Cash flows into the NBA and out of Disney

Everyone watches Disney and know their iconic characters, but not everyone is watching ESPN.

 

NBA, ESPN and the industry

Along with their notable business and franchises in entertainment such as Pixar and the Star Wars franchise, Disney also owns 80% ESPN.  Disney purchased their stake in the popular sports programming network in 1996 and hasn’t looked back since. One of ESPN’s largest partners is the National Basketball Association (NBA) and as a result, during the last 20 years, ESPN (along with other networks) has been broadcasting NBA games every season to cable subscribers in the USA.  Every once in a while, the rights to broadcast these games come up for renewal. During this time, ESPN and other networks would have to pay more money in order to keep broadcasting these games or risk a competitor stealing the TV rights.

These broadcasting TV contracts can get very expensive but to help offset the cost, two major factors were always present:

  1. Advertisers are willing to pay top dollar to have more people see their ads. Advertisers know that millions of eyes are watching these sporting events every night and it would be a crime not to try to put their ads on during the commercial break or sponsor a segment of the game.  With that being said, potential advertisers are more willing to spend top dollar, especially when two national recognized teams are playing or during a big game.
  2. Consumers would help pay for these TV contracts monthly every time they pay their cable bill. Let me explain.  Broadcasting networks such as ESPN charge a fee to cable providers (think Comcast, AT&T, etc) in order to carry their channels. Even though these cable providers don’t appreciate being charged the fee, they know if they don’t cough up the dough,  then they cannot broadcast the channels provided by the network. The less channels the cable provider has, the more likely it is for consumers to go to a competitor.  As a result they agree to pay but not before passing these fees on to the consumer.  So ultimately, your paying the big network companies for the right to have their channels in your cable package, even though you may not watch it.  Additionally, the more channels the broadcasters have in the cable package (ESPN, ESPN2, ESPNU, SEC Network, etc) the more money they receive.

This was the structure for many years and explains how companies like ESPN could afford to pay top dollar for TV rights to broadcast sporting events, but times have changed recently.

So what is the relationship between the stock price and salary cap?

For the last ten years, Disney’s stock (stock symbol DIS) has enjoyed a successful run from the low 30s to a high of 120 in the summer of 2015.  But as of recently, the stock has endured many hardships and challenges.  These hardships find their origins within the sports industry, more noticeably the NBA. If you look at Disney’s stock price in the last two years you will see a decline from $113 in November 2015 to $92 in October 2016.  From there we see an increase in value to $120 in April 2017 and then a decline to $97 in October 2017.

In comparison, lets take a look at the last two years of the NBA salary cap.  At the beginning of the 2015-2016 season, the salary cap was $69.1 million and at the end of the 2016-2017 season, the salary cap jumped to $91.3 million. That is an increase of 32 percent.

2015-2017 NBA salary cap amounts, provided by basektball-refernece.com

The reason for the huge jump in salary cap is due to the previous TV contract expiring.  ESPN and Turner (the company who owns TNT)  paid $24 billion between them for the rights to broadcast the NBA games exclusively through 2024-2025 season, that’s about $3 billion a year. To put it into perspective, the previous contract had TNT and ESPN pay less than a $1 billion a year. If you look at the above chart and table, the timelines of Disney’s stock decline and the increase of the NBA salary cap increase directly correlates to each other.

With the new cash influx into the NBA, teams are able to give their star players historical larger contracts, just look at the past summer. Several star players signed record breaking contracts within weeks of each other. Stephen Curry agreed to the league’s first $200 million ($201 million to be exact) contract with the  Goldenstate Warriors in late June. Then, James Harden signed a $228 million extension with the Houston Rockets in early July.  Not to be outdone by the MVP runner up, Russell Westbrook agreed to a $205 million contract extension with the Oklahoma Thunder.  Bleacher Report states Adrian Wojnarowski “…notes that Westbrook now owns the “biggest total contract” in league history since there are six years and $233 million left on his deal.”  To put it into perspective, these players will now make more money per game in a season, than the U.S. President makes all year.

OK, so ESPN is paying a lot more money for their TV rights, but based on the structure, they will make that money back up, right?

Wrong, and here is why.  The traditional structure was fine ten years ago, but now its obsolete and the reason can be summed up in one word, streaming.  More and more people today are opting to use internet streaming for their dose of entertainment instead of watching traditional TV and as a result, consumers are canceling their cable packages. This isn’t just a theory, theres hard data to support this, below is a snapshot of Disney’s third quarter results for their Media Networks business segment:

Disney earnings excerpt

 

You can see that their cable networks (ESPN family of channels) had a 3% decrease this year compared to the same time frame last year.  If you would to look at the same data for the last 3-5 years, you would see that the decrease has been happening for a long time now. As more people opt for streaming services (Netflix, Youtube, Hulu [which Disney actually owns part of], or Amazon Video) instead of their cable service  Disney’s bottom line takes a direct hit.  On their third quarter reporting, they even admit the same:

The decrease at ESPN was due to higher programming costs, lower advertising revenue and severance and contract termination costs, partially offset by affiliate revenue growth. The programming cost increase was due to a contractual rate increase for NBA programming, partially offset by a decrease in the cost of time for ESPN programming aired on the ABC Television Network. Lower advertising revenue was due to a decrease in average viewership and lower units delivered including the impact of two fewer NBA finals games, partially offset by higher rates. Affiliate revenue growth was due to contractual rate increases, partially offset by a decline in subscribers.

(Link to Disney’s third quarter earnings report)

Additionally, the cable provide Comcast recently announced it lost 150,000 subscribers in their third quarter alone.

 

With more people opting to cut the cord and start streaming their entertainment, less money is flowing in Disney that would of helped cover the billions of dollars they are contracted obligated to pay to the NBA.

What about the advertiser money? 

Companies won’t pay a premium price if viewership is declining.  The point of advertising something is to show it to as many potential consumers as possible.  But if the market for potential customers are declining then these companies will take their money somewhere else.  Disney has already started to feel the pressure from some of their sponsors based on their latest quarterly report, from the above quote:

The decrease at ESPN was due to higher programming costs, lower advertising revenue and severance and contract termination costs, partially offset by affiliate revenue growth. The programming cost increase was due to a contractual rate increase for NBA programming, partially offset by a decrease in the cost of time for ESPN programming aired on the ABC Television Network. Lower advertising revenue was due to a decrease in average viewership and lower units delivered including the impact of two fewer NBA finals games, partially offset by higher rates. Affiliate revenue growth was due to contractual rate increases, partially offset by a decline in subscribers. 

Additionally, ESPN is having another problem that they didn’t account for.  The star players are opting to rest more and play in less games.  If the star players like Lebron James, Stephen Curry, James Harden and Kevin Durant are playing less, then the direct result will be less casual fans tuning in to watch, which adds to the decline in viewership.  Its gotten so common in the league of star players resting on national televised games that the NBA had to implement a new rule.

Theres no denial that the NBA is now costing Disney money

The time of Disney’s stock decline and the new increase of the NBA salary cap is no coincidence. I’ve talked about the main reasons on the issue of Disney decline but there are other smaller causes.  One of them include the new Fox Sports 1 and 2  (FS1 and FS2) networks that are direct competitors of ESPN.  Admittedly, FS1 and FS2 ratings has not been anything to write home about, but even with a smaller market share compared to ESPN, they cannot discount them.  Another reason worth mentioning is the image people have of ESPN being overly democratic, which causes a rift in viewership especially in these political times. Regardless of the reasons, it will be interesting to see how Disney and the NBA do business together in the future, espcailly with the next TV rights contract.

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