Walt Disney (DIS 1.01%) reported results for its fiscal 2016 first quarter last week. The diversified entertainment giant posted strong year-over-year results with revenue increasing 14% and adjusted earnings per share jumping 28%. The results were driven by the phenomenally successful Star Wars: The Force Awakens, which opened in domestic theaters in mid-December and smashed many box office records.
Despite posting strong headline numbers that beat analysts' expectations, shares of Disney dropped about 4% following the release. This was due to decreased profitability in the media networks segment, feeding into market concerns around "cord-cutting" and "cord-slimming." The fear is that subscribers cancelling or trimming their large cable bundles will negatively affect the future profitability of Disney's cable networks, particularly sports juggernaut ESPN.
The market has driven Disney stock down over 20% since it notched an all-time high about six months ago over this concern, which first surfaced when Disney reported its third-quarter 2015 results last August. Here are seven important takeaways that Disney CEO Bob Iger shared on the company's conference call.
Source: Josh Hallett/Flickr
1. ESPN had a recent uptick in subscribers
From Iger's opening remarks, "In the last couple of months, we have actually seen an uptick in ESPN subs[cribers] which is encouraging."
Granted, "uptick" wasn't defined, and this could be just a seasonal blip. Nonetheless, it's still good news -- or, at the least, not bad news. For background, Disney released its ESPN subscriber numbers in an SEC filing the day before Thanksgiving, revealing a downward trend from 99 million at the end of fiscal 2013 to 92 million at the end of fiscal 2015. That's an annual subscriber loss of about 3.6%.
In response to an analyst's question about the reason for the uptick, Iger said, "[W]e believe that we've benefited from the growth of certain light packages that ESPN has been part of, particularly [Sling TV's] Dish."
2. Nielsen lowered its estimate of losses of multi-channel households
The market's ballyhooing about cord-cutting was largely set off by Nielsen statistics reflecting the drop in ESPN subscribers through 2015. From Iger's opening remarks:
It's interesting to note that Nielsen has significantly lowered its estimate of losses of multi-channel households in 2015. Regardless, in any market, we believe ESPN is well-positioned to continue to thrive for many reasons, including the demand for sports programming, especially live sports, is undiminished and consumption is at an all-time high.
3. ESPN subscriber count drop is due largely to cord-slimming
This is a key point and one many investors may not know, since it represents a change from what Iger said last August. From Iger's response to a question about this change of opinion:
At the time that I made the comments last August, we were seeing some sub erosion from both sides, from skinny bundles and ... a decrease in the total number of subs. At the time, because of what Nielsen was telling us, we concluded that most of it was coming from simple loss of subs. Once Nielsen corrected those numbers, reducing the loss of subs by some two million subscribers -- or two million households, I should say -- we concluded that, at that point, our sub loss was largely due to the fact that ESPN was not part of skinny bundles that had launched.
4. Disney is in talks to have ESPN included in light bundles
Disney is taking action to halt ESPN subscriber losses. From Iger's opening remarks:
The popularity of sports and the strength of ESPN add great value for consumers who want lighter packages, and we're currently in discussions with new and existing distribution partners to create an array of innovative new services and light packages featuring ESPN. We will continue to focus on subscriber trends, moving quickly to embrace and create opportunities to drive value in the evolving market.
5. Disney's media properties are tailor-made for over-the-top products
While Iger believes the large cable bundle will remain the dominant media product for some time, he made it clear that Disney plans to successfully adapt to a changing marketplace:
The expanded basic bundle will remain the dominant product for consumers for the foreseeable future, but competition from new video services and products will only grow. Better user interfaces and greater mobility make these newer services enormously appealing, especially among young people and many of our brands, including Disney, Marvel, Star Wars and ESPN, are tailor-made for over-the-top direct-to-consumer app-based video products. So expect innovation and continued pursuit of new distribution opportunities.
6. The American love affair with ESPN
From Iger's opening remarks:
Last year, 95% of Americans with a multi-channel bundle watched sports, and 81% of those viewers watched ESPN content. Across all platforms, more than 200 million adults engage with ESPN in an average month. In other words, four out of five adults in this country connect with ESPN on some platform every month, usually more than one.
7. ESPN ad sales significantly outpaced the market
The bulk of revenue Disney generates from ESPN is from cable affiliate fees that it receives from distributors based upon subscriber households. However, ad sales are also an important part of the revenue stream. From Iger's opening remarks:
ESPN's ad revenue continues to grow, thanks to its proven ability to reach audiences that advertisers value most. In fact, ESPN's ad sales significantly outpaced the market, growing three times faster than television advertising overall over the last six years [emphasis mine]. MVPD's [multichannel video programming distributors] just ranked ESPN number one in perceived value for the 16th year in a row, due in part to the fact that ESPN drives more local ad sales and broadband subscriptions than any other service in the market.
Wrap-up
While cord-cutting and cord-slimming fears are legitimate, especially as the media networks segment contributes the largest portion of operating income to the company, the issue is overblown. The market is underestimating Disney's ability to overcome this challenge and/or compensate for it.
The House of Mouse has been masterful at profitably adapting to changing markets since it was founded in 1923. The company is second to none when it comes to leveraging its assets across its businesses to generate revenue that's stronger than many industry followers project, and/or to generate new sources of revenue that few could see coming. These are precisely the reasons that the acquisition prices of Lucasfilm, Marvel, and Pixar are now looking like bargains, and why the company's quarterly earnings results regularly surpass analysts' expectations.
