the fading of Bloomberg Radio

first ESPN…

Over the Thanksgiving holiday my older son pointed out to me that family friend, John Koblin, had written a critical article for Deadspin on how ESPN has gradually lost its journalistic way as it chases television ratings.

The example John focusses on is the network’s apparent obsession with New York Jets football player, Tim Tebow–a legendary college football figure who appears to be the latest in the parade of Heisman Trophy quarterbacks not quite good enough to make it in the NFL.

How is Tebow a continuing story?  ESPN2’s unsuccessful morning show First Take switched format in late 2011.  The new look:  …a staged debate between two cartoonish figures who duel in vintage WWF fashion over some item of sports news.  Their favorite topic:  Tebow.

ESPN discovered that the new First Take was surprisingly popular, even taking audience share away from its mainline morning show, Sportscenter.  It reacted in two ways:

–more phony debates all over the network, complete with loud voices, exaggerated gestures and bombast, and

–Tim Tebow all the time, no matter what the ostensible topic of a given show.

I’m of two minds about this ESPN development.  As a holder of DIS shares I guess I should approve.  As a sports fan, I’ve got to find other sources of sports information and analysis.

…now Bloomberg

Yesterday I was on my way in the car to Delaware and turned on the Bloomberg Radio morning broadcast for the first time in a while.  Five years ago I used to listen every day, either live or through podcasts of important segments.  No longer.  As Bloomberg dialed down the information content and dialed up the reporter self-congratulation I began to look elsewhere.

Anyway, I caught the last part of The First Word, with Ken Prewitt, who strikes me as the only savvy professional journalist left on Bloomberg.  Then came Bloomberg Surveillance, which appears to have had a format tweaking since the last time I listened.  Mr. Prewitt is gone (…or maybe he was just taking a day off from the insanity).  What remains is a veritable First Take of loud voices and self-congratulatory glorification of trivia.

To my mind, this can’t be an accident.  The radio personalities must have been trained, à la ESPN, to speak louder, create fake “debate” and constantly tell the audience how important the topics–and the radio hosts themselves–are.

And, as with First Take, the quest for higher ratings is the most likely explanation, with Fox News and CNBC as the models.  It’s probably also cheaper to simply act as if you’re conveying relevant information rather than to do the research and analysis needed to create it.

The written Bloomberg news appears not to have been infected by this broadcast tendency.  I figure the investment professionals who pay $30,000 a year or more for Bloomberg terminals wouldn’t put up with the stuff that’s now on Bloomberg Radio.

Where is the real financial news today?  It’s in newspapers like the Financial Times  and the Wall Street Journal.  And, like sports, it’s in the blogosphere.

We may mourn the loss of Bloomberg Radio as an information source, and the fact that the search for relevant stock market information is somewhat more difficult without it.  But this also means that insights we may develop are that much more valuable–because they are less likely to have been fully disseminated into the market at the time we figure them out.

ESPN’s role in DIS

Still no internet/TV.  Still no sign of Comcast trucks.  Nor is Comcast willing to say how much longer the outage will last–today is Day 17.  The whole neighborhood is switching to FIOS.  

This is, of course, a trivial issue when compared with the devastation in low-lying areas of Long Island or with the low-income housing in NYC that still has no power (but whose residents are still being charged full rent–rebates to come in January???).  

This post is prompted by a reader’s question about ESPN.  It also addresses some assumptions I’m making about ESPN in saying I think DIS will be a good relative performer over the coming year.

limits to what I know

I’m very comfortable as an investor that I know more than I really need to about how the Disney part of DIS works.  I think I know enough about ESPN, too.

This is an important distinction, however.  In my mind–if nowhere else–there’s an unresolved question about the long-term growth prospects for ESPN.  I don’t think this is a near-term issue.  I don’t think it’s primarily about competition, either.  In its simplest form, it’s how long can ESPN continue to grow revenues at twice the rate of nominal GDP, as it is currently.  When does growth slow down?

ESPN’s importance to DIS

Today, ESPN accounts for 2/3 of DIS’s profits.  What happens if ESPN stops growing at 15% a year and slows down to 10%?  What does the rest of the business have to do to take up the slack? The answer: rev up growth to +25%/year.  Is that possible??  Possible, yes; probable, no–in my opinion.  Therefore, if ESPN slows down, Wall Street revises down its estimates of DIS’s long-term growth rate–and the stock adjusts downward.

