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In a surprising and sudden major development (or at least what could be) DISH Network (NASDAQ:NASDAQ:DISH) has dropped Disney’s (NYSE:NYSE:DIS) networks as of midnight October 1st. As a dispute between the king of linear TV channels and a member of the Big Four distributors, this is already newsworthy, but this particular blackout dispute may have ramifications that go beyond DISH and Disney given the knife’s edge pay-TV is balancing on at the moment.
In this article, I will try to do three things in a semi reasonable amount of words: examine the disputes implications for DISH and Disney, offer a broader framework in which to think about any blackout dispute, and consider the wider ramifications of this special time for the industry as a whole.
Another Blackout Showdown
I have to say, I, like every other industry analyst this weekend, am scrambling a little bit right now. Normally, blackout disputes are telegraphed well in advance by both sides because they want to get a head start on igniting public pressure against the other side.
This was different. For both this author and, as far as I can determine, every other industry analyst out there, the very first sign there was even a hint of trouble in these renewal negotiations was when Twitter suddenly lit up with customers complaining their live feeds of all Disney channels – which includes, in addition to the eponymous children’s networks, broadcasting powerhouse ABC, Freeform, FX, National Geographic and a slew of sports networks including the king of linear TV, ESPN – had suddenly terminated. Since then, both companies have issued statements. But this came literally out of the blue, in a way that blackout disputes simply do not usually arrive.
This dispute also has implications for more than just traditional linear TV because of one of the things that makes DISH Network truly unique among pay-TV providers: its bifurcated streaming-TV operation.
Sling TV
Sling TV, DISH’s streaming live TV option, has fallen on hard times after leaping out to an early lead in the live-TV field of the streaming wars. It was the first service to launch, well ahead of Hulu Live or YouTube TV, and it offers customizable channel packs which can be packaged together in various ways, sometimes yielding a significantly lower price than the $65-$70 that has become standard for streaming TV services. Sling service can be had for as low as $35 if only one channel pack is selected.
But Sling has fallen far behind Hulu and YouTube TV and has registered negative growth over the past three years. In addition to having fewer channels than its competitors, it charges more for the complete service, ie., all its available channels, at $77 per month and its DVR is less generous. This makes its unique ability to offer ESPN on an a la carte basis its main, if not only real selling feature.
But Disney probably hates that very feature. The unbundling of its channels from the broader bundle is nothing less than Disney’s worst nightmare, considering the outsized profits it extracts from cable customers. Now that ESPN has officially disappeared from DISH’s lineup, Sling Orange doesn’t even really have a reason to exist, considering that Sling Blue has literally every channel Orange has, and more.
This means that in addition to price, Disney and DISH are likely also now to clash over the basic question of the survival of the only a la carte ESPN offer on the market.
Disney Has Seen This Movie Before
The first question is simply who is likely to win this latest round of “how do we divvy up the monopoly profits of linear TV?”
For Disney, the single biggest reason to think it will emerge victorious from this is that we’ve already seen this movie … sort of.
Disney has been here before, and recently. Last year, YouTube TV dropped the Disney networks as well, citing much the same issues as DISH is citing now. The blackout lasted 39 hours, and ended with YouTube TV renewing its deal with Disney with no readily apparent changes in market terms or price. Put more bluntly, all evidence was that when YouTube TV and Disney went tête a tête, YouTube got trounced.
Not surprising, perhaps, since Disney like most producers is careful to always time its contract expirations for its time of maximum leverage. In Disney’s case, that’s right here in the fall-early winter period, when college football and the NFL are going full bore and the NBA is just about to tip off – all sports in which ESPN/ABC hold positions that are somewhere between substantial and absolutely dominant. Blackouts of Disney channels in this time of year make customers absolutely scream.
And Disney absolutely took steps to maximize the pain. This football season is the last under the NFL’s old TV contracts before the new ones kick in, although some early digital benefits are kicking in already, among them the rights to full DTC streaming transmission of games, at the rights-holders discretion. Before opening night kickoff, Disney announced that ESPN+ would enjoy simulcast access to some of the early Monday Night Football games on ESPN. The DISH blackout kicked in just before Week 4 of Monday Night Football.
I will give you one guess which week is the first week without simulcast access to MNF on ESPN+?
