be a wise move that would allow it to focus on its growing theme park and movie businesses.
