If Iger does stay beyond 2018, he is doing so to navigate their media networks, specifically ESPN into the streaming/ un-bundled from cable packages new world-order. That new world order has penetrated their protective moat as the internet disrupted the music and news industries before it. Iger is staying to fix ESPN, and if he’s able to do so, that would put him in the running to be as one of the very best public CEOs of the digital generation, up their with Jobs & Gates.
Iger single handily orchestrated the acquisition of three of the dominant movie studios over the last 11 years, starting with the $7.4 billion purchase of Pixar in 2006, the $4 billion purchase of Marvel in 2009, and his $4 billion buy of LucasFilms in 2012. If it were not for those deals, and the contribution of the studio and entertainment biz, we would be discussing DIS as a wilting empire.
The key focus for investors and the company over the last year and a half has been subscriber declines in their Media Networks segment which accounted for 42% of their revenues in their fiscal Q1 and 33% of their operating profit. Revenues and perating profits declined year over year 2% and 4% respectively. The company specifically stated that the “decrease in operating income was due to a decrease at ESPN”. This week the company took some fairly drastic efforts to cut costs at ESPN, which included massive layoffs of on-air talent.
Last week on his Stratechery Blog, Ben Thompson offered what he feels is “key to understanding ESPN’s Travails… that “all three pillars of their past success are under assault”:
Thanks in large part to the rather tardy appearance of competition in the form of Fox Sports 1 in particular, as well as NBC Sports Channel and CBS Sports Network, ESPN has had to pay much more for sports rights in recent years. Competition isn’t the only story though: the NFL, in particular, extracted much more from ESPN in the latest rights negotiation, cognizant that the network not only needs live games but highlights for its time-filler shows as well.
SportsCenter has become completely obsolete thanks to the Internet. Not only are results available instantly, but so are highlights. This further extends to a lot of ESPN’s other programming, like Baseball Tonight (which is one of the programs most impacted by yesterday’s cuts).
Thanks to The Great Unbundling the number of cable subscribers has been dwindling; this effect has been felt more strongly at ESPN than at other cable networks thanks to the fact that ESPN negotiated the right to raise its carriage fees higher than usual in exchange for cable operator guarantees around subscriber percentages (for most cable channel, cable operators have to deliver 90% of subscribers; for ESPN it is 80%).
On DIS Q1 call back in Feb., Iger was sanguine regarding ESPN:
my confidence in ESPN is due to a number of things, but clearly, the deals that we have done with new platform owners, mostly over-the-top, have already yielded some nice gains from those services in subs, but they are not right now being counted fully by Nielsen. We have also done a deal with Hulu, and we have done a deal with
another entity that has not been announced, and we are in discussions with others.
what is really important is the deals that we have negotiated for distribution, particularly for ESPN, are to be in all subs or all households launched. These are light packages that offer us 100% penetration from those packages. And so we think that this wave that we are seeing is really a signal of what is to come, and what the future will be.
Of course it’s not just about ESPN at Disney. The company has had tremendous success with their Star Wars, Marvel and Disney Animation franchises. And given the success of The Force Awakens in 2016, Q1 faced some difficult comparisons. But with Beauty and the Beast recently topping $1.1 billion in sales, and the sequel to The Guardians of the Galaxy opening this weekend, sure to hit $1 billion, this could put a massive wind in their studio’s sails as they get closer to the Star Wars The Last Jedi release on December 15th.
DIS reports FQ2 results on Tuesday after the close. The options market is implying about a 3% one day post earnings move, which is slightly shy to the average of about 4% over the last 4 quarters and basically in line with the 10-year average.
If this past week’s bloodbath in media stocks got you a bit spooked, long holders should consider near dated protection into the print. At one point this week shares of DIS were down 6% from their 52-week highs made on April 27th, but have since rebounded a bit. A continued bounce into the print might present an even better opportunity to slap on short-dated protection or an outright defined risk bearish play (the stock could be higher on Tuesday, and therefore waiting until the last minute to choose strikes is probably prudent). However, here’s what I’d choose today:
DIS ($112) Buy May 111 / 106 put spread for $1.20
- Buy 1 May 111 put for 1.60
- Sell 1 May 106 put at 40 cents
Break-Even on May Expiration:
Profits: between 109.80 and 106 of up to 3.80
Losses between 109.80 and 111 of up to 1.20 with the max loss of 1.20, or 1%.
Next, for those who think this is merely a consolidation (but one that could last a few months), and the worst is behind sub losses, an intermediate term bullish call calendar targeting the mid-December launch of the Last Jedi can be had with defined risk:
DIS ($112) Buy the June / Dec 115 call calendar for $3
- Sell 1 June 115 call at 1.45
- Buy 1 Dec 115 call for 4.45
Break-even on June expiration:
If the stock is 115 or below the June 115 calls will expire worthless and will have helped finance a third of the cost of the Dec 115 calls, which is the best case scenario for the trade, a little less than the implied move of Tuesday’s event, but with possibilities to rebound out until December.
Rationale: after such a big run from its 2016 lows, it makes sense to look to finance long call positions, if I got to June expiration, and the stock had appreciated but not gone through the 115 strike it could be turned into a vertical call spread to further reduce the premium at risk.
But playing for the prior highs at $122 makes some sense if they’ve truly addressed the trials and tribulations at ESPN: