Tipping Point? How the Disney-Charter Showdown Could Impact Pay TV Overall

Georg Szalai
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“The end of the end,” Bank of America analyst Jessica Reif Ehrlich called the carriage dispute between Hollywood giant Walt Disney and cable powerhouse Charter Communications in the headline of a Tuesday report. “Breaking up is hard to do,” emphasized Guggenheim analyst Michael Morris before also posing the more ominous question: “Is this the video tipping point?” MoffettNathanson analysts Craig Moffett and Michael Nathanson echoed that, asking: “What is the future of video?” And LightShed Partners’ Rich Greenfield and colleagues went all Star Wars, wondering of the Charter CEO: “Can Chris Winfrey destroy the sports media Death Star?”

The very fact that all these experts used such colorful phrases, worthy of a Hollywood blockbuster film script, shows just how seriously Wall Street is taking the battle of the titans that erupted Aug. 31. The resulting blackout of Disney channels in Charter households hit at a critical time, with ESPN’s networks airing the U.S. Open tennis tournament and a college football game between Utah and the University of Florida. Charter, which does business under the brand name Spectrum, is the second-largest U.S. cable TV provider with 14.7 million subscribers, but, as in the case of its peers, broadband has in recent years become its clear core business.

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After all, cord-cutting and streaming losses have been drags on media and entertainment companies’ bottom lines and stocks. And pay TV giants have complained that the rising affiliate fees they have to shell out for TV networks reaching fewer and fewer viewers don’t make business sense anymore.

“The current video ecosystem is broken,” Charter said. “With The Walt Disney Company, we have proposed a model that creates better alignment for the industry and better choices for our customers.” Disney retorted: “Disney Entertainment has successful deals in place with pay-TV providers of all types and sizes across the country, and the rates and terms we are seeking in this renewal are driven by the marketplace.”

So how big a deal for pay TV overall, and Disney and Charter specifically, is the showdown? Wall Street analysts have weighed in on that topic in recent days.

“If Charter further shifts strategic focus away from its video product, we see increased and sustained risk for not only Disney but for video economics across our media coverage,” Guggenheim’s Morris wrote about entertainment stocks. He also noted the size of Charter and its rising relative importance: “Charter represents about a third of publicly reported video subscribers and about a fifth of the total pay-TV universe.”

How much money is at stake? With Charter saying it had expected to pay Disney about $2.2 billion in 2023, or around 20 percent of Charter’s video programming costs, Morris wrote that “we see risk to Charter as limited to the relationship of actual subscribers lost less the reduction in Disney cost across the entire base.” He warned, though: “Because video overall is gross margin positive, we do believe that accelerated subscriber losses are a net negative for Charter.” Strategically speaking, if this dispute hastens Disney’s plans to roll out a stand-alone ESPN streaming product, “we believe Charter faces greater risk of faster gross profit pressure across the video product,” Morris also concluded.

For Disney, meanwhile, the $2.2 billion in Charter affiliate fee revenue represents 16 percent of Morris’ estimated fiscal year 2023 cable affiliate revenue of $13.4 billion and “12 percent of overall linear networks affiliate revenue,” his report noted, also highlighting: “We do not anticipate there would be significant cost savings to Disney related to this blackout.” Morris also pointed out that the $2.2 billion figure represents 33 percent of Disney’s linear networks fiscal year 2023 segment operating income.

Beyond the company-specific financials, other experts also see the potential of an industry sea change and risk for all big Hollywood companies as two gigantic corporations jostle for leverage in the age of cord-cutting and streaming.

The Charter-Disney “dispute puts [the] entire ecosystem at risk,” argued BofA’s Reif Ehrlich in her “end of the end” report. “If this posture were to be extrapolated across all other major video distributors, we believe it would have a devastating impact on the profit and loss of the entire traditional media and entertainment group. The result would lead to a significant decline in highly profitable linear subscribers that would be only partially recouped by likely fewer and less profitable direct-to-consumer (DTC) subs.”

Not surprisingly, big-name entertainment stocks beyond Disney — from Paramount Global and Warner Bros. Discovery to Fox Corp. — were hit late last week, the expert noted. “While the secular decline in the linear business is no surprise, the concern is this could accelerate the ‘melting ice cube’ and put the ‘nail in the coffin’ on the linear video subscriber business that is generating an overwhelming percentage of cash flows for all these companies and is funding their transitions toward streaming,” Reif Ehrlich explained. “Furthermore, several of these companies are burdened by significant debt loads, and the absence of these cash flows amplify longer-term leverage concerns.”

