Why a Disney Spinoff of ESPN Would Be a Whiff | Analysis

The Walt Disney Company’s share price has risen more than 3% since Monday’s news that activist investor Daniel Loeb’s Third Point has acquired a new stake in the company, though analysts and experts have questioned Loeb’s push to spin off ESPN into a standalone company.

In a letter to Disney CEO Bob Chapek, Loeb argued that the sports property “would have greater flexibility to pursue business initiatives that may be more difficult as part of Disney.” But due to a range of financial and streaming factors tied to Disney’s future, many analysts argue that ESPN may be most valuable right where it is.

“I don’t see too many positives of spinning it off,” Dale Welaufer, CEO of Charlotte Lane Capital, told TheWrap. “Theoretically, there are some big holes in Loeb’s argument.”

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Why Disney needs ESPN financially

The worldwide leader in sports currently exists within a media conglomerate capable of monetizing the asset in both content creation and distribution. In other words, Disney can help wring out the best audience-friendly TV from ESPN while providing it with the stretchiest overall reach.

Disney’s ownership of ABC helps the cable network contribute to the hefty cost of sports broadcast rights and provides more potential eyeballs (ABC will simulcast “Monday Night Football” with ESPN this NFL season, for example). Disney’s support systems and resources are a boon for ESPN — and TV networks/streamers should want that sort of corporate safety net.

Plus, ESPN currently serves as a profit center that the conglomerate desperately needs. Disney has bled $3 billion in cash over the last nine months, including a loss of $1.1 billion on its direct-to-consumer segment in the most recent quarter. It needs to be able to sustain these streaming losses, which are expected to peak this year, while paying down roughly $50 billion in debt and around $1.8 billion in interest each year. That’s some suboptimal math right there.

“Disney needs capital — why would you deprive it of a cash generative force?” Wetlaufer said of ESPN.

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The company’s linear networks segment, of which ESPN is a main contributor, generated an impressive $7.2 billion in revenue in the most recent quarter. Linear ESPN earns about $10 per month per subscriber and was in 76 million U.S. homes to end last year. ESPN+’s average revenue per user (ARPU) is rising year over year — most recently it saw a 2% increase. Put more simply, ESPN still makes a ton of money!

“It’s really hard to pay interest when Disney+ is losing all this money on the side,” David Offenberg, associate professor of entertainment finance at LMU’s College of Business Administration, told TheWrap. The company “needs something to create cash flow for them to pay off interest, debt and support Disney+. ESPN is a perfect fit for that.”

If Loeb is concerned about the duration and longevity of ESPN, which lost 8 million subscribers in 2021 and has seen its customer base steadily shrink over the last decade much like all of pay TV, then why wouldn’t the market share the same concerns? Turning the sports network into a freestanding company would likely increase the network’s overhead expenses — and lead to a complicated negotiation to unravel sports broadcast rights currently shared with ABC.

Yes, the cable TV model is in decline. No one is arguing that. But its death has been greatly exaggerated overall. “I suspect ESPN is going to continue making positive cash flow for Disney for many years to come,” Offenberg said. “It will dwindle as the cable subscribers decline, but its demise isn’t coming anytime soon.”

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ESPN boosts Disney’s streaming power

The other big reason analysts say Disney should keep ESPN in-house is the value it provides to the evolving Disney streaming bundle, which includes Disney+, Hulu and ESPN+. Any potential spinoff would need to maintain that business relationship to maximize value.

According to first-quarter 2022 Parks Associates consumer research, 52% of U.S. internet households have at least one Disney streaming service in their home. Within that, “ESPN+ is the most popular and valuable sports streaming service in the [over-the-top] market,” Parks Associates senior analyst Eric Sorensen told TheWrap.

Zooming out, 16% of internet households have ESPN+, which is twice the penetration of the next highest sports subscription service, NBA.TV (8%), per Parks Associates.

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Loeb noted in his letter that Disney’s family-friendly brand may be preventing ESPN from embracing the legalization of sports gambling as a lucrative new revenue generator. But Disney already holds a nearly 5% stake in the sports-betting giant DraftKings, and last summer explored licensing the ESPN brand to DraftKings and Caesars Entertainment in deals worth up to $3 billion — although no agreement has been announced.

With major states such as California, Texas and Florida expected to follow in the footsteps of New York and New Jersey in the coming years, the legalized sports gambling market is only going to grow more valuable.

“If Disney had any reason to part ways with ESPN as Daniel Loeb suggests, it would be to pursue other business interests,” Sorenson said. “However, when wagering becomes legalized in all 50 states and it gets tied to the worldwide leader in sports, it has the potential to be a cash cow for ESPN and the Mouse.”

The only way a spin off can work is if Disney loads up ESPN with its debt, similar to what AT&T did with WarnerMedia, and then gets a one-time cash payment in return. But then the question becomes how much debt can ESPN handle before it’s no longer a viable spinoff? The juice just isn’t worth the squeeze, especially since ESPN brings both free cash flow and streaming value to a company that’s banking on both.

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