Why Disney Is Smart to Keep ESPN

In this podcast, Motley Fool senior analyst Jason Moser discusses:

• Why Disney spinning off ESPN wouldn't be the same as eBay spinning off PayPal.
• Live sports driving ad rates (and audience figures) higher.
• Major retailers continuing to invest despite recent challenges.

Plus, Motley Fool contributor Marc Rapport talks with Joseph Ori, executive managing director at Paramount Capital Corporation, about commercial real estate trends and the red-hot industrial market.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Sept. 12, 2022.

Chris Hill: Don't look now, but big retailers are making big investments in the future. Motley Fool Money starts now. I'm Chris Hill, joining me in studio, Motley Fool senior analyst Jason Moser. It's good to be back in the studio.

Jason Moser: It's always good to be back in this. A little chilly, but it's good to be back.

Chris Hill: We're going to have to have some sweatshirts just on hold. The listeners don't care about whether or not we're comfortable. Before we get to the retail, let's get to Disney's big event over the weekend. They had the D23 Expo and overwhelmingly was focused on new movies, and new programming coming to Disney+, but CEO Bob Chapek was on hand and talking to the media, and by way of background, Dan Loeb, who we've talked about every once in a while on this show, activist investor from the firm Third Point. Loeb has been publicly pushing for Disney to spin off ESPN and in at least one and possibly more than one interviews, Chapek was asked about that and just shot it down point-blank. You and I were talking right before we started recording. The surprising thing to me is that Dan Loeb completely reversed course. Let me just read this thing he tweeted out. We have a better understanding of ESPN's potential as a stand-alone business and another vertical for Disney to reach a global audience to generate ad and subscriber revenues. We look forward to seeing Mr. Pitaro, Jimmy Pitaro, the president of ESPN. We look forward to seeing Mr. Pitaro execute on the growth and innovation plans, generating considerable synergies as part of the Walt Disney Company.

Jason Moser: Synergies.

Chris Hill: Were you also surprised at Loeb? Part of me wonders did they have a private conversation? Was this just in response to Chapek? Because by the way, when you look at what's happening with live sports being the last thing to actually generate meaningful ratings for television networks, both broadcast and cable, and the reports we're getting on the next Super Bowl already being almost completely sold out, I'm on Chapek's side in terms of no, we're keeping ESPN because we believe in the future.

Jason Moser: Well, yeah, I think that when we talk about Disney today, more so today than really probably ever before, this is a true entertainment company reaching every corner of the entertainment industry, whether it's the parks, the on-site, or ultimately what you find in video form, whether it's in the theaters or on one of their direct consumer offerings. We've talked about this for years in regard to Netflix and this move toward streaming away from the bundle in a little bit more to the a la carte offerings. Reed Hastings had the foresight years back to really recognize the value of exclusive content. I don't think that's something you can really emphasize enough. Exclusive content really does make a big difference, particularly now in this landscape where there are so many streaming apps, so many different services now.

It is getting to be a little bit frustrating from the consumer's perspective because you're telling me, instead of having this convenient bundle that I used to have, now I've got to have this whole collection of 6, 7, 8 different streaming services to be able to watch all of the stuff that I want to watch. I think that when you consider the exclusive nature of sports, I absolutely understand why Chapek would want to hang onto ESPN. It feels like maybe it gets batted around a little bit from critics as far as how the business has performed lately, but the bottom line is there's a ton of brand equity still on ESPN and they do something that not a lot of other properties do.

They really do have that brand equity in sports that gives them a lot of opportunities to grow here in the near future. For me, I think it makes absolute sense ultimately to hang onto it because it gives them access to that exclusive content, and then ultimately exclusive content is going to garner the eyeballs, which is what advertisers want. You see Disney being able to capitalize on not only the subscription fees but really more so the advertising. When you consider the other properties that Disney has, whether it's Hulu or Disney+, you see all of this coming together. It's a very complementary offering. I have no doubt that ESPN could succeed on its own, but I think it can do better as a part of a bigger family. In times when maybe ESPN runs into some challenges, that gives Disney the luxury of emphasizing the parts of the business that are working better so that maybe people aren't so laser-focused just on that one thing.

