ESPN may be looking to venture outside the friendly confines of the cable bundle. The Disney (NYSE:DIS) company is looking to diversify its revenue streams by offering a direct-to-consumer digital video subscription service (i.e., it's going over the top).
According to a report from Re/Code, ESPN plans to test the waters starting with the Cricket World Cup early next year. While cricket is a niche sport in the U.S., this move is reminiscent of how ESPN got its start as a cable network in the '80s. ESPN also plans to offer MLS soccer matches and select NBA games via stand-alone Internet streaming subscriptions in the coming years.
Why this isn't a cable killer
ESPN relies on cable operators just as much as cable operators rely on ESPN. This year, ESPN is expected to generate more than half of its total revenue from carriage fees paid by pay-TV operators. That's astounding, considering the increase in ad spending during live sports events.
This year, ESPN is expected to generate about $6.3 billion from carriage fees, $3.9 billion from advertising, and another $1 billion from ESPN.com, ESPN the Magazine, and its international presence. Clearly, a lot of its business is tied directly to the success of the cable bundle. It's not going to do anything to disrupt that.
Events like the Cricket World Cup, MLS regular-season soccer matches, and out-of-market NBA games are supplementary to the cable bundle, not a replacement. Unlike offers from HBO or CBS, where subscribers get the exact same content, ESPN is offering something new and different.
Why Disney investors should love this move
ESPN's decision to forgo the pay-TV operators to distribute those events is still significant for cable operators and investors. ESPN could have just made another channel and pushed it into the bundle or broadcast the events on one of its existing networks and justified a higher price from operators.
By going directly to consumers, ESPN is establishing the infrastructure necessary to make bigger, potentially more disruptive moves in the future. That move alone will give it more leverage in negotiating carriage fees, which is one of the main reasons HBO and CBS are going a la carte. As a result, ESPN will be able to continue raising its carriage fees.
Additionally, going direct-to-consumer will allow ESPN to make the most of its sports rights. ESPN's deals with the MLS, NBA, and Cricket World Cup give them the broadcast rights and the digital rights. But ESPN has a limited number of outlets vis-a-vis cable networks to broadcast every event it has the rights to. Naturally, some events are more valuable to broadcast than others, which leaves some events relegated to the WatchESPN.com website to avoid "warehousing" claims of the kind it faced last decade.
With a direct-to-consumer subscription available, ESPN can charge viewers and actually make some revenue off those events that may attract a very niche yet passionate audience -- like the Cricket World Cup.
Sports leagues are happy to part with these rights for guaranteed income as well as the brand strength of ESPN, but some still offer competing direct-to-consumer subscriptions. ESPN offered the NBA an equity stake in its streaming service to make up for any lost revenue it might cause for its League Pass subscription, and it could do the same for other sports leagues as well -- compensating them on the merits of their product. The result is a win-win for ESPN and sports leagues.
Preparing for the future of television
Many people believe the cable bundle's days are numbered. I'm not one of them, but it never hurts to be prepared. ESPN's plans are smart because its over-the-top service is not a substitute product, but it creates the potential for a substitute product that the company can hold over the heads of cable operators. This move should set up ESPN to continue growing its revenue for years to come while capitalizing on all of the expensive content it's bought the rights to in recent years.
Adam Levy owns shares of Apple. The Motley Fool recommends and owns shares of Apple, Google (A and C shares), Netflix, and Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.