How to cure the malaise? Bloomberg’s Tara Lapachelle argues to forget a cure and instead sever the joint by spinning the unit out into its own company. I guess it becomes someone else’s problem then? The main advantage of a spinoff would be to ‘right size’ the company’s multiple as it is being dragged down by ESPN. She cites RBC analyst Steven Cahall who notes that ESPN has ‘”almost single-handedly de-rated Disney by about 3.5 to 4 turns” of its Ebitda multiple.’ The other advantage noted is that the move could potentially solve the company’s successor issue after two leading contenders recently left the company. With a spinoff, Bob Iger, the current CEO, could remain atop one company, while a new appointee could take the helm of a more focused and smaller company. Others jumping on the spinoff bandwagon argue that ESPN has little synergy with the rest of the company, which operates like a well-oiled machine turning movie franchises into toys and theme park attractions. For some perspective, the unit generates ~43% of the overall company’s revenues so this would be a big spinoff.
While I wouldn’t expect the company to take advice from a competitor, John Malone also floated the idea of an ESPN spinoff. In a November interview with CNBC, Mr. Malone said that ‘if I had to guess, what you will see is a split of Disney with ESPN spun off and, probably, ESPN could be owned and protected by a distributor in the U.S.’ He also speculated that Apple (AAPL) could be an acquirer of Disney post-spinoff because…they are both global companies?
As if that weren’t enough, investors are also focused on the company’s pay TV issue. At a recent Citi conference, attendees were asked to vote on the following question:
The single most important factor that prevents me from buying Disney’s stock is; 1, it’s unclear how management navigates changes in the pay-TV ecosystem, given ESPN’s fixed costs; 2, I expect the strong string of hit and views to come to an end; 3, the theme park trends have to roll over; or 4, I need to know who the next CEO is before I can invest?
and the response was striking:
…Wow, 84% unclear how Disney navigates the changes in the pay-TV ecosystem. Only 2% were concerned about the movie hits coming to an end. None expect the theme park to roll over. And only 15% needed to know who the CEO is. Wow, that’s interesting.
Despite all of this, Forbes doesn’t buy the spinoff story and argues that although ESPN is declining, the unit (really the Media Networks segment) continues to throw off healthy amounts of cash which the overall company uses to invest in its other businesses. It also uses that cash for shareholder friendly activities like share buybacks (which it has done aggressively in 2016) and dividends so it makes sense to keep it.
My guess is also that a spin isn’t coming right now. The ESPN spinoff idea isn’t new and has actually been floating around now for several years. Interestingly, about 10 years ago the discussion was about whether or not the company would spin off its theme parks and resorts business, an idea it obviously didn’t pursue (and is probably pretty happy about). For its part the company seems optimistic about ESPN’s future with CEO Bog Iger remarking during the Q4 conference call that ‘the long term’ prospects for ESPN are good. When pushed on this topic, here was his response:
I think you have to start with what ESPN offers and its popularity. I mentioned in my comments the popularity, and there are certainly recent examples like the World Series of live sports. So I feel really good about their programming. I feel good about their continued ability to drive solid advertising. We have a good sense of what their rate structure is in terms of existing deals with distributors, but we have some opportunities and some new deals to improve the rate structure even more. We have taken a more bullish position on the future of ESPN’s sub base. We think that while we were candid a few years — a year ago in sub losses, we believe that, to some extent, the causes of those losses have abated, notably the migration to smaller packages. But we also believe that new entrants in the marketplace, particularly DMVDs — digital MVPDs, I should say, are going to offer ESPN opportunities that they haven’t had before to reach more people. And in particular, we think those offerings, because of their pricing, their user interface, their mobile-friendly nature, are likely to cause more millennials to either stay in the multi-channel ecosystem of subscribers or to enter it when they might not have in the past. So we just generally feel bullish about ESPN’s future. We are, I’d say, realistic about what we’ve seen in — with recent sub trends and again, have been, I think, fairly candid about that. And we think the long-term prospects for the reason I cited for ESPN are good. The other thing that ESPN has, which we’ve talked about a lot, is the ability to take product out direct to consumer, and that’s why we invested in BAM. And we think that gives us a really interesting opportunity to create a new product. It gives us an interesting opportunity to create product that is more user friendly and therefore, is likely to gain more consumption, and it gives us an ability to mine data from that user consumption that can improve our advertising prospects and give us the ability to tailor the product more — in a more customized way for those consumers.
Additionally, some recent comments at the Citi conference from CFO Christine McCarthy also make a spinoff sound unlikely. When asked about declining ratings for sports, she noted that:
Well, I think there is a lot of things that contribute to any kind of rating in the short-term time frame. So I just like to take a step way back and say that when you look at our ESPN business, it has been in enduring success for over 3.5 decades. So that is something that shows that sports viewing has a lot of viewership, a lot of demand over time…
and when asked point blank about Mr. Malone’s comments:
Well, Jason, I think I’d say that everyone is welcome to their opinions, but we are very pleased with our company assets. They’re very strong. Our company asset mix is very strong. And we also are very, very bullish on the future of our company. And I’d also say, we don’t comment on that kind of speculation.
While that is what she is expected to say, there was no comment about reviewing our portfolio or options or anything like that. One of Mr. Iger’s strategies is to create and invest in high-quality branded content and ESPN is the biggest and best brand in sports media. Sure, there are some concerning trends and the marketplace is evolving, but it’s not like the company is sticking its head in the sand or hasn’t faced challenges in the past. I expect them to try and move with the changes and fix the business rather than make it someone else’s problem. Additionally, the company has always focused on the ‘long term’, a point both Mr. Iger and Ms. McCarthy referenced, and given that, I wouldn’t expect management to jettison a large and historically very strong piece of their business merely for a multiple re-rate.
Of course shareholders might feel differently. At the end of her piece, Ms. Lapachelle wonders if ‘all this talk of a split turn into a self-fulfilling prophesy?’ While I’m certainly a critic of much of Corporate America, I hope it doesn’t work like that! That said, if the unit’s struggles continue and the stock continues to lag then pressure from shareholders will certainly ratchet up.
Disclosure: Author is long shares of DIS and AAPL.