A stream­ing bet at ESPN

Dis­ney plan to of­fer over-the-top live video ser­vice raises ques­tion of whether new rev­enue will off­set dol­lars lost from cord cut­ting

Los Angeles Times - - BUSINESS - By Stephen Battaglio

Walt Dis­ney Co. fi­nally un­veiled its plan to of­fer an over-the-top video stream­ing edi­tion of ESPN for the grow­ing num­ber of fans who want live sports — but not the big ca­ble bill that a pre­vi­ous gen­er­a­tion paid.

Now the ques­tion is whether the rev­enue gen­er­ated by the new ser­vice to be launched in 2018 will be enough to off­set the sub­scriber dol­lars that go away ev­ery time a house­hold de­cides it can do with­out ca­ble. It may take a few years for that to hap­pen, but the con­sen­sus in the sports TV in­dus­try is that Dis­ney could not af­ford to wait any longer to find out.

“It was al­most manda­tory that ESPN had to do some­thing like this,” said Lee Burke, pres­i­dent of LHB Sports, Me­dia & En­ter­tain­ment, and a for­mer sports TV net­work ex­ec­u­tive. “It’s not go­ing to all be made up for in the next six months or a year or two years, but stream­ing is where the growth is and it’s where the next gen­er­a­tion of view­ers are in­creas­ingly head­ing.”

While ESPN con­tin­ues to be a sig­nif­i­cant profit cen­ter for Dis­ney, the mi­gra­tion of view­ers to stream­ing con­tin­ues to cut into the rev­enue it gets from pay TV providers.

Dis­ney this week re­ported a 22% third-quar­ter drop in op­er­at­ing in­come in its me­dia net­works unit, which houses ESPN and ABC. Within the ca­ble net­works group, which in­cludes ESPN, seg­ment op­er­at­ing in­come was down 23% to $1.46 bil­lion. Dis­ney at­trib­uted the drop-off, in part, to higher pro­gram­ming costs — in­clud­ing $400 mil­lion to­ward a new NBA TV con­tract — and lower ad­ver­tis­ing rev­enue at ESPN, which fell 8% in the quar­ter due to smaller au­di­ences.

Ev­ery house­hold that de­cides to can­cel its pay TV sub­scrip­tion means less rev­enue for ESPN, which com­mands the high­est car­riage fees of any net­work — com­mand­ing around $7 to $8 out of ev­ery monthly ca­ble bill, ac­cord­ing to SNL Ka­gan. In other words, ca­ble and satel­lite TV com­pa­nies pay ESPN about $8 a month for ev­ery house­hold that re­ceives the sports chan­nels.

ESPN was in 100 mil­lion ca­ble and satel­lite house­holds in 2011. It’s now at 87 mil­lion house­holds, ac­cord­ing to Nielsen data, as stream­ing video has be­come a way of life for the cur­rent gen­er­a­tion of TV view­ers, many of whom are fore­go­ing a pay TV sub­scrip­tion.

That group is on the rise. Ac­cord­ing to Nielsen, 62% of all U.S. house­holds — around 73 mil­lion — now use In­ter­net-con­nected tele­vi­sions or stream­ing video de­vices. In those homes, stream­ing video con­sumed by those ages 25 to 34 ac­counts for 23% of TV us­age.

The new ESPN over-thetop of­fer­ing meant to ap­peal to stream­ing video users will not be the same chan­nel ca­ble sub­scribers cur­rently re­ceive. It will be a sep­a­rate ser­vice avail­able through the ESPN app and of­fer ac­cess to thou­sands of live events from Ma­jor League Base­ball, the Na­tional Hockey League, Ma­jor League Soc­cer, Grand Slam Ten­nis, and var­i­ous col­lege sports or­ga­ni­za­tions.

It will not in­clude NFL or Na­tional Basketball Assn. con­tests that are the big rat­ings driv­ers for ESPN’s ca­ble chan­nels, which can only be streamed with a pay TV sub­scrip­tion. Dis­ney has not said how much the ser­vice will cost.

