ESPN: Disney's Reliable, Cash Cow

Daniel is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Disney (NYSE: DIS) has many powerful, durable brands, including Disney, ABC, Pixar, Marvel, and now Lucas Film. But some simple analysis of financial data provided by Disney's annual report reveals that one brand trumps all others in significance to Disney's bottom line: ESPN. In fact, ESPN represents approximately 43% of Disney's operating income:

<img src="/media/images/user_13783/espn-operating-income-2_large.png" />

How did I get here? Easy. Let's walk through it.

A Cash Cow

ESPN falls under Disney's Media Networks business segment, which represents 46% of total revenue. Parks & Resorts, Disney's second greatest contributor to revenue, comes in second, at 29%. But the Media Networks business segment is, by far, Disney's most profitable segment. Its operating margin is 38%, followed by Parks & Resorts at 10%. So Media Networks may represent 46% of revenue, but it totals a staggering 67% of operating income.

A further breakdown of Disney's Media Networks segment is required to approximate ESPN's specific contribution to Disney. In Disney's annual report, Media Networks is divided into Broadcasting and Cable Networks.

<img src="/media/images/user_13783/disney-media-networks-operating-income_large.png" />

Cable Networks makes up the majority of Media Networks operating income at 85%. According to comments from Disney executives and notes in the 2011 annual report, ESPN represents approximately 75% of Disney's Cable Networks revenue. This specific sub-segment has a 41% operating margin, much larger than Disney's other businesses. So any increase in revenue from this segment has a disproportionately larger affect on the bottom line.

Since two-thirds of ESPN's revenue comes from lucrative affiliate fees, which are not typical in the industry, ESPN definitely contributes more per dollar of revenue to operating income than the other brands that fall under the Cable Networks segment (Disney Channels Worldwide, ABC Family, and SOAPnet). But to be conservative we'll assume that Disney contributes to Cable Networks' operating income in the same proportion that it contributes to revenue: 75%.

Based on this assumption, ESPN contributed $3.93 billion to Disney's total operating income of $9.13 billion, or 43%. In other words, ESPN is by far the most significant contributor to Disney's bottom line among all of its brands and businesses. Chances are, if ESPN succeeds over the next decade, Disney will too. 


So can investors count on Disney? I believe so. Over 100 million U.S. households pay for ESPN content through cable, satellite, and telecom providers. Advertisers pay hefty, above average fees to to show their ads on ESPN networks. ESPN has a very large and established customer base. 

Is the demand sustainable? Absolutely. Profits can be sustained when a business possesses some sort of durable competitive advantage, or an economic moat. Pricing power and above average operating margins are both recognized by many value investors as great indicators of an economic moat. So let's see how these indicators measure up:

ESPN's growing operating margins:

  • Operating margin for Disney's Media Networks business segment is on the rise: 29%, 32%, and 38% in 2009, 2010, and 2011, respectively
ESPN pricing power:
  • Affiliate fees (two-thirds of ESPN revenue) grew 9% in 2011, driven primarily by an increase of 6% in contractual rates
  • An increase of 14% in advertising revenue at Disney's Cable Networks segment was due solely to higher rates.
With a huge base of subscribers, years of experience as the leader in sports television, and clear indicators of a durable competitive advantage, it's safe to say that ESPN possesses an economic moat. This moat is bound to a brand that consumers trust. Day in and day out, ESPN delivers live sports, entertainment, expert commentary, news, and stats. As Internet access to television networks grows and media friendly devices proliferate, sports are becoming an even more integral part of fans' lives. Hence, 2011 was, of course, ESPN's most-watched fiscal year.
This trend should continue. ESPN has contractual agreements with the world's greatest sports events, including NFL, NBA, and MLB games, Wimbledon, the Indy 500, NASCAR, college sports, and cricket. And to put the icing on the cake, ESPN recently renewed its contract to get the rights to 17 Monday Night Football games every year between 2014 and 2021. ESPN's great live sports and unmatched coverage should continue to reward Disney investors over the next decade.
But ESPN can't be purchased cheaply. Bundled with Disney's other wide-moat brands, Disney probably has the most durable competitive advantage in media. Disney's free cash flow (FCF) yield, a great indicator of value, definitely isn't high enough to call Disney is a bargain--but it isn't expensive either.
The FCF yield shows you what percentage of a company's share price is represented by the cold, hard cash it's churning out. The higher this percentage, the better. Let's compare Disney with some other media giants, measured by the FCF yield: Comcast (NASDAQ: CMCSA), CBS (NYSE: CBS), Time Warner (NYSE: TWX) and Discovery Communications (NASDAQ: DISCA) .

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DIS Free Cash Flow Yield data by YCharts

Disney, along with CBS, trade at the greatest premiums among their peers. But with Disney's powerful intangible assets and a thriving ESPN, Disney trades at a fair enough valuation for the long-term investor to buy into this wide-moat castle.

The bottom line

ESPN amounts to a significant 43% of ESPN's operating income. But this shouldn't worry investors. ESPN, in and of itself, possesses characteristics of a business with a wide economic moat. Backed by Disney's cash hoard, synergies, and an experienced executive team, ESPN should continue to deliver for Disney investors.

DanielSparks has no positions in the stocks mentioned above. The Motley Fool owns shares of Walt Disney. Motley Fool newsletter services recommend Walt Disney and Time Warner. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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