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ESPN must evolve beyond TV, and still has time to do it

Disney reported a slight earnings and revenue beat Tuesday, on the strength of its recent hit films “Captain America: Civil War” and “Finding Dory.” Earnings came in at $1.62 per share (a cent better than analyst expectations of $1.61) and revenue was $14.278 billion (vs. expectations of $14.15 billion).

The stock fell anyway, down 1.3% after hours. It’s down 11% in the past year, but up a nice 7% in the past six months.

Regardless of Disney’s success in movie theaters, the focus every quarter now is on ESPN, which has been something of a dark cloud over Cinderella Castle for just over a year.

This time around, ESPN did well. The network is part of Disney’s cable networks division and accounts for more than half of the division’s revenue, and that revenue was up 1% in the third quarter to $4.2 billion. The division’s operating income also rose 1% to $2.1 billion. Disney pointed specifically to ESPN as the source, adding that other parts of the cable networks division, not ESPN, held the division back from even better growth.

“The increase in operating income was due to growth at ESPN, partially offset by a decrease at the Disney Channels, lower equity income from A&E and lower Freeform results,” it said in a press release. “The increase at ESPN was due to affiliate and advertising revenue growth, partially offset by higher programming costs. Affiliate revenue growth was due to contractual rate increases, partially offset by a decline in subscribers and an unfavorable impact from foreign currency translation.”

The key phrase there is “decline in subscribers.” ESPN’s growth this quarter was thanks to ad rate increases that were built in to its contracts—contracts that are set to end soon. (Cablevision renews in 2017, Time Warner in 2019.) It masks the fact that subscribers dipped yet again—and that is what many will latch onto to spur the narrative that ESPN is in a death spiral.

It’s a misleading narrative.

Yes, ESPN is slowly hemorrhaging subscribers. According to August estimates from Nielsen, the network was in 90.98 million homes in February, and is now in 88.78 million. Yes, cord-cutters and so-called “cord-nevers” (people who never had a cable subscription to begin with) are hurting premium networks like ESPN. But ESPN isn’t vanishing from the airwaves any time soon, and more importantly, it is ramping up its efforts in areas other than traditional television.

There is another false sub-narrative that ESPN’s subscriber decline is because the network has shifted to the left politically, as evidenced by ESPN and ABC broadcasting a “race relations town hall” with President Obama last month, and by ESPN firing analyst Curt Schilling over social media posts. But the decline isn’t about politics. ESPN isn’t losing subscribers because of anything it’s done wrong or failed to do right, it is losing subscribers because of the overall decreasing appetite for sports content on television. Its closest competitor, Fox Sports 1 (FS1), part of the same company that houses conservative-leaning Fox News Channel, is being hit just as hard by the shift: FS1 dropped from 84.16 million households in February to 82.70 million this month, according to Nielsen. And FS1 only just launched in 2013.

In recent months, Disney CEO Bob Iger has indicated, in interviews with The Hollywood Reporter and CNBC, that he can see a time when ESPN might offer a standalone product without a cable subscription. He’d better be able to see it. If he can’t see it, the network is doomed.

That time won’t be tomorrow, or next week, or next month, but it could certainly be next year, or in the next five years. “Is it inevitable that ESPN will have a more direct consumer product in the marketplace? Yes,” he told THR. “What that product is, to what extent it mirrors the product they have now… I can’t get into those details. I don’t think it’s safe to assume ESPN is going to take the product it has now and immediately take it over the top like HBO did.”

For now, ESPN has taken a number of smart steps recently to lay a foundation for a digital future. Could it be doing even more? Certainly. It must plan for life after cable television. It must expect cord-cutting to increase, rather than just prepare for it. But it has done quite a lot: It struck a deal with Dish Network to put ESPN on Sling TV; it struck a deal with Chinese Internet giant Tencent to reach Chinese consumers on their smartphones; it allowed a march of expensive, legacy on-camera talent to walk out the door, cutting costs and potentially making room for more diversity; it has made great strides growing its female audience on ESPN Radio, and just this week announced an ambitious, 16-part narrative podcast series.

And its biggest digital step of all is a 33% equity stake in BAM Tech, the white-label video-streaming business recently spun off from MLB Advanced Media (“BAM”), which has been insanely successful and now powers digital video for the likes of HBO Now and Glenn Beck’s network The Blaze. Consider that MLB’s tech arm is so effective that a completely different sports league, the NHL, gave it the keys to its digital kingdom; now Disney has a piece of that powerful business. Disney will pay $1 billion, in two installments, for its slice of BAM Tech, which boasts a total 7.5 million paying subscribers on its clients’ over-the-top video platforms.

Disney’s press release reveals that the result of the MLBAM stake will be “a new ESPN-branded multisport subscription streaming service in the future,” but that, “current content on ESPN’s linear networks will not appear on the new subscription streaming service.” That’s a reminder that ESPN isn’t ready to go fully digital (a la HBO offering a standalone iPad app, which is Iger’s favored comparison) just yet. The phrase “in the future” is key. BAM Tech will be pivotal in whatever the streaming offering from ESPN is, and whenever it comes.

As an August 1 UBS note on Disney explains cogently, Disney bulls believe the company’s cable networks division “will still see modest growth” in part thanks to “int’l growth (Disney Channels and ESPN), stable ESPN affiliate revenue growth of 3.5% until new renewals kick in (CVC in ’17, TWC in ’19), and low cable programming cost increases from FY18-FY21.” Disney bears think the company is in trouble because of “skinny bundle risk to high fixed-cost ESPN.” But either way, the answer will take a while longer to reveal itself.

There’s a classic line in the 1988 Wes Craven horror film The Serpent and the Rainbow, uttered by Bill Pullman: “Don’t let them bury me; I’m not dead yet.” It’s true of ESPN. Iger put it simply on CNBC: “While the business model may face challenges over the next few years, long term for ESPN… they’ll be fine.”

Daniel Roberts is a writer at Yahoo Finance, covering sports business and technology. Follow him on Twitter at @readDanwrite. Sportsbook is our recurring sports business video series.

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