ESPN doesn’t have to speed up for DIS to be a good stock.  But it can’t slow down either, in my view.

sports programming

What’s unique about sports programming–and what makes ESPN so attractive–is that it’s the only type of mass media where consumers are regularly willing to pay higher prices for pictures of events in cutting-edge resolution, and for tons of expert (or even not so expert) commentary.

This is not only true in the US, where there’s a mad rush to buy the latest model TV set just before the Super Bowl (the Big Game, to those unwilling to pay to use the SB moniker).  It’s the same in every country whose stock market I’ve ever been involved in.

programming rights

Not everyone can broadcast a sporting event.  Most sports teams/leagues periodically auction off to the highest bidder exclusive rights to broadcast their games.  For many profession teams (and icons like Notre Dame), these broadcasting rights can be their single most important asset, running into the hundreds of millions of dollars in value.

Many organizations break the rights down into a number of pieces to make them more affordable, and therefore encourage more spirited bidding.  The NFL, for example, has separate packages for Sunday Night Football, Monday Night Football, Thursday Night Football, NFC Football and AFC Football–broadcast by NBC, ESPN, the NFL Network, Fox and CBS, respectively.

where ESPN fits in

ESPN is by a mile the dominant sports broadcasting distribution network in the US.  It broadcasts all the major sports.  It also fills a bunch of channels, in both English and Spanish, with 24/7 commentary and analysis.  Over the years it has been consistently innovative, so it possesses an unparalleled internet presence as well–only commentary but fantasy league and broadcasting, too.

network effects

ESPN’s is a business where the rich get richer and the poor get poorer.  As a distribution network gets larger and if a distributor can raise prices (which so far ESPN has been able to), the distributor generates more money to spend on content, including broadcasting rights.  This gives it a huge, and growing advantage over smaller rivals.    At some point, the amount of capital needed to enter the market, or even to maintain a presence, becomes prohibitively high and the weak links drop out.

For market leaders like ESPN, this is a great business.

a sign of maturity?

About two years ago, ESPN decided to make a major move into soccer.  Two reasons:  this would be the leading edge of ESPN’s expansion into Europe; and ESPN could become the leading distributor to a small but growing fan base in the US.

The heavy investment ESPN began to make implied to me that management saw this as the company’s most attractive long-term expansion opportunity.  (Otherwise, it would have focused on something else.)

ESPN, however, lost out in the bidding for Premier League soccer rights in Europe to incumbents who recognized the threat ESPN posed.  It was worth losing money to them just to keep ESPN out.  Not a great solution to the threat of ESPN, but probably the best alternative available.

So, for now anyway, the geographical expansion is off the table.

spending up on the Disney side

Since then, DIS has agreed to buy Lucasfilms for $4 billion.  It has added Cars Land to Disneyland and is overhauling Fantasyland at Disneyworld.  It’s also installing new reservations/guest interface software at the parks.

…a coincidence that Disney capital spending is rising just after ESPN’s need for capital has decreased?  Maybe.  Another interpretation, though, is that DIS’s capital is going into the highest return projects–and that none are in ESPN.

my take

It’s not necessarily a bad thing if ESPN sees no new big untapped markets to enter.  In fact, DIS’s generally conservative accounting philosophy implies ESPN’s near-term profits will likely be higher because the expenses of European soccer rights and of expanding its soccer coverage won’t be there.

But DIS’s shifting capital allocation priorities do bring up the issue that ESPN won’t continue to grow at the current rate indefinitely.

The only practical conclusion I’m drawing is that if what I’ve just said is right, I’ve got to be careful to set a price target ($55?) and remember to sell.

DIS 3Q12 earnings–highest all-time profits

the report

On August 7th, DIS released profit results for 3Q12 (the DIS fiscal year ends in September).  The company posted its highest quarterly profits ever–$1.83 billion.  At $11.1 billion, revenues were up 4% year on year for the period.  EPS were $1.01.  That was 29% from the $.78 posted for 3Q11.  It also compares favorably with the Wall Street consensus estimate of $.93/share.

The stock initially broke through the $50 barrier on the upside on the news.  It has since settled back a bit below that mark.

the details

media networks

This segment makes up 2/3 of DIS’s operating income.  It’s mostly cable; and of that, the lion’s share of profits come from ESPN.

