The Walt Disney Co. (NYSE:DIS) released its third-quarter earnings report on Aug. 6 to generally negative reviews. Expectations had been high, with many analysts predicting a blowout quarter driven by record box office receipts. Alas, Disney disappointed on both the top and bottom lines. Unsurprisingly, the market took the news poorly, driving shares down nearly 5% by the close on Aug. 7.
However, there were plenty of reasons for investors to take heart. The most eye-catching was Disney's announcement that the Disney+ streaming service would be available as a bundle with ad-supported streaming service Hulu and online sports platform ESPN+.
The inclusion of ESPN+ is particularly intriguing. It is a clear signal that Disney is not merely making a play for Netflix (NASDAQ:NFLX)'s streaming crown, but also positioning itself to have a leading role in the future of sports entertainment.
Wonderful world of discounts
The bundle of Disney, Hulu and ESPN+ looks like a great deal for consumers. At $12.99 per month, the bundle will cost the same as a standard Netflix (NASDAQ:NFLX) subscription. The monthly subscription fees are $6.99 for Disney+ and $5.99 for Hulu.
In other words, buying the bundle gets subscribers ESPN+ for free -- a literal steal.That makes some sense, since ESPN+ is small potatoes compared to its subscription television counterpart. The ESPN network is still by far the more valuable platform for Disney, as CNBC recently reported:
"There are less than 3 million ESPN+ subscribers today, suggesting the product has a relatively narrow audience. Disney has purposely kept its most valuable properties -- such as Monday Night Football -- off ESPN+ to maintain the value of the linear cable station, which commands about $10 per month per pay-TV subscriber. There are still about 88 million people paying for TV, so ESPN's greatest value to Disney remains in the old-fashioned TV market."
ESPN is still doing well, but there is little doubt that the era of pay-TV dominance is coming to an end. That realization is what makes Disney's decision to bolt on ESPN+ as a free addition to a three-platform bundle look so brilliant.
Selling sports streaming
Remarkably, not only has ESPN remained profitable in this era of accelerating cord-cutting, it has actually grown as a source of cash flow for Disney. As the Los Angeles Times reported in May, ESPN has managed to keep growing its bottom line thanks to aggressive cost management:
"In recent years, ESPN has laid off hundreds of workers in the face of declining subscriptions. Subscriber levels have declined from a peak of 100 million in 2010 to about 85 million, according to Nielsen data. But ESPN still remains a major profit center for Disney. Disney does not break out ESPN's financials, but research firm S&P Global Market Intelligence says its revenue for 2018 totaled $10.2 billion, up 6% from the previous year, and it had cash flow of $3.23 billion, up nearly 8%. Even with cord-cutting, ESPN's revenue from pay-TV subscriptions increased 6% to $7.3 billion."
While cost-cutting can keep the bottom line growing for a while, deteriorating subscriber numbers will inevitably start to bite into profits. By giving free access to millions of bundle subscribers, Disney can take more control of gradual migration from pay-TV, and profit along the way.
A modest proposal
Bundling Disney+ and Hulu with ESPN+ could be just the tip of the iceberg for the company's evolving streaming pricing strategy. Disney could end up leveraging a range of streaming packages in order to entice marginal customers to sign up. As prolific financial Twitter gadfly modest proposal has opined, Disney can even use some customers hating professional sports to its advantage:
"[I] think they should add a Hulu/D+ bundle at $10.99 to capture the militant 'don't want to pay for sports' crowd and also b/c behavioral psyche would say it makes $12.99 even more enticing ... Any customer with intention to buy one of the individual services at $5-7, an incremental $6-8 for the other 2 is almost a no brainer."
Disney has mastered the art of consumer psychology, which it has used to great effect in order to squeeze every last bit of value from its customers across virtually every conceivable medium. Streaming is merely the next step. By creating a "no-brainer" bundle upgrade -- or range of upgrades -- to its standard programming menu, it can help to steer sports watchers to ESPN+, growing that value channel semi-organically and at low cost.
Disney has built a sprawling media empire, touching virtually every conceivable medium. A casual observer may be forgiven for considering ESPN a relatively insignificant piece of the Disney story, given the company's highly visible (and heavily branded) theme parks, films and merchandise. Yet, ESPN is a vital cog in the Disney cash-printing machine.
Consumers are cutting the cord with increasing frequency, but Disney has no intention of losing its lucrative sports entertainment business as a result. Bundling ESPN+ with Disney+ and Hulu for no extra charge will help its sports entertainment business build a wider base of subscribers that will help it continue to thrive despite the death of pay-TV. In that way, it can maintain its preeminent place in sports broadcasting in the new age of streaming.
The latest earnings report may have been a tad disappointing, but the future still looks bright for every segment of its enterprise.
Disclosure: Author is long Disney and short Netflix.
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