Chris Hill: We have years of data now just looking at when it comes to broadcasting cable television, what are the most-watched shows? Overwhelmingly, it's pro sports, put aside the Super Bowl because that's a single event. Although Fox has the Super Bowl next year reportedly, it is almost completely sold out and a 30-second ad is going to cost more than $7 million. But putting that aside, you look at things like Sunday Night Football routinely being at or near the top of the most-watched things. We got the other part of this that never really made a ton of sense the comparison that Dan Loeb was using was eBay spinning off PayPal. I agree with your point, ESPN, I believe, succeeds over the next 10-20 years, whether it is part of the Disney empire or not. But the eBay spinoff of PayPal, that was something years before that happened, we were all clamoring for that. That all just seemed like yes, there is true value to be unlocked there.

Jason Moser: It felt like you look at that comparison. We were all happy to see PayPal spin off from eBay because eBay seemed to be at the time and even still today a somewhat challenged business, whereas I would not classify Disney or ESPN necessarily as challenged businesses. Maybe going through a little bit of a challenging time as our viewing habits are making this big transition. We're going from cable to direct-to-consumer, it's funny. We talked about years ago, the value in the bundle that we got from our cable providers and you're paying your cable bill every month and you're getting 700 channels that you don't ever watch, but you're getting the core channels that you do watch and ultimately there's value in there because it's an easy interface, it's all in one place. Then we see streaming take over and we get back to that collection of all of these different apps. It's not the greatest user experience. Now we're moving back to this bundle, so to speak.

I think that where Disney is concerned, they want to make this bundle as valuable as possible because I think a lot of this really does boil down to just bundling this content and in offering consumers a value proposition and a place to be able to go see anything they want whenever they want. I think that's one of the big questions that probably a lot of folks have. I know I have it today. As a subscriber to the Hulu Live product and we also have Disney+, which means we also have ESPN+ because we have that bundle. Right now, you do have that experience where I've got to log in to Hulu or I've got to log in to ESPN+, or I've got to log in to Disney+. There's going to be a time where they're going to have that consolidation. They're going to bring everything under one roof. Now, what that ultimately looks like, whether it's under the Disney+ roof or whether it's under the Hulu roof, we don't really know that yet, but they definitely have that plan.

Then I think another thing to keep in mind, too, is in regard to sports, we're talking more and more about it now, but sports betting is becoming a bigger part of this equation, becoming a greater consideration. Because there's a tremendous market opportunity out there to do that and that's something that is being discussed more and more on the calls. They're not giving away their hand yet. I mean, we don't know exactly what they're going to do but when you look at the market opportunity. Wagering on sports came in and was an $89 billion business in 2021, it's estimated to hit $144 billion by the year 2026. Now, I'm not saying that Disney or ESPN has to be the leader in sports betting, and chances are they will probably choose to take the partnership path on this particular part of the journey but that's going to be something else they can incorporate into their business because of the exposure to sports, because they have so much under that ESPN roof.

That I think is going to be another valuable part of the equation. Maybe that was part of why Loeb changed his mind so quickly on this is that he saw Chapek's commitment to ESPN, and heard more in his tone that, "Hey, listen, we're not taking this for granted. We've got big plans, but right now we're in this big transition. We're moving over from this cable relationship, that legacy relationship that we've built this business around for so long. We're having to blow that up and reapproach this. We're taking this one step at a time, but trust me, we will get there," and maybe that was enough to sway Loeb into believing that yes, it makes more sense to remain a part of the Disney family because I think most people would agree it should.

Chris Hill: How many DraftKings ads did you see over the weekend watching college football?

Jason Moser: Quite a few.

Chris Hill: Let's move on to retail because like a lot of industries retail stocks have gotten hit in 2022 and yet we're getting more data coming out about Walmart, Amazon, Target, just to name three, continuing to spend money continuing to invest. You look at the research, Gartner Research had come out looking at the past as an example of how this can pay off in the future. They looked at all these companies to continue to invest through the Great Recession and what that did for their earnings potential over the subsequent 5, 6 years. It's one of those things that reading all that made me think, if you're a shareholder of Amazon, Target, Walmart, you should probably be happy about the investments that they're making because they are making huge investments.

