Disney and Cord Cutting: Known-Unknowns

As much as I like to post and read things confirming my opinion on an investment, it is actually the information that contradicts me that I like and that helps the most.

One of the things I’ve learned from Philip Tetlock’s Superforecasting is you have to constantly update your information models and change your forecasts when the facts change. Always reading information that confirms my hypothesis does the opposite. It makes me overconfident and this leads to poor decision making. Balancing out confirming information with contradictory information “should” help me make a more informed decision.

It is why we added the Pre-Mortem to the Dividend letter. What are the “known-unknowns” that could torpedo our investment. For Disney, the known-unknown is cord cutting and its effects on Disney’s cable networks and its most profitable channel, ESPN.

We outlined the issues in the 24th dividend letter and Rich Greenfield, an analyst at BTIG Research, stated them again when he downgraded Disney the day before opening day for Star Wars.

“Investors must remember that at its core, Disney is a cable network company that has the highest level of fixed costs (sports rights) in the industry,” he wrote. “ESPN now appears poised to become Disney’s most troubled business as consumer behavior shifts rapidly.”

In the past year, HBO and CBS have begun “unbundling,” meaning that they now offer their programming à la carte for a monthly fee that’s far less than a bundled cable bill. Mr. Greenfield believes that as more cable networks shift to selling their programming this way, ESPN will have to follow suit. But he says it will not be able to sign up enough viewers to pay a monthly subscription fee that would offset the loss in cable subscribers who now pay a monthly carriage fee (about $7 a household) whether or not they watch ESPN.

These lucrative fees currently cover the enormous cost of licensing live sports programing. Mr. Greenfield has been especially critical of ESPN’s aggressive sports-rights acquisitions in recent years, which he says has been driven in part to block the growth of rivals like Fox and NBC.

As the article goes on to say, some people are dismissing the cord-cutting threat while others are extremely dire. I’m in the middle right now. Affiliate fees for Disney’s cable networks have set increases that exceed the expected cable attrition rates. For now.

Cord-cutting is happening, but it is a relatively new phenomena with a lot of questions still left to be answered.

The biggest cord cutters are millennials. Young people in college and in their 20s. This group does not have a lot of disposable income which makes the group primed to be looking for the cheapest entertainment option. Internet plus Netflix works well for this group. But what happens when they start earning more money? Do they come back to cable? What about when they start having families and forming households? Do they come back to the relative ease of a cable subscription or is the user and customer experience so bad that they stay with OTT services?

What about costs? Netflix is cheap right now, but Netflix is sacrificing profitability to gain subscribers. Eventually, they will need to make profits and cash flow to justify their lofty valuation. When that time comes how high will they have to raise subscription rates? How often will they have to keep raising rates if Content companies charge Netflix more for their content?

What about fees from the cable companies? They’re not going to stand by and let people pay $40-60 per month just for the internet and slam their infrastructure with downloads. Comcast is already implementing rate caps and high overage charges for data hogs. They’re expanding the plan and you can bet the other cable providers will do the same. Maybe you can get unlimited internet again with a cable subscription? Or maybe a cable subscription becomes way cheaper than the internet only option?

My point is there are still a lot of unanswered questions about cord-cutting and the future of cable for me to make a definitive call. It is what makes cord-cutting a “known-unknown”. We know about it, but we just don’t know enough to fully grasp how it will truly affect the cable industry. It is something that we have to continue to pay attention to and update our models/forecasts as we get more information.


Beyond ‘Star Wars,’ a Dark Force Looms for Disney: Cord-Cutting (Dealbook)