Image source: The Walt Disney Company
The Walt Disney Company (DIS 0.62%) reported another solid quarter. The entertainment conglomerate topped analyst expectations of adjusted EPS of $1.61 and revenue of $14.17 billion by posting results of $1.62 and $14.28 billion, respectively. Still, it wasn't a perfect report. Let's look at where Disney is underperforming and consider CEO Bob Iger's strategy to transition the company to withstand future threats to its business.
Media Networks is still sluggish, and things could get tougher from here
Analysts are understandably concerned about the slowdown in Disney's media networks division. To recap, media networks is a major part of Disney's revenue and operating income. The following chart shows Disney's revenue on a divisional basis over the past eight quarters:
Data source: Disney 10Ks/10Qs.
And here's Disney's operating income by division during the same period:
Data source: Disney's 10Ks/10Qs.
While Disney doesn't release interdivisional figures, it's assumed a large part of Disney's media networks is ESPN. And ESPN is facing the double whammy of lower subscriber totals and higher costs. According to Nielsen, ESPN has lost about 11.3 million subscribers -- roughly 11% -- over the past five years.
Whether or not this is due to cord cutters or cord shavers is inconsequential, but the preponderance of information suggests ESPN is losing subscribers, and that's a problem. In the absence of subscriber growth, the company has been able to grow revenue by raising affiliate fees and marketing increases. Unfortunately for the sports-related network, there's an outer bound to price increases and commercial increases.
On the other hand, the cost ESPN pays for sports-related content has substantially increased. The new NBA deal, which should show up within two quarters, is nearly 200% higher than the expiring one. In an effort to deal with higher content costs, ESPN has undertaken an ambitious cost-cutting plan of $100 million from fiscal 2016 and $250 million from 2017. Even including internal cost cuts, Disney reported narrowly lower operating income from its media networks division last quarter than in last year's corresponding quarter, as costs grew at a larger clip than revenue grew.
And BAMTech appears to be an insurance policy
Interestingly enough, many have chosen to focus on Disney's announcement of the MLB streaming-based service BAMTech. The Walt Disney Company paid $1 billion for 33% interest with an option to take a minority position in the company. While an interesting proposition, it's important to note that BAMTech appears more of an insurance policy for shareholders than anything else.
The New York Times notes that current content on ESPN's networks will not appear on BAMTech, and CEO Bob Iger described the service as complementary. Additionally, Iger defended the current pay-TV model but noted that BAMTech gives the company the "optionality to pivot" to a full direct-to-consumer offering in the event the current model rapidly changes. Iger also noted that the current model is the most lucrative for the company and even expressed his desire for a DTC offering not to occur.
Long story short, if BAMTech becomes a large part of Disney's revenue haul, it's because the company's proverbial golden goose, traditional TV, has unraveled. The most likely result for this streaming service is a minor increase in revenue by monetizing the company's large library of sports-related broadcasting rights.
But Disney's real plan to combat ESPN's falloff appears to be succeeding
It seemed Iger's plan to combat weakness in the company's core media networks was to cut non-content-related costs, seek new ways to monetize sports-related content (see: BAMTech), and increase the profitability in other divisions. Over the past few years, this growth has been mostly from the company's studio entertainment division. This quarter was no different: On a year-on-year basis, Disney increased revenue and operating income by 40% and 62%, respectively.
Look for Iger to continue this strategy. Disney will continue to release movies from its Marvel, Pixar, and Lucasfilm acquisitions in the upcoming years, and the company's recently opened theme park joint venture with the Chinese government, Shanghai Disney, will both continue to add to revenue and operating income. Unless the cord-cutting and cord-shaving trend picks up in a major way, Disney should be able to withstand slowing core operations.