Jason Moser: They are. The beauty of having the scale and retail that companies like that have your Amazons and Walmarts of the world is they can afford to continue investing. That's what that scale gives them, those financial resources. They can continue investing in times like these when other smaller players, they have to play a little bit more defense. They have to be far more careful with where their investment dollars go and we talk about that a lot. I think in tough times, that's when the strong tend to get stronger. This made me think back toward, and I don't know if you recall, but I think over the past couple of years, we talked a little bit about Darden Restaurants throughout all of this. In Darden, obviously, over the last couple of years, restaurants have had a very difficult time. We saw a lot of smaller restaurants go under.

But the bigger restaurants that have multiple brands under that umbrella have been able to play offense, and Darden was a good example of that. They really were playing offense, opening new stores, trying to take share, understanding that was going to hamper the financial performance in the near term, but that it was going to give them a greater footprint in the longer term. Ultimately it gets back to that scale argument. You want to be bigger and sometimes you got to take a little bit of a risk there and spend when the times are tough. It seems like with companies like Amazon and Walmart, Home Depot, Target, they're all doing that and it makes a lot of sense. I think ultimately the investments that they make just depend on the nature of the business. I thought there were some interesting data in there in consulting company executives and asking what investments will they cut first versus what investments will they cut last? I was encouraged to see this in the sense that the last that they're going to cut, this is what they're going to focus on first and foremost, they're going to cut technology and investments in the workforce last, in other words, that's where they're going to be really focused on.

Making sure they're up to speed on their technology and making sure that they're actually investing in their workforce. We're hearing a lot of stories these days about unionization. A lot of that just boils down to companies who have not invested in their workforce the way that they should have. I'm not saying that Amazon or Walmart necessarily has that figured out, either, but that's something that's encouraging to see at least that executives are going to be focused on investing in things like technology and the workforce, whereas the investments they'll cut first are things like M&A, mergers and acquisitions. I wasn't terribly surprised to see this, but also sustainability and environmental impact. I think that sustainability and environmental impact is important is that is, I think that's still a very squishy subject, it's very open for interpretation of exactly what that means. Maybe as time goes on, if that becomes a little bit more of an understandable concrete definition, maybe that changes but for now, I do believe that the investments in technology and the workforce make the most sense. Again, it goes back to when you have the scale and the space it really gives you a lot of opportunity to when you come out of these difficult times, the strong can be stronger as long as they make the right investments.

Chris Hill: Part of that in terms of the workplace, you look at Target, which is on track to invest $5 billion this year in their stores, opening 30 new ones, but giving a refresh to 200 more which is, you think about their footprint, that's a sizable impact. A nice reminder that increasing the store count is not the only way to invest in locations. That when you look at a business and they say, it's like, well in the grand scheme of Target, 30 new locations isn't necessarily a huge increase, but the upgrade of 200 more can make a meaningful impact. Again, all of this with an eye toward like we talked about on the show with Emily on Friday. All with an eye toward, hey, we got to get through the next 6-12 months. This is setting us up for beyond that.

Jason Moser: The E word, what we talked about last week, efficiency. A lot of these companies are focused on efficiency right now and I think in retail, particularly, efficiency matters a lot. When you look at the way these companies are spending their investing dollars, I think a lot of this also depends on the nature of the business. You look at something like a Target or a Walmart in investing in that in-store experience, just like you said, it's not just about opening new stores, but it's about making your existing stores better and getting them up to snuff and up to speed. With today's technology. You look at something like a Target and Walmart, it makes sense to really invest in those stores. Whereas Home Depot has been focused more so on investing in their supply chain, really trying to maximize the efficiencies there because part of the difference between something like Walmart and Home Depot, you look at the customers that Home Depot serves. It's not just the do-it-yourself, but they have an entire pro demographic that they have to cater to. That pro demographic is really important because they spend a lot of money with Home Depot. It's not necessarily about the in-store experience for them, it's about the supply chain. We've seen Home Depot making a lot of investments in the supply chain over the last couple of years as opposed to that in-store experience just because of the difference in the nature of the customer, so just something to keep them on.

Chris Hill: Jason Moser, thanks for being here.

