As cable subscriber counts have dwindled in recent years, many analysts have been focused on the effect upon ESPN and its parent entity The Walt Disney Company (DIS). The reason for this is because the monthly channel cost for ESPN dwarfs everything else in the cable field. ESPN charges its cable distributors $7.21 per month for each subscriber, whereas Fox Sports 1 only charges $1.10. Fox Sports 1 can lose a bit over six subscribers in order for the shareholders of 21st Century Fox to sustain the same absolute dollar loss that Disney shareholders experience when just one ESPN subscriber is lost.
With 85 million subscribers, ESPN currently brings in $7.3 billion from subscriber fees. It also brings in another $3 billion from advertising.
On the expense side, ESPN pays $2 billion this year for Monday Night Football, $1.5 billion to show NBA basketball games, $700 million for baseball, and $600 million for the college football playoff. Sum it all up, and ESPN is on the hook for $7.3 billion in rights-related expenses over the next month.
The big picture is that ESPN has $10.3 billion coming in, $7.3 billion deducted for rights, and the another $800 million deducted for the cost of paying ESPN employees and creating the channel. Basically, ESPN is a machine that produces $2.2 billion per year in net profit.
The manifested risk, however, is that the subscriber counts are falling fast. Just five years ago, ESPN subscribers existed in over 100 million households. ESPN has lost over 1 million subscribers in the past two months, which is historically high and worrisome for ESPN executives because the fall months have football and the attrition rate is usually slower.
ESPN has been losing subscribers at a rate of 3 million per year for the past five years.
In 2019, ESPN is on the hook for about $8 billion in rights-related expenses. Even if it raises the monthly channel cost for distributors up to $8.50 by that time, it will need to have at least 78 million subscribers for the subscriber fee to equal the rates-related expenses. Now, ESPN also receives advertising income, but the cost advertiser have been paying per eyeball have been declining by about 5% each year since 2005, and the number of eyeballs watching ESPN is shrinking.
So the cost of overpaying for rights is about to collide with a dwindling subscriber count. The NBA deal was a gross overpayment, and the NFL deal was a moderate overpayment. It is a bit of a conjecture, but I would say that the key number at which ESPN only breaks even is 75 million subscribers. If the ESPN subscriber count dips below that number in the next three to five years, then it will be a net drag on Disney’s earnings.
Some people have been calling for ESPN to come up with an over-the-top offering. I’m not sure that’s the answer, as HBONow only has 1 million subscribers paying $20 per month. If HBO can only get a $240 million stream, what can ESPN expect?
Also, this is a moot point, as the NBA and NFL contracts prohibit ESPN from making an over-the-top offering. That could be renegotiated at a certain price, but it makes you wonder whether this type of strategy would sow the seeds of ESPN’s own self destruction. If ESPN’s over-the-top offerings gained traction, why wouldn’t the content owners just do it themselves and cut out the middle man? You’re just as capable of paying the NFL $15 per month to watch football online as you are paying ESPN. The question then would become: How much value added does ESPN independent of transmitting sports games?
If ESPN keeps shedding subscribers at its current rate, it is three years away from no longer being profitable. That is a byproduct of paying escalating fees for content at the same time the base of viewers declines. As things stand now, ESPN remains a cash cow for Disney. And Disney’s non-ESPN related entertainment holdings are growing earnings at 12%. So you can say with certainty that Disney shareholders will be fine over both the medium and long-term. But regarding ESPN specifically, management will require some boldness to avoid a day of reckoning in 2019.