Yeah, so maximum pain for DISH Network viewers for sure.
Has The Big Four Become The Big Three?
However, the deck is not stacked entirely in Disney’s favor. DISH does have a few things going for it to give it at least a fighting chance in what is most certainly not a battle of equals.
First, DISH is larger than YouTube TV. While Alphabet (GOOG) (GOOGL) comfortably trumps DISH Network by not just one, but two orders of magnitude in market cap – and could similarly trump a DISH twice as large in like fashion – DISH brings more firepower than Alphabet to a showdown with Disney in this sense: it has more subscribers, meaning it represents more in foregone revenue for ESPN and Disney Channels.
DISH began the year with its satellite/Sling combo still holding well above 10 million subscribers, but back to back quarters of heavy losses have now pushed it just below that benchmark and legitimately raise the question of whether the Big Four is really now just a Big Three. Even so, it is roughly twice the size of YouTube TV – the largest MVPD outside the Big Four – and represents roughly 15% of the total pay-TV market, counting Sling TV and DISH satellite service together.
This means that in addition to asking how long DISH can last without ESPN, we must equally ask how long Disney can last without DISH.
Estimating ESPN’s Financials
This is where things get complicated. Because Disney steadfastly refuses to breakdown ESPN’s finances separately from the rest of its linear networks. Even when it did breakout Cable and Broadcast separately, it did not distinguish between ESPN and the Disney/Freeform lot. Now, it no longer even offers that level of detail. Disney earnings simply report ‘Linear Networks’ as a whole.
This is a level of disclosure bordering almost on the completely useless. The reason is, as I’ve written about before, that ESPN has a fundamentally different economic model than ABC or Disney Channel – changes in revenue transmit to operating income in a completely different way. Because sports contracts are locked in for a decade or more for a fixed fee, any increase/decrease in revenue translates more or less 100% to the bottom line – unlike scripted/unscripted content where salaries for stars can be renegotiated or, failing that, the show simply cancelled entirely.
This means that it takes a much smaller amount of revenue loss to completely wipe out the profitability of a sports network like ESPN than a broadcast network like CBS (PARA) or ABC. With twice as many subscribers as YouTube TV, Disney is taking a considerably larger gamble going down to the wire with DISH.
Even so, I think we can say with some confidence that DISH is simply not large enough to threaten ESPN. Industry analysts estimate that of ESPN’s $15 billion or so in revenue, only about $10 billion goes to content payments while $2.5 billion is cash flow. That means that ESPN is generating close to 20% net margin in profit, and DISH cannot take away that much of the revenue pie.
Shedding Light On Blackouts
DISH’s other advantage lies in the market structure: it doesn’t actually need its current customers to stand by it for this decision to be a winner. And this is something we can say about blackout disputes more generally, as well.
Time Favors The Distributor
The general rule of a blackout dispute is that the longer it goes on, the stronger the distributor’s hand becomes and the worse it is for the channel owner. This is not just because of the retrospective implications – it means that not enough customers have complained and cancelled to make acceding to the provider’s demands worthwhile for the distributor – but also because of the nature of a market of differentiated bundles in a commoditized market.
In a market where various commodities – channels can be thought of as commodities for this purpose, at least, since the ESPN feed on Comcast (CMCSA) is the same as the one on DISH or DIRECTV (T) – are being sold but the commodities are being sold in different bundles, consumers tend over time to “self-sort” according to which bundle they value most.
This means that if DISH does manage to make it through the first week or two and starts offering a far cheaper TV service – the absence of ABC, ESPN and Disney Channel will save DISH upwards of $20 per subscriber per month – then over time, consumers who attach different values to those two factors of price and ESPN access will tend to rearrange themselves accordingly. DISH will start advertising a lower price compared to competitors and it will also quickly develop a reputation as “that one that doesn’t have ESPN.” Consumers hearing that will weigh whether to defect from their current provider depending on how much they value ESPN, and those who value it less will tend over time to gravitate to DISH’s lower price.
It’s All About The First Few Weeks
Thus, DISH can in time build a consumer base of those who can get by without ESPN/ABC. DISH doesn’t need to retain a certain percentage of its current customers so much as it needs the total market size of those who don’t care about ESPN nationwide to be at least a certain level. Over time it can draw those people to its service.
