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Upon Further Review, Wall St.Still Rooting for TV Sports | @jlafayette

A surprisingly large decline in profits from the usually reliable cable networks
owned by the Walt Disney Co. had analysts scrambling last week to make sure ESPN was still a blue-chip investment.

Sports have been gold for the TV business
lately. Unlike entertainment programming,
sports ratings are stable. Games are watched
live, making them valuable to advertisers.
And many viewers regard big sporting
events as must-have programming, justifying
big-league affiliate fees. All of which
have intercepted investors’ normal concern
about businesses that incur high and rising costs.

So when earnings for Disney’s cable group in
the company’s fiscal fourth quarter ended Sept. 30
came in $130 million under expectations, the first
item analysts examined was ESPN, which is facing
new competition from 21st Century Fox’s recently
launched Fox Sports 1.

“There are hundreds of numbers in Disney’s earnings
release, but the only ones that will matter to investors
are the cable networks’ revenues and operating
income,” Sanford C. Bernstein analyst Todd Juenger
wrote after the earnings announcement. “The question,
as always, is whether ESPN is somehow fundamentally
damaged, or whether it’s just quarterly noise.”

Based on the earnings release and senior executives’
comments on their conference call with analysts,
Juenger concluded that “we do not believe the
cable network miss can be traced to ESPN.”

While “the focus for investors remains the cable networks
miss,” Michael Nathanson of MoffettNathanson
reiterated his buy rating on Disney stock.
Reason No. 1: “Concerns about ESPN are
overblown,” Nathanson wrote.

On the call, Disney CEO Bob Iger attempted
to reassure the analysts that the
ESPN playbook still called for growth.

“I think that you’re likely to see nothing
particularly dramatic to change the trajectory
of growth of ESPN over the next five
years or so, partially because a lot of our distribution
deals are done, as are a lot of our licensing deals for
sports rights,” Iger said.

But analysts had to take some of this on faith, because
of the way ESPN’s earnings show up in Disney’s
financial report. Firstly, ESPN is just a part of Disney’s
cable group, which includes many networks and investments
in the U.S. and around the world. On top of
that, earlier this year, Disney had warned analysts that
$172 million worth of deferred ESPN affiliate fees
would be reported in the fiscal third quarter that had
previously been reported in the fourth quarter. That
$172 million set up a difficult comparison. But even
though they had been warned about the deferred revenue,
analysts’ estimates were still way off.

Why? “We think the miss was a function of bad
sell-side forecasting — including us — rather than evidence
of underlying factors” at ESPN, Juenger said.
Some factors analysts might have missed included
the shutdown of an ESPN channel in the U.K., foreign
exchange fluctuations and investment in nonsports
channels overseas.

A Hard Play to Read

On the earnings call, Disney CFO Jay Rasulo acknowledged
that it can be hard to decipher what’s
going on at the cable networks based on the earnings
release. He tried to help the analysts by saying that
taking the $172 million in deferred affiliate revenue
out of the picture, cable revenue and operating income
would have been up 6%. “ESPN was significantly
higher than that,” Rasulo said, adding that
ESPN ad revenue climbed 9% in the fiscal fourth
quarter. So far in the current quarter, Rasulo added,
“ESPN’s cash ad sales are pacing up nicely.”

Looking ahead to fiscal 2014, Nathanson expects
7% earnings growth for Disney’s cable networks.
Quarterly growth rates will be determined by when
the company completes deals with Dish Network
and DirecTV, along with the success of the new European

Cable network expenses will increase by midsingle
digits in the first half of the year, but will hit
double digits in the second half as new agreements
with Major League Baseball and the National Football
League kick in.

But Nathanson still wants to know more about
what happened to ESPN in the quarter, and is looking
ahead to SEC filings with additional details. “We
will need to comb through the 10-K [filing] over
Thanksgiving turkey to dig into all the actual results
for the quarter,” he said.