Walt Disney (NYSE:DIS) is the quintessential family entertainment company. Its empire includes theme parks, movie studios, TV channels, and more. One of the company's crown jewel assets is ESPN, which is the world's largest sports broadcaster.
Many investors focus on Disney's parks and films and overlook ESPN, but that would be a mistake, because ESPN likely generates more profits for Disney than the entire film studio. With COVID-19 forcing the suspension of operations at parks and theaters, the media business is more important than ever for the company.
How ESPN makes money
Disney doesn't break out ESPN's financial performance, so understanding the segment takes some detective work. The business falls under the company's media networks segment, where Disney accounts for its numerous TV channels. Last year, the media networks segment generated $24.8 billion in revenue. Furthermore, it earned $7.5 billion in operating income -- more than any other segment!
TV channels such as ESPN make money from affiliate fees (fees per subscriber charged to cable companies and other pay-TV operators), advertising, and online streaming.
Each cable TV channel charges a nominal fee to be carried in a cable package. ESPN is notorious for being the most expensive channel, and it's not even close. As of 2017, cable subscribers were paying more than $9 per month for ESPN's top four channels (ESPN, ESPN 2, ESPNU, and SEC Network), and affiliate fees have continued to rise since then. For comparison, most channels charge less than $1. ESPN has about 80 million subscribers. Even at 2017 affiliate fee rates, that would translate into roughly $8.6 billion in affiliate fees annually ($9 x 80m subscribers x 12 months).
Why does ESPN garner so much money from cable operators? Because ESPN is the highest-rated cable channel among men and reaches 200 million viewers per month. High ratings and reach also enable ESPN to generate strong interest from advertisers. SNL Kagan estimated $2.3 billion in ESPN advertising revenue for 2018.
Finally, ESPN has a streaming service called ESPN+, launched in 2018. ESPN+ isn't a replacement for the ESPN channel; it is more of a companion. The app doesn't broadcast the most-watched sports games, but it does have broadcasts from the MLB, NHL, UFC, and more. The service costs $4.99 per month and had 7.6 million subscribers as of February 2020. This equates to roughly $460 million in annual revenue, and it is growing quickly.
In total, ESPN likely generated at least $11.4 billion of revenue last year ($8.6 billion affiliate fees + $2.3 billion advertising + $0.5 billion streaming). This accounts for well over 40% of Disney's Media Networks segment, making ESPN one of Disney's highest-grossing businesses.
How ESPN spends money
Although ESPN likely generates over $11 billion of revenue annually, it has significant costs. Most notably, Disney invests a ton of money into acquiring sports rights from leagues each year. These acquisitions are competitive, as networks such as CBS (owned by ViacomCBS) and NBC (owned by Comcast) also bid for many of the same properties.
Again, Disney doesn't disclose ESPN's income statement, but it does provide some information on its content costs. In Disney's 2019 annual report, it noted $8.8 billion in sports programming commitments over the next year. In 2015, ESPN reported sports content costs of $5.0 billion, which shows how much more expensive broadcasting rights have become.
Content costs aren't ESPN's only expenses, as it also needs to pay for overhead, on-air personalities, and supporting staff. These overhead expenses likely add hundreds of millions of dollars to ESPN's budget. If you assume a total expense base of around $9 billion for ESPN, it implies that ESPN generates over $2 billion of annual operating income, based on our rough estimates for revenue and expenses -- and probably a good deal more, depending on how much affiliate fees have increased since 2017. That's a pretty penny for Disney.
A cloudy future for TV broadcasters
While ESPN is a prized business for Disney, its future, as well as the future of the entire TV ecosystem, is in doubt. Most of ESPN's revenue comes from its affiliate fees, which are charged to pay-TV companies based on the number of subscribers they have. However, the number of pay-TV subscribers has declined by nearly 10 million since 2016 and is expected to continue plunging.
ESPN has been able to raise its affiliate fees each year to offset lost cable subscribers, but there is a limit to how much ESPN can charge. ESPN+ may be part of the solution in terms of finding a new audience in a post-cable TV world. If ESPN+ can gain tens of millions of subscribers, it may be able to afford much of the sports rights that ESPN currently carries on linear TV, but this strategy is not on the table today.
On top of the normal business issues, ESPN is also suffering from a lack of sports programming due to COVID-19. Sports have effectively been off the air since early March, and may not fully return for several more months. This is more of a short-term issue that will be solved with time. Professional sports will likely resume in the second half of 2020, but without live audiences.