The Walt Disney Company is an iconic American brand. On the back of successful franchises like “Frozen,” networks such as ABC and ESPN, and entertaining theme parks, Disney has performed well, giving investors many reasons to give thanks. As of close-of-business Nov. 11, 2015, the stock averaged a 36.6% return over the past three years and 17.1% over the past 10, a fantastic run for any company. (Source: Morningstar). With that in mind, for those of us who have owned the stock, it may be time to think about taking a bit off of the table.

Revenue and earnings

Disney (DIS) ended fiscal year 2015 with a 7% gain in revenue from 2014. Of Disney’s $52 billion in revenue, over 44% comes from Media Networks, by far its largest contributor. Parks and Resorts come in second at just over 30%, while studio entertainment operates a distant third at 14%. Media Networks additionally comprise around 53% of Disney’s operating income. (Source: Disney Full Year Earnings For Fiscal 2015). Mr. Kudla says. “We buy on headline risk, knowing that fundamentals are still good for the sector and that it will eventually rally, probably just with earnings reports, and that’s what we’re seeing now.” ...

Increasing costs

ESPN paid handsomely for broadcasting rights to live sports coverage. For example, it pays the NFL almost $2 billion a year, will pay the NBA $1.4 billion starting in 2016, and pays MLB $700 million for scant coverage throughout the year. Industry experts have questioned extensively whether ESPN overpaid for these long term deals. (Source: Sports Business Journal) Decreasing subscriber base ESPN generates the highest “per subscriber” fee in cable of over $6 per subscription a month. Whether you are a sports fanatic or have little interest, ESPN receives the subscription fee under most traditional cable bundles. When negotiating the above-mentioned deals with sports leagues, ESPN relied on the continuation of the bundle revenue stream, which amounts to a subsidy to ESPN and its sports-fan subscribers.

According to Nielsen however, subscription growth is not going in the right direction, “since July 2011, ESPN’s reach into American homes has dropped 7.2%, from more than 100 million households — roughly the size of the total U.S. pay-TV market — to 92.9 million households.” (Source: WSJ). To put the value of the bundle subsidy into dollars, some analysts project that ESPN would have to charge more than $36/month as an a-la-carte offering to match its current $6 rate in bundled subscription revenue. (Source: MoffettNathanson Research).

Headline risk

During the third-quarter earnings call in August, CEO Robert Iger alluded to further concerns regarding ESPN subscriber losses and changes in the business-distribution model. Disney executives also came out and revised growth expectations for its cable business from high single digits for fiscal years 2013-2016 to mid single digits. The stock sold off around 6.4% in after-hours trading on that news and has yet to reach previous highs. ...

...It is pretty clear that Disney’s business model regarding ESPN is bound to go through some shake up in the coming years. ...


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