ESPN Is a Disney Crown Jewel, but Its Financials Demand ‘Drastic Pivot’ to Direct-to-Consumer | Analysis

Disney’s disclosure last week that ESPN generated $17.3 billion in revenue last year — 21% of the entertainment giant’s $82.7 billion total — showed that the sport network remains a crown jewel for the company. But ESPN’s standalone financials highlight the urgency for Disney to make an aggressive direct-to-consumer pivot for the legacy network, analysts told TheWrap.

ESPN has lost 19% of its pay-TV subscribers since 2018, and sports rights remain its biggest expense at about $9 billion in 2023, Bloomberg Intelligence analyst Geetha Ranganathan said in a Friday note to clients that this cost was up more than 20% from about $7.3 billion in 2022.

“We calculate that operating income could decline to around $2.5 billion in fiscal 2023 vs. $2.9 billion last year on new NFL and college football contracts,” she wrote. And despite streaming service ESPN+ having 25 million subscribers, it is “unlikely to be a major profit contributor, implying that a drastic pivot to a premium streaming model is necessary.”

Disney broke out its sports division’s financials for the first time last week. The division, which includes ESPN, ESPN+ and Star India, generated $2.7 billion operating profit and revenue of $17.3 billion in revenue for fiscal year 2022 and $1.5 billion in operating profit and $13.2 billion in revenue for the first nine months of fiscal 2023, which ended on July 1.

Of that total, ESPN generated a $2.9 billion operating profit on $16.07 billion in revenue for fiscal year 2022, compared to an operating profit of $1.89 billion on $12.56 billion in revenue for Disney’s first nine months of 2023. Star India accounted for the remaining $637 million in revenue and a $444 million operating loss in the first nine months of 2023 and $1.2 billion in revenue and a $237 million operating loss in fiscal 2022.

Affiliate fees from cable providers made up $10.8 billion of Disney’s total sports revenue during fiscal year 2022 and $8.05 billion during the nine-month period, while advertising made up $4.37 billion and $3.19 billion, and subscription fees made up $1.1 billion and $1.14 billion, respectively. Other revenue — which came from pay-per-view events on ESPN+, ESPN programming on ABC, sub-licensing of sports rights and licensing the ESPN brand — made up the remaining $991 million in fiscal year 2022 and $814 million in the nine-month period for fiscal 2023.

In comparison, the entertainment networks division brought in $39.6 billion in revenue and $2.1 billion in net income in fiscal year 2022 and $31.1 billion in revenue and $1.21 billion in operating income for the first nine months of 2023.

Direct-to-consumer services accounted for $17.98 billion and $14.85 billion of total revenue, linear networks accounted for $12.83 billion and $9.07 billion. Linear networks generated $5.2 billion and $3.3 billion in operating income for fiscal year 2022 and the first nine months of 2023, while direct to consumer (DTC) posted operating losses of $3.4 billion and $2.08 billion.

Despite the apparent downward trajectory, the financials suggest that Disney’s sports division, excluding Star, “is not declining at an overly precipitous rate,” Wells Fargo analyst Steve Cahall wrote in an Oct. 18 note to clients. “This does not solve the problems of taking sports from linear to DTC while rights fees climb, but it may provide some semblance of relief that the main Sports biz isn’t imploding as we speak.”

Keybanc Capital Markets analyst Brandon Nispel, who has previously compared ESPN to a “melting iceberg,” has said that ESPN’s standalone financials “reflect negatively” on the firm’s previous valuation estimate of $30 billion. Ranganathan values ESPN at roughly $22 billion, based on seven times its $2.9 billion EBITDA for fiscal 2022.

The Search for Strategic Partners

In July, Disney CEO Bob Iger told CNBC that the company was on the hunt for a strategic partner that could help take ESPN fully direct-to-consumer.

“Sports stands very, very tall in terms of its ability to convene millions and millions of people all at once,” Iger said on the network. “We’ve had a great business, and we want to stay in that business. That said, we’re going to be open minded there too. Not necessarily about spinning ESPN off, but about looking for strategic partners that could either help us with distribution or content, but we want to stay in the sports business.”

Potential partners who have been floated in recent months have ranged from sports leagues themselves — such as the NFL, NBA and MLB — to telecommunications giant Verizon and tech giant Amazon, according to various media reports.

“Iger is showing those types of partners that the ESPN business has a strong balance sheet that is not being weighed down by the general entertainment networks,” Scott Robson, an S&P Global analyst, told TheWrap.

Wedbush Securities analyst Dan Ives has also previously suggested a potential Apple-ESPN strategic partnership or acquisition, calling the move a “no brainer.” Following the latest disclosure, Ives believes the tech giant is now more likely to try to head down that path.

“The financials show the difficulty of this business in Disney’s business model and we see Apple likely acquiring ESPN over the next six-12 months,” Ives told TheWrap.

But West Monroe M&A senior partner Brad Haller told TheWrap that he “wouldn’t bet” on an Apple acquisition, emphasizing that ESPN is a “declining business.”

Representatives for Disney declined to comment on the strategic partner search. Apple did not immediately return TheWrap’s request for comment.

Can ESPN Grow?

Morgan Stanley analyst Benjamine Swineburne said that growing ESPN won’t be easy, given cord-cutting trends and escalating sports-rights costs.

“However, it is starting off on a more stable base than we had expected and should benefit from broadly rising engagement levels across both its live content and shoulder programming,” he wrote in an Oct. 19 note to clients.

MoffettNathanson estimates that ESPN linear networks EBIT grew 6% in fiscal year 2022, which the firm sees as evidence that the network’s decision to pass on some of its prior sports rights may have helped it remain more stable and grow more than expected. In addition to passing on the NFL Sunday ticket, ESPN has pared down or entirely dropped rights to the Big 10, Pac 12, MLS, Champions League and a smaller MLB package.

Ranganathan expects “robust” bidding for NBA sports rights, which come up for renewal after the 2024-25 season, with potentially interested parties including NBC Sports, Apple and Amazon. She noted that the current NBA rights deal is valued at $2.6 billion per year, with ESPN currently paying $1.4 billion, while Turner is paying $1.2 billion.

“We think Turner and ESPN might pursue smaller deals given their focus on cost cuts,” she added. “The NBA’s allure is its global brand appeal and a younger demographic (men 18-34), a key cohort for advertisers.”

Meanwhile, ESPN’s domestic EBIT declined by 4% for the first nine months of 2023, according to MoffettNathanson. When factoring in adjustments for ESPN+, the research company estimates linear ESPN EBIT is down “mid-to-high teens year to date.”

“We will have to wait to see if [the fiscal fourth quarter] can help reverse some of that decline as we were expecting a much improved quarter relative to the drop in EBIT during the first nine months of the fiscal year,” MoffettNathanson added.

Disney shares, which closed at $83.10 apiece at the end of Monday’s trading session, have fallen 6.6% year to date and 18.3% in the past year. The company will report earnings on Nov. 8 after the bell.

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