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ESPN Earnings Weakness Puts Disney on the Defensive

ESPN’s tough mix of subscriber losses and higher programming costs put Disney on the defensive during its fiscal second quarter earnings conference call.

Disney chairman-CEO Bob Iger tried to get out in front of the news, emphasizing during his opening remarks that Disney has been working for the past two years to transform its sports media powerhouse for the new era.

“We recognized the early signs of a shift in the industry, anticipated its impact, and reacted quickly with a strategy that reflects the reality of the evolving market,” Iger said.

The perfect storm of higher programming costs in the first year of ESPN’s new NBA contract, higher production costs from three college bowl games that weren’t in the comparable quarter last year, and subscriber erosion led to a 3% year-over-year decline in operating income for the cable networks, which came in at $1.8 billion for the quarter.

Freeform and Disney Channels Worldwide also suffered subscriber losses and lower ratings. ESPN saw viewership climb during the quarter by 15%, but a 5% gain in ESPN advertising revenue wasn’t enough to offset the drop in distribution revenue from an undisclosed number of subscriber losses.

Disney chief financial officer Christine McCarthy reiterated that Disney expects to deliver modest profit growth for its fiscal 2017, but  will return to “robust” territory in fiscal 2018.

To adapt to changing times and viewer behavior, ESPN has amped up its digital presence and enhanced the functionality of its various apps, designed to make them increasingly video-centric and to allow consumers to tailor ESPN’s vast programming offerings to their tastes. Iger asserted more than once that ESPN will launch a standalone streaming service by year’s end that will be a mix of subscription and advertising-based. That service will not replicate the live feed of the mothership channel, but be designed for customization by sports, teams, and regions.

The era of instantaneous news and sport highlights clips readily available on smartphones has taken a toll on ESPN’s traditional role as the center of gravity for the sports world. Iger conceded that ESPN’s challenge is to adjust its delivery systems accordingly.

“The best thing we can possibly do is to make the mobile experience great,” he said. “We’ve taken advantage of that and we believe the money will follow.”

Disney has also been aggressive in making ESPN an anchor tenant of emerging digital MVPD platforms, with carriage on Dish’s Sling TV, DirecTV Now, PlayStation Vue, YouTube TV, and the upcoming service from Hulu. There’s been a lot of talk about skinny bundles coming to market without the sports channels that are the priciest in cable, but to date no startup OTT service has come to market without ESPN, Iger noted.

“Launching new platforms without ESPN is very challenging,” Iger said.

Iger stressed that the combination of new entrants in the bundle business and enhanced offerings in digital and mobile would shore up what appears to be a shaky foundation for the channel that has been the single-biggest earnings generator for the world’s biggest media company.

But he acknowledged that to date “the growth in the number of (OTT) subscribers has not made up for the loss we’ve seen in expanded basic (cable),” he said. He is confident that over the long-term they will take root because the lower price point and digital user interface are more attractive to the younger consumers that are most likely to eschew traditional pay TV service.

Iger took pains to emphasize that Disney does not have its head in the sand regarding the situation.

“We had our eyes wide open. We fully intended to address what we were seeing and what we will continue to see,” Iger said. “We will deal with this issue in a way that over the long-term will serve this company very well.”

ESPN has also sought to better manage its costs and made some headline-generating layoffs last month — about 100 positions in a staff of 8,000. “The number gets headlines, but if you think about it in the scheme of things, it wasn’t a particularly significant number of reduction — we need to manage more efficiently,” he said. At the same time, ESPN isn’t going to pull back on its pursuit of marquee sports rights.

“We will continue to be aggressive in buying live sport rights. They haven’t gotten cheaper, but they have gotten more valuable,” he said. He pointed to the fact that Amazon just made a $50 million one-year deal with the NFL for streaming rights to “Thursday Night Football” games as prime evidence. “Live sports is important to anyone trying to reach consumers in the media business,” he said.

Among the other topics discussed during the call:

Succession: Iger expressed some exasperation at the intense focus on who will follow him into the CEO suite when his contract expires in 2019. He said he recently extended his contract by one year in order to help ensure a smooth transition, despite the lack of an obvious successor at present. “We have enough time to consider the right candidates, to make the right decision, and to craft a transition that should be successful,” he said.

Shanghai Disney: The Disney park that opened in Shanghai last year is days away from hitting its 10 million guest milestone, Iger said. “Attendance is outpacing our most optimistic projection,” he said. The park is expected to hit the break-even point this year.

To-Do List: Asked about the things he still wants to accomplish during his tenure as CEO, Iger cited three top priorities: “To grow the company in a digital direction, to globally solidify ESPN’s future, and probably, above all, that it’s making sure the leadership of this company across the board continues to be really strong so they can continue to deliver the kind of results everyone expects from us,” he said.

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