(By Michael Corty, CFA) Disney (DIS
) is an undervalued wide-moat stock, and we'd get even more enthusiastic if the price dips back to the mid-$30s again. Disney's cable networks, mainly ESPN and Disney Channel, contribute more than half of the company's annual cash flow, so monitoring the competitive position of this business is crucial to our opinion on the stock. Rising TV sports programming costs were a constant theme in 2011, and we think this trend is likely to continue. Despite these costs, we maintain that ESPN is well-positioned as it has pricing power and remains dominant in live sports, which we view as essential for the pay-TV business as time-shifted viewing increases.
NFL Rights Expensive, but Vital
Let's be clear: Given its dominant position and pricing power, the National Football League's moat is wider than ESPN's, Disney's, and most publicly traded stocks. The NFL is the most popular sport in the United States, and we don't expect this to change anytime soon. The short list of reasons for its popularity, in no particular order:
- Great TV sport: High-definition makes the hard-hitting action better than attending in person.
- Competitive balance: Thanks to the salary cap, all teams are on a level playing field.
- Convenience: Games are played one day a weekend (with a few exceptions).
- Gambling: Proliferation of ways to have "action" on games (point spreads, fantasy leagues, office pools).
In September, Disney and the NFL announced a long-term contract that extends ESPN's rights for Monday Night Football through the 2021-22 season. Various media sources peg the average annual cost at $1.9 billion per year, up from the estimated $1.2 billion per year (costs for additional rights added to the $1.1 billion announced in 2007) for the agreement that runs through the 2013 season. This drives the headline increase of roughly 60%, but we think it's more informative to view this figure on an annual cost-growth basis. We estimate that the average annual cost increase is roughly 6%, and we believe ESPN can obtain average affiliate fee increases at or above this level over the next decade.
While the headline cost increase is significant, we think the NFL deal is crucial for ESPN, especially given the sport's popularity and the year-round nature of programming that makes ESPN the most valuable channel for pay-TV distributors. These NFL rights contracts typically have escalators, so the new deal will start well below $1.9 billion. We estimate that ESPN will be paying about $1.3 billion per season when the 2013-14 contract ends. Disney has indicated that the annual increase in rights will be roughly 4% following a steep initial step-up.
In December, the NFL announced deals with its three broadcast network partners--CBS (CBS), Fox, and NBC--that reportedly will average at least $1 billion annually (a more than 65% increase). The current deals expire in 2013; the new ones run through 2022. We estimate that the headline increase is a similar percentage to what the NFL received from ESPN.