ESPN Gets Caught In Transition

Back in October, ESPN, along with Turner Sports, renewed its broadcast and digital rights deal with the National Basketball Association through 2025 for $2.3 billion, more than twice the price of the previous deal, even though the old deal still had two years to run.

With prices skyrocketing for sports rights and new 24-hour sports competitors from Fox and NBCUniversal circling hungrily for deals that would put them in the game, locking up the NBA for another decade — even at twice the price — seemed to pencil out at the time. It was the last such major deal ESPN would need to nba_espnnegotiate for several years, having recently locked up long-term deals with Major League Baseball, the NFL, the college football playoffs and four of five major college sports conferences, thus putting a cap on its major cost-driver until at least 2021.

”We believe at the end of the deal it will feel inexpensive,” ESPN president John Skipper said at the time. ”It’s hard to imagine.”

After this week, it’s even harder to imagine.

As with any asset, locking in a price when prices are rising is a good strategy. Locking in a price when returns are falling, not so much. And for ESPN, the return on pricey sports rights are starting to fall.

On Tuesday, ESPN’s parent company Disney lowered its full-year 2015 and 2016 forecast for its cable unit, of which ESPN makes up about 80 percent, due to what CEO Bob Iger characterized as some “modest” subscriber losses from cord-cutting. Given that ESPN accounts for nearly half of Disney’s operating profit that was enough to spook investors.

In the earnings call, Iger mounted a spirited (if somewhat defensive-sounding) defense of the sports channel and Disney’s strategy for it:

ESPN experienced some modest sub losses although those have been less than reported by one of the prominent research firms and the vast majority of them, 80%, were due to decreases in multichannel households with only a small percentage due to skinny packages. Overall though we believe the expanded basic package will remain the dominant package of choice for some years to come, because to the quality and variety it represents for a price that is generally considered fair and appropriate. We also see the continued development of new platforms with smaller channel offerings, which we see as a positive trend for us, since ESPN is a must-have brand as part of the initial service offering for these new packages…

Now we all know how valuable live programming has become and ESPN is the leader in live programming. 96% of all sports programming is watched live and this is particularly valuable in today’s rapidly changing advertising marketplace. This year’s Upfront provided ample proof. ESPN enjoyed both increased demand and sell-through rates as well as pricing increases.

ESPN’s embraced technology better than anyone in traditional media reaching its fans and engaging with them in more meaningful ways online and on mobile devices with its linear channels as well as with an array of additional programming, sports information, commentary conversation and very rich social media features. All of this adds up to a very strong hand and gives us enormous confidence in ESPN’s future no matter how technology disrupts the media business.

Investors weren’t buying it, however, and sent Disney shares down more than 9 percent the next day, leading to a broad sell-off of TV-heavy stocks. The sell-off became a rout the next day when Viacom reported weaker-than-expected quarterly revenue on a 9 percent decline in advertising revenue.

Subscriber fees and advertising. The two pillars of the pay-TV ecosystem. And both were looking wobbly this week.

As Iger stressed, Disney and ESPN have been forward-leaning toward new distribution channels, particularly compared to many of their peers. Iger has even talked about eventually taking ESPN direct-to-consumer over the top, although not anytime soon. But there’s no certainty those new distribution channels will ever deliver the same sort of per-viewer or per-subscriber return as traditional pay-TV. Digital monetization tools remain underdeveloped relative to traditional TV, especially on mobile platforms, and the proliferation of platforms, by definition, means more audience fragmentation, making it harder to quantify and deliver audience reach for advertisers.

As discussed at the Second Screen: Sports Summit in New York last month, moreover, advancing technology threatens to create new competitors seizing rights to new viewing options not covered in existing broadcast contracts, diluting the audience still further. At the same time Disney was lowering its forecast for ESPN, in fact, Major League Baseball Advanced Media unveiled a breakthrough deal with the National Hockey League to handle the NHL’s over-the-top streaming. As part of the deal, the NHL is taking an equity position in BAM Tech, the technology platform that MLBAM is preparing to spin off into a standalone entity, hinting at a possible future in which a league-owned distribution consortium could decide it doesn’t need as many broadcast partners anymore.

It’s the loss of financial leverage from the accelerating breakup of the big pay-TV bundle that poses the greatest threat to ESPN and other broadcasters. ESPN may be the most watched channel on cable, but half of current cable subscribers rarely if ever watch yet. Yet all of them pay for it through the magic of bundling. Analysts have estimated that ESPN would need to charge an improbable $30 a month on an a la carte basis to generate the same subscriber revenue to generates from the bundle.

ESPN is not alone in its dilemma. CBS, NBC, Fox, Turner and other broadcasters have all invested heavily in live sports in recent years, largely through long-term rights contracts. As with ESPN, those long-term deals were designed as hedges against future price spikes at a time when prices for sports rights were rising rapidly. But they were also premised on a steady increase in subscriber fees to offset their costs.

What looked like a smart long-term strategy as recently as a year ago may soon turn into a long-term headache for ESPN and its peers. It’s not hard to imagine.