ESPN: Disney's Reliable, Cash Cow

By Daniel Sparks - November 9, 2012 | Tickers: CBS, CMCSA, DISCA, TWX, DIS | 0 Comments

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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:

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.

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. 

Reliable

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

DIS Free Cash Flow Yield data by YCharts

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.

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