But the ser­vice could be­come more ro­bust over time. Walt Dis­ney Chair­man Bob Iger said the com­pany will have the abil­ity to de­liver the ESPN chan­nels di­rectly to view­ers if the num­ber of pay TV sub­scribers con­tin­ues to de­te­ri­o­rate, but in­di­cated there would be an im­pact on the rev­enue it re­ceives from ca­ble and satel­lite providers.

“If we wanted to take ESPN di­rect [to con­sumers], we could,” Iger told an­a­lysts Tues­day.

Iger added that an over­the-top of­fer­ing would have an ef­fect on some of its agree­ments with pay TV providers that he de­scribed as “sub-op­ti­mal.”

Dis­ney’s prepa­ra­tion for the stream­ing fu­ture in­cludes in­creas­ing its stake in BAMTech, the in­ter­ac­tive me­dia com­pany formed by Ma­jor League Base­ball which de­signs and op­er­ates the plat­forms for stream­ing video ser­vices. The ac­qui­si­tion an­nounced Tues­day gives ESPN ac­cess to BAMTech’s tech­nol­ogy and the stream­ing rights to sport­ing events that the com­pany cur­rently holds.

But what­ever strides the com­pany makes in reach­ing over-the-top users, it may not be fast enough to out­pace the loss in rev­enue that oc­curs through the loss of ca­ble sub­scrip­tions. An an­a­lyst note from Bar­clays Cap­i­tal called the Dis­ney an­nounce­ment on ESPN a de­fen­sive move.

An­drew Zim­bal­ist, an eco­nom­ics pro­fes­sor at Smith Col­lege who spe­cial­izes in the sports busi­ness, agreed with that as­sess­ment. He said the bounty that ESPN and other ca­ble sports net­works have en­joyed by get­ting fees for ev­ery ca­ble house­hold they reached is go­ing be missed if sports moves to an over-thetop dis­tri­bu­tion model and con­sumers get used to hav­ing the abil­ity to pay only for the chan­nels they watch.

“That is go­ing to di­min­ish or dis­ap­pear and that’s bound to hurt,” said Zim­bal­ist. He added the new pro­lif­er­a­tion of over-the-top ser­vices is only go­ing to make the TV land­scape more crowded and com­pet­i­tive.

Shift­ing TV habits have al­ready prompted cuts at ESPN. It went through a ma­jor round of lay­offs in 2016, re­duc­ing its work force by 4%. This year, the net­work fired around 100 re­porters, an­a­lysts and com­men­ta­tors.

ESPN has also been un­der pres­sure from es­ca­lat­ing sports rights fees — its costs to carry the NBA just dou­bled. Other fees may get even higher go­ing for­ward as tech­nol­ogy com­pa­nies such as Google, Ama­zon and Face­book are ex­pected to pur­sue ex­clu­sive rights to one of Na­tional Foot­ball League pack­ages when they be­come avail­able in 2022. Ama­zon is pay­ing $50 mil­lion this year for the non-ex­clu­sive stream­ing rights for 10 of the NFL’s “Thurs­day Night Foot­ball” games this sea­son that will also air on CBS or NBC.

Pa­trick Riche, di­rec­tor of the sports busi­ness pro­gram at Wash­ing­ton Uni­ver­sity, said ESPN and other TV net­works are still in a bet­ter po­si­tion to reach to de­liver a mas­sive num­ber of view­ers to ad­ver­tis­ers than a stream­ing ser­vice.

“Given where the rat­ings are and what au­di­ences the net­work can gen­er­ate, I’d be very shocked if it could make busi­ness sense for an Ama­zon or [Google] to out­bid them,” he said.

Joe Faraoni ESPN Im­ages

DIS­NEY this week re­ported a 22% third-quar­ter drop in op­er­at­ing in­come in its me­dia net­works unit, which houses ESPN and ABC. The en­ter­tain­ment gi­ant at­trib­uted part of the drop to an 8% de­crease in ad rev­enue. Above, Scott Van Pelt on the set of Sport­sCen­ter.

Carl Court Getty Im­ages

ESPN WAS IN 100 mil­lion ca­ble and satel­lite house­holds in 2011. It’s now in 87 mil­lion house­holds, ac­cord­ing to Nielsen data. Above, an ESPN oper­a­tion room at the Wim­ble­don ten­nis tour­na­ment in Lon­don in 2015.

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