Jason Moser: Thank you.

Chris Hill: From consumer retail, we move to commercial real estate. Joseph Ori is an executive managing director at Paramount Capital Corporation. Motley Fool contributor Marc Rapport caught up with Ori to get his thoughts on commercial real estate trends and the red-hot industrial market.

Marc Rapport: Well, the industrial sector has been really one of our hottest since the pandemic. How hot has it been from your perspective? Do you have numbers you could point out to indicate that record-low vacancy rates, soaring rents, all of the above?

Joseph Ori: Yes, the industrial market in U.S. has been booming for the last four or five years. The cap rates, that's the return you look at when you buy a property at record lows between 3% and 5%. They should be between 5% and 7%. Again, there's 16 billion square feet. Right now there is 700 million square feet under construction. That is a record, and it's all getting absorbed, absorbed meaning it's getting leased as soon as it's built or a few months thereafter. We have record rents in various markets, 3% vacancy, so yes, it's on fire, it's slowed down a little bit now with higher interest rates. Remember when the Fed raises interest rates and cuts back demand, and higher inflation, food costs, gas costs, etc, people are cutting back and they're not buying stuff and a lot of the demand for industrial comes from all the stuff people are buying, primarily coming over from Asia and then they need a place to store it and distribute it and the logistics for it and that was the big creator of demand, but it's starting to slow down.

Marc Rapport: Well, what involvement do you and your clients have in this sector and where in general terms, of course?

Joseph Ori: What we do is we provide advisory services. We tell our clients and my clients are primarily institutional, large real estate developers, private real estate firms, money managers, investment managers, REIT managers and we tell them how to make more money in commercial real estate. Since the industrial market has been so hot the last few years, we've done a lot of stuff on industrial.

Marc Rapport: Well, do you think valuations have gone too high and why or why not? What is the bubble and are we in one?

Joseph Ori: Yeah, definitely. I mentioned cap rates, for most of your viewers, you probably don't know what a cap rate is, but it's a measure of return on a real estate, commercial real estate deal. The way you calculate it, you take the net operating income nature, your rents less your operating expenses divided by the value of the property. Cap rates today for industrial are between 3% and 5%. I've been doing this for 40 years, Marc. If you would ask me 10 years go, hey, industrial is going to trade at a three cap rate in 10 years, I would have bet you a million dollars, no way. But that's what's happened and a lot of it has been the Federal Reserve since 2008. We've had zero short-term interest rates other than the short-term blip higher in 2018 and then the last six months when they've been raising it, so yes, they are compressed. I'll give you another good example, Prologis is the largest industrial REIT, they're buying a competitor, Duke Realty for a huge price. That's three and a quarter cap rate acquisition. Five or six years ago, cap rates on industrial were average 6%, 7%, now they're between 3% and 4% and 5%. We're in a little mini-bubble, but as demand starts to pull back and rates go higher because capitals cost more now, cap rates will rise and we'll start to see the market get back to some normalcy. It's not going to be where it was five or six years ago, but it won't be so robust as it is today.

Marc Rapport: That's what we're hearing about the retail on especially the residential markets, too, including multifamily, is that rather than a bubble, maybe we're just going to see a general cooling off. Can you share your observations about those sectors? Of course, retail has been pretty hard hit by the pandemic, but what about those sectors?

Joseph Ori: Apartments are the second-hottest sector, have been the last four or five years after industrial rents have taken off in a bunch of markets. But that's also starting to soften. We're out in Silicon Valley, I see it here, so yes. A single-family what I'm hearing right now, it's hit a brick wall with these rate rises. A year ago, you could finance a 30-year mortgage at three and a quarter, today you're at five and a quarter, and that's if you have a great FICO score, you're going to be a 5.5. I'm hearing that prices are being cut, buyers are backing out. What happens in housing is going to depend on what the Fed does in the next two meetings. They have a meeting in September and then another one in November.

Marc Rapport: Well, back to industrial then, what markets do you see as being perhaps particularly overpriced or underpriced? What building types, for instance, large warehouses versus small last-mile infill facilities, can you shed some light on those there?

