A surprisingly large decline in profits from the usually reliable cable networks owned by the Walt Disney Co. had analysts scrambling last week to make sure ESPN was still a blue-chip investment.
Sports have been gold for the TV business lately. Unlike entertainment programming, sports ratings are stable. Games are watched live, making them valuable to advertisers. And many viewers regard big sporting events as must-have programming, justifying big-league affiliate fees. All of which have intercepted investors’ normal concern about businesses that incur high and rising costs.
So when earnings for Disney’s cable group in the company’s fiscal fourth quarter ended Sept. 30 came in $130 million under expectations, the first item analysts examined was ESPN, which is facing new competition from 21st Century Fox’s recently launched Fox Sports 1.
“There are hundreds of numbers in Disney’s earnings release, but the only ones that will matter to investors are the cable networks’ revenues and operating income,” Sanford C. Bernstein analyst Todd Juenger wrote after the earnings announcement. “The question, as always, is whether ESPN is somehow fundamentally damaged, or whether it’s just quarterly noise.”
Based on the earnings release and senior executives’ comments on their conference call with analysts, Juenger concluded that “we do not believe the cable network miss can be traced to ESPN.”
While “the focus for investors remains the cable networks miss,” Michael Nathanson of MoffettNathanson reiterated his buy rating on Disney stock. Reason No. 1: “Concerns about ESPN are overblown,” Nathanson wrote.
On the call, Disney CEO Bob Iger attempted to reassure the analysts that the ESPN playbook still called for growth.
“I think that you’re likely to see nothing particularly dramatic to change the trajectory of growth of ESPN over the next five years or so, partially because a lot of our distribution deals are done, as are a lot of our licensing deals for sports rights,” Iger said.
But analysts had to take some of this on faith, because of the way ESPN’s earnings show up in Disney’s financial report. Firstly, ESPN is just a part of Disney’s cable group, which includes many networks and investments in the U.S. and around the world. On top of that, earlier this year, Disney had warned analysts that $172 million worth of deferred ESPN affiliate fees would be reported in the fiscal third quarter that had previously been reported in the fourth quarter. That $172 million set up a difficult comparison. But even though they had been warned about the deferred revenue, analysts’ estimates were still way off.
Why? “We think the miss was a function of bad sell-side forecasting — including us — rather than evidence of underlying factors” at ESPN, Juenger said. Some factors analysts might have missed included the shutdown of an ESPN channel in the U.K., foreign exchange fluctuations and investment in nonsports channels overseas.
A Hard Play to Read
On the earnings call, Disney CFO Jay Rasulo acknowledged that it can be hard to decipher what’s going on at the cable networks based on the earnings release. He tried to help the analysts by saying that taking the $172 million in deferred affiliate revenue out of the picture, cable revenue and operating income would have been up 6%. “ESPN was significantly higher than that,” Rasulo said, adding that ESPN ad revenue climbed 9% in the fiscal fourth quarter. So far in the current quarter, Rasulo added, “ESPN’s cash ad sales are pacing up nicely.”
Looking ahead to fiscal 2014, Nathanson expects 7% earnings growth for Disney’s cable networks. Quarterly growth rates will be determined by when the company completes deals with Dish Network and DirecTV, along with the success of the new European channels.
Cable network expenses will increase by midsingle digits in the first half of the year, but will hit double digits in the second half as new agreements with Major League Baseball and the National Football League kick in.
But Nathanson still wants to know more about what happened to ESPN in the quarter, and is looking ahead to SEC filings with additional details. “We will need to comb through the 10-K [filing] over Thanksgiving turkey to dig into all the actual results for the quarter,” he said.