Although carriage disputes of the past have often included tough talk before coming to an agreement, Reif Ehrlich cautioned about too much optimism about such a deal. “While there may be a short-term resolution, this dispute adds additional uncertainty at a challenging time for the industry when various strikes are underway and advertising trends remains challenged.”

The team at MoffettNathanson also noted that the Disney-Charter war of words sounded much more serious than past standoffs. “While this was initially viewed as another example of a carriage dispute ahead of football season, it is clear at this point that this is not a typical blackout,” they argued. “Charter seems genuinely willing to walk away from Disney, and even the entire linear video model, if necessary.”

The analysts weren’t completely surprised, though, having previously warned of a tipping point for the pay-TV space. Iger’s plan to take ESPN direct-to-consumers could provide just that.

Despite cord-cutting accelerating, the MoffettNathanson experts had so far “not yet seen any significant pushback in affiliate fee negotiations with those companies that we have labeled ‘cheaters,’ or those leaking their premium content to their own streaming services (i.e., Paramount and NBCUniversal),” they pointed out, speaking of an “impoverishment cycle.” But the analysts concluded that everyone is at risk: “The stark reality is the media and distribution landscape has been building up to this moment for many years. Each media company owns some of the blame.”

As such, the whole entertainment landscape must be holding its breath these days, given the “dramatic ramifications” of the Charter-Disney talks on the whole industry.

Trying to highlight the biggest losers, the MoffettNathanson report argued: “If Charter is successful in changing the terms of affiliate fee deals going forward, or in fact punishing the ‘cheaters,’ we would expect to see the biggest hit to Paramount and NBCUniversal’s linear affiliate fees. Fox has the greatest exposure to linear affiliate fees relative to its peers but should stand to take a greater share of the overall pie as long as its premium content remains exclusive to the pay-TV bundle.”

Just like Bank of America, MoffettNathanson put a spotlight on Hollywood biggies’ debt burdens. “The elevated levels of leverage at each company adds to the risk, especially for Warner Bros. Discovery and Paramount with their dependence on linear networks cash flows,” its analysts noted.

Meanwhile, LightShed’s Greenfield & Co. explored their Death Star question and asked if the Disney-Charter battle could end up being “a watershed event for the linear TV business that also blows up the entire sports media ecosystem.” Their take: “Sure, however, we have lived through enough of these battles to know that they usually end in an agreement.”

The analysts outlined two scenarios. The first one assumes that Charter is “ultimately focused on reduced packaging penetration requirements,” in which case “we suspect a deal will be reached in the next couple of weeks,” they wrote. The alternative is much darker. “If however, including the streaming services at no extra cost is a must-win for Charter, then we do not expect a deal to be reached anytime soon and the drop could, in fact, be permanent,” they explained. “We simply do not see how Disney would agree to that, even if it is incredibly pro-consumer.”

The LightShed team also noted how Disney was looking to follow the playbook of peers that have leaked pay-TV content to their own streamers. “If Disney can offer ESPN directly to consumers without the need for Charter, why should Charter have to pay for ESPN to be in at least 80 percent of Charter subscriber homes?” their report summarized the key quandary. “Disney/ESPN effectively wants to have its cake and eat it too as it makes the transition to streaming. To be fair, Disney/ESPN is not alone in this.”

In contrast, Wells Fargo analyst Steven Cahall sounded less alarmed in his takes on the topic. In a Charter report, he highlighted: “Video is much less important to Charter than broadband and mobile, so we don’t see the dispute radically changing sentiment.”

And in a Tuesday report about Disney, he argued that the “Charter dispute [is] not as material for Disney as bears think,” adding that “we’re also not convinced this is a pivotal moment for Disney.” His explanation: “For one, if there’s a persistent Charter blackout or perpetuity drop of Disney content, then subs will likely reappear on other TV services including Disney’s streaming services, Hulu Live TV, YouTube TV, etc.”

Macquarie analyst Tim Nollen expects the two companies to reach a deal but also noted the larger implications of the dispute. “We expect the two sides to resolve their disagreement in some form before long as the stakes are too high for both,” he wrote in a report. “But this is another example of the complexities Disney faces in the near term as it plots a future TV landscape, for itself and the industry as a whole.” He maintained his “neutral” rating on Disney with a $94 stock price target, but highlighted: “TV industry disruption is why we downgraded Disney shares in May.”

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