Disney(DIS)/ESPN: from growth to value

the maturing of ESPN

In the 2016 DIS fiscal year (ended in October), earnings from the Media Networks segment, which is basically ESPN, decelerated from its fiscal 2015 +6% pace to a slight year-on-year decline.

Two problems:  increasing costs for sports rights; and “cord cutting,” that is, consumer reluctance to pay increasing fees for cable service and cancelling instead.

Part of the issue is the proliferation of new sports content generated by individual teams.

Part is the high cost of ESPN programming to consumers:  SNL Kagan estimates that by the year after next, ESPN will be charging $9.17 per cable subscriber for its services, up from what I think is around $8 now.

Part is also ESPN’s preferred position in the basic packages offered by cable companies.  I’ve read analyses, which I’m not sure are correct, that maintain that although all cable subscribers pay for ESPN, at few as 20% actually use the service regularly.  If so, $100 per year per subscriber translates into $500 per year per user.

In addition, as a sports fan I’m offended by the faux debates and shouting matches that ESPN has begun in an attempt to woo viewers.  Covering WWE as if it were a real sport   …Really?

the move from growth to value

It seems pretty clear to me that ESPN is no longer a growth business.  Gathering realization of this by investors is the reason, I think, that DIS has underperformed the S&P over the past two years by about 25%–despite its movie and theme park success.

The important question for investors is how much deceleration at ESPN is factored into today’s DIS quote.  Is the worst that can happen already priced in?

worst case

I think I understand the worst-case scenario.  It’s that pricing for ESPN ultimately shifts from per subscriber to per user.  This most likely means a substantial decrease in ESPN revenues.  The big question is how much “substantial” is.  If it’s correct that only one in five cable subscribers actually uses ESPN, then revenues could be cut in half by the change, even if users are willing to pay double what they are laying out today.

That outcome may be extreme, but it’s certainly not priced into DIS stock, in my view.

I’m not sure what the right calculation is.  However, while the outcome of this important issue is so up in the air, I find it hard to imagine DIS outperforming.

 

 

 

net neutrality

Happy Veterans Day!!!

On Monday, President Obama made a strong statement in favor of net neutrality, maintaining that the provision of internet access should be a utility service like the provision of water and electricity.  Personally, I think this is common sensical and correct, and it’s the way we should do things if we were starting from scratch.

His statement comes a few days before the Federal Communications Commission will release its newest version of internet rules, one that will likely allow internet service providers to continue to charge extra to big services like Netflix.  Mr. Obama is now on record as opposing what the head of the FCC, Tom Wheeler, is about to do.

I can’t help thinking that the statement is more than a little disingenuous.  It comes just after the election, so voters don’t have a chance to weigh in on the issue.  It also comes less than a year after Mr. Obama appointed Mr. Wheeler, who spent his career working in and lobbying for the biggest ISPs, the cable companies, to head the FCC. (Wikipedia says Mr. Wheeler is in the cable industry Hall of Fame–wireless HOF, too.)  What did Obama expect Wheeler to do?

I don’t have a solution for the net neutrality issue, but I think know where the problem lies.

Government creates utilities when the public interest is best served by having only a small number of companies providing a capital-intensive service.  Certain firm are granted monopolies or near-monopolies in given service areas.  To prevent abuses, the firms’ business focus is restricted and profits are regulated.  Profit growth is (almost always) tied to the increases in new capacity the utility brings into service.

Consumers are charged by the amount of the service they use; utilities are chomping at the bit to provide more and better service.

Almost none of this applies to the cable companies, whose profits, in the short term anyway, can be maximized by doing the opposite–providing the worst service at the highest price (think:  Comcast or Time Warner Cable).  Yes, both the cable companies and their mobile brethren, ATT and Verizon, have the advantage of being able to build their internet presence using their monopoly cable/telephone infrastructure.  But that in itself doesn’t make their ISP services monopolies.

I don’t see any quick fix.  The orthodox economic solution in a case like this is to encourage competition–that is, prevent further consolidation among existing ISPs and provide incentives to new entrants.  Let’s see if Mr. Obama speaks out against the proposed Comcast-TWC merger, which would be his next logical step if he means what he said on Monday.

 

 

 

the Supreme Court ruled against Aereo yesterday

Aereo, the antenna company

As Aereo would describe itself, it’s kind of like a company that rents storage lockers to individuals–only it rents TV antennas.  Each customer has his own individual micro-antenna, located in a central antenna farm.  These micro-antennas receive the free over-the-air broadcasts from the major TV networks and retransmit them over the internet to a customer device, where TV programs can be viewed in real time.

If Aereo had started up ten years ago, this might not have been a big deal.  But in today’s world the TV networks collect hundreds of millions of dollars in annual retransmission fees from cable networks in return for allowing them to stream network content in real time to cable customers.  In the current cord-cutting environment, Aereo offers/ed an easy and cheap way for getting TV content (sports programming is the key) without having a cable subscription.