But in order to do this, DISH must first survive those first few weeks, when football fanatics bolt the service in an instant, but the lower price offering has not yet had time to build consumer awareness. And given that we are talking about Disney, home of ESPN and ABC, in the middle of football season, there’s likely to be a lot of bolting happening.
Thus, while Disney has a lot of advantages here, it can probably be safely said that a tie goes to DISH. If DISH looks at its numbers in a month and sees that dropping ESPN and attracting more price conscious customers has had about an equitable impact on profit, it is absolutely going to want to maintain this new arrangement and trust that over time, it will attract even more price-conscious customers while the worst of the defections are probably already behind it. Indeed, even if DISH looks at the first few months and sees a significant but manageable loss, it may still tough it out a while longer and see just how many price conscious customers it can attract.
In order to win this showdown, Disney needs the costs vs benefits of lost and gained customers to be so slanted in its favor that DISH is practically beating down its door to get a new deal done. In this showdown, not only does a tie go the runner, the runner is called safe if he’s even “close enough” to first base.
Verdict: Not In, But Disney Favored
Advantage: Disney
Even so, the advantage here probably goes to Disney. It is Disney with the essential content of football, which we’ve already learned from other blackouts is the quintessential content of an MVPD in the middle of a streaming revolution. It has the balance sheet to wait out any short-term damage, unlike DISH which has a wireless network buildout to fund – sort of, although I and others have our doubts actually building it is the plan – and a loss-making wireless retail business to stabilize. And most importantly, DISH is almost certainly not large enough for its loss to push ESPN into the red. All this adds up to very limited leverage for DISH.
Terms of Surrender
Assuming a surrender is forthcoming, then, what will it look like? Well, at minimum Disney wants DISH to pay higher fees, like everyone else is already paying. But my guess is that, given DISH’s unique streaming posture vis a vis Disney’s networks, Disney management wants some changes there too. At the very least, they’ll want ABC integrated into Sling Orange the same way NBC and Fox are already integrated into Sling Blue.
But will Disney demand all-or-nothing, and insist on eliminating the Blue/Orange distinction completely and forcing DISH to offer a single base plan, like YouTube TV, fuboTV and Disney’s own Hulu Live already do? That is the real question.
Sling In A Sling?
If Disney succeeds in getting that, it will be highly detrimental to DISH, probably well beyond whatever subscriber losses it can’t reverse. With most of its competitors offering higher DVR space, more streams per account, and a lower all-in price, Sling has no real claim to consumer loyalty except that it offers customization. While its higher all-in price means that anyone who wants all the channels should go somewhere else, someone looking only for certain channels may find they can get a lower price at Sling in exchange for going without. Only need broadcast networks and news networks? Sling Blue’s got you covered, and for only $35 if you don’t need Orange’s family/sports channels or any of the expansion packs. A few expansion packs at $6 per might still leave you better off than with a competitor’s full-service offering.
Of these various customization options, however, hands down the biggest is the ability to take ESPN in the months that you want it and drop it the months that you don’t. No other service provider offers this, which is probably just about the only thing keeping Sling TV competitive in a market where it charges more for fewer channels than all of its competitors. The loss of this option, either through a prolonged blackout of the only channels that make Orange worth having or a deal that requires Orange and Blue be integrated, will be a major blow to DISH in a market share battle where it has few other cards to play.
Investment Summary
Ultimately, I expect DISH’s attempt to bring down costs from the most expensive linear provider in the market is probably going to go about as well as YouTube’s did, but the fact that Disney has now been blacked out twice in 12 months by two of the top five MVPDs in the market is indicative that the pay-TV ecosystem, long strained, is now probably well and truly on its last legs.
DISH and others aren’t picking fights with Disney because they want to: the industry math just doesn’t add up anymore, and this is one of the last places they can look to find real savings. While an individual MVPD is probably dead if they drop ESPN, the industry as a whole is probably dead if everybody keeps it.
That means that while Disney will probably win this battle, it seems like it is likely to lose the war. For Disney, keeping ESPN anchored firmly on all the major pay-TV services is of limited benefit if those services continue to hemorrhage subscribers. With cord-cutting now approaching 10% per annum rates, ESPN and Disney are in big trouble even if not a single provider ever finds the formula to successfully drop ESPN.
I rate DISH and Disney both dubious Holds.
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