Joseph Ori: Sure. Here's the hottest markets, the highest rents in industrial, the Inland Empire, remember 40% of our goods comes from Asia, primarily China, they come to California, Oakland and then Long Beach, those three ports, primarily Long Beach and LA, and once it gets off the ship and we've had some supply issues in our supply line and that's gotten a little better but six months ago there were 70,80,90 ships outside of the LA ports. I just counted them this morning, there's 50, so we we're getting better, but it's not the best. Here's the markets with the most building, most robust, highest rents, the Inland Empire, in Southern California, LA, Boise, Oakland, and Orange County. All these locations have industrial rents that are in the double digits, typically in the good old days and when I say the good old days I'm talking about five or six years ago, industrial rents were six, seven bucks. Now these are triple-net rent. Now Inland Empire is 16, LA is 14, Boise $11 a square foot, Oakland 12, Orange County $17 a square foot.

Marc Rapport: That's amazing. By the way, when you mentioned Boise, that's like which one of these is not like the rest? Why Boise when you got all these West Coast?

Joseph Ori: Well, they want to get out of California because of the higher cost and taxes and stuff like that so that I can see. But then you would think, what about Vegas, what about Arizona? But their rents aren't as high.

Marc Rapport: Well, Boise has been one of the hottest residential markets certainly the last few years.

Joseph Ori: Definitely. That's cooled down, too, I'm hearing.

Marc Rapport: When you talk about 16, 17, you're talking about per square foot rentals?

Joseph Ori: Per square-foot rental rates, yes.

Marc Rapport: Just to clarify, let's tell our listeners what you mean by net lease.

Joseph Ori: A net lease is in industrial, if I say the rent is $16 a square foot, that is triple-net so the tenant will pay that every year. Plus, they will pay all the operating expenses on the property, real estate taxes, maintenance, insurance, landscaping, etc, and that's what a triple-net lease is.

Marc Rapport: The opposite of course, would be a gross lease.

Joseph Ori: Exactly.

Marc Rapport: When you say 16% or something like that, you're talking about the rent increase per square foot and a renewed lease, is that correct, or in a new lease versus the previous tenant?

Joseph Ori: Yeah, well, $16 is the rent per square foot but that rent has doubled in the last five years.

Marc Rapport: Got it.

Joseph Ori: Almost all of these markets I mentioned, it's doubled.

Marc Rapport: What about the underlying demands in spaces? We've heard, of course, the headlines about Amazon not needing this space perhaps going forward than it has and are they a real bellwether in this or how do you see this demand changing and fluctuating?

Joseph Ori: They definitely are a bellwether. They're probably the largest outside of some of the REITs single owner of industrial in the country. I think that when Bezos was a CEO, they overexpanded a little bit with their real estate. The new CEO came in like eight months ago and I think he's tightening things up. But demand is slowing, when the Fed raises interest rate and you have high inflation, it hurts demand because people don't have enough money to pay for their groceries and gas and everything else so they cut back on buying stuff. Remember, we don't make anything here anymore. We have to buy everything from overseas but that demand is starting to slow down. It's not dropping off a cliff yet. It's going to depend on how high interest rates go, but it's definitely slowing down.

Marc Rapport: Well, in your work, do you have a pretty good view of who the clients are renting these spaces because it's like we assume when we're talking about industrial space and warehouses, we're all talking about nothing but logistics warehouse, but a lot of stuff manufacturing space, too, isn't it?

Joseph Ori: Some of it is. When you look at that 16 billion of industrial, maybe 10% is manufacturing, the other 90 is distribution and warehouse. Who are the tenants for these? Any big company, from Procter & Gamble down to Skechers, down to Amazon, any company who's selling or distributing a product has a network of distribution warehouses around the country, and retail. You look at any retail, look at calls, look at Macy's, they'll have 10,12 distribution centers and these are huge buildings. There are 700, a million, a million two square feet, that's like five football fields. They distribute all their goods around the country. It's a very important part of our logistics and supply chain in the country and we definitely need it. Like I say, we're building 700 million square feet, 1,000 million new space, and it's all going to get absorbed. Even though the demand is starting to slow down a little bit.

Chris Hill: As always, people on the program may have interest in the stocks they talk about and the Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.