Aereo had two claims:

–it was acting just as if it were putting a rental antenna on each customer’s roof, only the antenna is located in a warehouse somewhere with good reception, and

–because each customer was choosing what to have streamed to him, even if there were copyright issues, the networks’ beef is with the individual customer, not Aereo.

prior lawsuits

The networks sued Aereo in Federal court in New York   …and lost.  They sued an Aereo knockoff  in Utah   …and won.

Both Aereo and the networks urged the Supreme Court to take the case and decide.

the ruling

The decision, 6 – 3 against Aereo, with the most conservative justices dissenting, came yesterday.

If I understand the ruling (don’t bet the farm that I do), the decision came in a way that Aereo hadn’t expected.

The majority said that back in the day, cable companies set up their own antennas to capture over-the-air network content and deliver it to cable customers without paying the networks for doing so.  Congress expressly made this illegal in 1976, through a revision to the Copyright Act .  So it didn’t matter if Aereo owned one humongous antenna or a gazillion teeny-tiny ones.  It also didn’t matter that the customer ordered his personal antenna to send the content or not.  All that mattered was that Congress outlawed delivering real-time network content without paying retransmission fees.

The majority also made a point of distinguishing real time delivery from time-shifting, where a customer records content for later viewing.

stock market implications

Take the Aereo IPO off your calendar for now.

It’s a big win for the broadcasters, protecting their cable retransmission fees for at least several years.

Unfortunately for them, it also leaves a lot up in the air.  We now know what Aereo can’t do, which is stream network content in real time, or with a brief delay.  But could it stream content with an hour lag?   …or the next day?  What about someone who records copyrighted content and shares it through Dropbox?  Is Dropbox responsible, or is it only the user who’s in trouble?

This case seems to show that operating through a big bunch of teeny antennas is colorful, but provided no legal protection.

My guess is that someone, maybe not Aereo, but someone, will try to revive the service, building in a time delay.  I’m not sure how much people would be willing to pay for time-shifted content, but my hunch is the audience would be surprisingly large.

Anyway, I think this possibility will prevent the content companies from running away to the upside.

 

 

 

cable TV cord-cutting is here to stay

That’s according to media consultant, SNL Kagan.

SNL Kagan is the firm that first called widespread attention to the phenomenon that significant numbers of subscribers to multi-channel entertainment service providers, like cable TV or satellite, are cancelling their service.  People are watching increasingly their favorite programs over the internet through services like Hulu.  And they’re using Netflix as a substitute for on-demand movie watching.

During the middle two quarters of last year, cable et al. in the US actually showed declines in subscriber numbers for the first time ever.  The fact that subscribership has since rallied back into the plus column has some observers concluding that internet-based “over the top” content distribution will remain a fringe phenomenon.  SNL Kagan disagrees.

The consultant points out that:

–while traditional cable/satellite is growing, its expansion is less than the rate of new household formation.  This means the older services are gradually losing market share;

–the number of OTT households will likely rise by 80% this year to 4.5 million, or about 4% of the market;

–for at least the next several years, the consultant expects OTT households to expand by a steady 2 million annually.  This means they’ll number 12 million or so by 2015, and represent 10% of the market.

Netflixing and Huluing are different

Neilson observes that, although they may be the same people, individuals behave quite differently while Netflixing from when they’re Huluing.

–Netflixers, as you’d suspect, primarily watch movies using the service.  A small majority view content on their TV screens, with a game console as their preferred connection device.  42% watch the movies directly on their computers.

–Huluers, as you’d also figure, watch almost nothing but TV shows.  They view their content almost exclusively on their computers, however, although sometimes they’ll hook the computer up to a TV screen.

One constant for both services:   almost no one uses Google TV or Apple TV.  More people watch on cellphones or tablets than on either.

my thoughts

Let’s assume that Huluing and Netflixing give us a peek into the future.  What are we seeing?

–a world where cable TV companies are valuable because they deliver internet access to customers, not entertainment content directly to a TV. Their rivals will principally be the wireless companies that are building their own mobile internet networks.

–a world where TV sets no longer play a prominent role.  Maybe you’ll have one in the house to watch sports events (the only kind of entertainment where people are willing to pay for picture quality), maybe not.  Viewing gets done on computers or tablets.

–a world where the low-end PC disappears.  Tablets are one successor, as the market already realizes.  Traditional PCs, laptop or desktop, with larger, better resolution screens and good audio may be another.   APPL is moving in this direction by eliminating the MacBook from its lineup and offering customers only the MacBook Air and the MacBook Pro as choices.  (This seems to me to open the door to Chromebooks in the education market, but time will tell.)

Implications for INTC are, at worst, mixed and maybe pretty favorable.  It may sell fewer chips, but its product mix will shift to higher value-added products.  Cloud computing becomes much more important.  And the performance bar is raised for ARMH’s much-discussed entry into the PC market.