Operating income was flat, yoy, at $2.13 billion.  But a change in contract terms with Comcast has shifted into 1Q and 2Q $139 million in payments normally recognized in 3Q.  There are other underlying complicating factors (the norm for this segment, and for DIS overall) as well.  On an apples-to-apples basis, op income for Media Networks is probably growing at 10%+.

parks and resorts

This segment represents a bit less than 20% of DIS’s op income.

Parks and Resorts were up 21% yoy during 3Q12, at $630 million.  The comparison is flattered, however, by higher yoy royalty payments from Tokyo Disneyland, based on a rebound in attendance from the earthquake/nuclear disaster-depressed 3Q11.  DIS also received in the current quarter an insurance settlement for business interruption at Tokyo Disneyland last year.

Business is recovering strongly at DIS’s domestic theme parks–thanks in part to the successful makeover of the California Adventure park at Disneyland.  The company has new cruise ships and bookings are perking up as well.

Normalized growth for Parks and Resorts is probably closer to 10%.

studio entertainment

Movie results were up over 6x to $313 billion, thanks to the Avengers film, which has taken close to $1.5 billion worldwide.  Even so, films now represent less than 10% of DIS’s overall operating income.  Of course, successful movies can also have positive rub-off effects on the theme parks.  They’re the foundation of much of DIS’s merchandise sales, as well.

consumer products

To some degree, Consumer Products earnings are affected by internal negotiations about revenue sharing among segments about sales of character-related merchandise.  That was a yoy positive in 3Q12, when this segment posted op income of $209 million on sales of $742 million.  Growing at maybe 10% yoy, Consumer Products represents considerably less than 10% of DIS.

interactive

DIS’s gaming and internet businesses continue to make losses.  The good news is that interactive is gradually approaching breakeven.  The segment lost $42 million in the current quarter, less than half the deficit in the year-ago period.

a shift in international strategy at ESPN

For the past couple of years, DIS has spoken enthusiastically about international expansion possibilities for ESPN.  Its initial foray was to be soccer broadcasting in the UK.  the company’s tone was somewhat less positive a quarter ago.

During Q&A after the 3Q12 earnings announcement (you can get transcripts for free from Seeking Alpha–a really very valuable service), DIS management said in effect that it is reining in its European expansion plans after losing in the bidding for Premier League broadcasting rights.  It has also ended its Asian jv with News Corp.  ESPN is now concentrating on expansion in Latin America.

It’s too simplistic to characterize the UK expansion attempt as a mistake.  Rather, incumbents there (correctly, in my view) recognized the threat that ESPN posed and were willing to take substantial near-term losses in order to deny a powerful new competitor a foothold in their market.  Not pleasant for them, but the correct strategic move.

As for ESPN, this removes the near-term possibility of large positive earnings surprise from a new profit source.  But the immense popularity of its sports programming in the US make it a steady grower at 15% or so for the foreseeable future.

theme park cap ex is peaking

Other than for its theme parks, DIS isn’t in very capital-intensive businesses.  Of its total segment capital expenditure of $2.5 billion so far in fiscal 2012, $2.3 billion is attributable to expansion at Disneyland and Disneyland Paris, as well as construction of Shanghai Disney.  With Disneyland expenditure finished, the company is beginning work on overhauling Fantasyland in Disney World.  Despite this expense, company cap ex will likely gradually decline from the current level, providing higher free cash flow for dividend increases and further stock buybacks.

buybacks continue

Year to date, DIS has repurchased 55 million shares of its stock at an average price of a bit over $38 each.  During 3Q12, the buyback pace slowed somewhat, with 8.6 million shares bought at an average price of $43.37.

In its earnings conference call, however, DIS made it very clear that it regards its intrinsic value as significantly higher than the current share price–and that, therefore, buybacks will continue.  It intends to devote about a third of its free cash flow to a combination of buybacks and dividend increases.

my take on the stock

Accounting quirks aside, DIS seems to me capable of delivering 15% annual earnings growth, with limited cyclicality.  The stock is trading at a slight premium to the S&P 500.  It has strong management and a collection of iconic brands, the most important of which is ESPN.  My guess is it will be a mild outperformer over the year ahead.