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The Science of Hitting
The Science of Hitting
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The Future of ESPN+

Why ESPN's over the top service could become important for Disney's future.

June 19, 2018 | About:

In April 2018, ESPN’s over the top (OTT) subscription service, ESPN+, was introduced in the U.S. Here’s what ESPN President Jimmy Pitaro had to say at the launch:

"This really is the next phase for us. Quite simply, it's an opportunity for us to serve sports fans in a way that no one else really can and at the same time expand our audience, expand our reach and expand our engagement."

At this point, I think it’s safe to say that Mr. Market is skeptical. Many Disney (DIS) investors view ESPN as a long-term risk to the business, not a growth opportunity. They are concerned by its reliance on the traditional pay-TV universe. While I can appreciate the risks, I think there’s another side to the story: In today’s world, ESPN has a real opportunity ahead of it.

One of the issues facing legacy ESPN is that the TV channel is constrained to offering customers one sporting event or one TV show (per channel) at a time. When you turn on ESPN, your only option is to watch whatever has been selected by the programming team in Bristol, Connecticut. Unsurprisingly, that team will try to select an event or show that will garner the largest audience. In primetime, that usually means a live sporting event. Using Major League Baseball as an example, the result it that ESPN might show a game or two a night during the regular season. If you flip to the regional sports network in your TV package, you can watch the game for your local team as well. Finally, there might also be a game on the MLB Network, the TV channel that the league launched in 2008 for hardcore baseball fans.

But let’s say you want to watch an out of market team that wasn’t selected for the national stage. While the system works well for local fans (thanks to the regional sports networks), it’s less effective if you don’t live in the same geographic area as your favorite team. If you’re a huge Boston Red Sox fans that moved to Florida to escape the cold, you had to accept limited access to your favorite ball club.

Starting in the early 2000s, Major League Baseball and the pay-TV providers launched out of market packages to address this need. Currently, these packages will cost you around $175, or about $30 per month during the regular season. MLB has also launched its own out of market package that consumers can access over the internet for $116 per year (or $25 per month).

So that’s a high-level look at the maze one of the professional leagues has created for its fans. It’s hard to find reliable subscriber data for the MLB out-of-market packages, but I’m willing to bet it’s small (a Los Angeles Times article from 2015 put the number at 3.5 million subs). I think the reality is most people will just stop watching if they’re faced with the hurdles described above.

As we look at the other major sports leagues in the U.S. (like the NHL or the NBA), we’ve seen the market develop in a similar manner. For consumers, you basically have two options: accept limited access through your pay-TV package or pay a lot more money for access to additional games.

Thankfully, Netflix (NFLX) has changed consumers' expectations. People want access to content whenever they want it and wherever they are. Because of how sports rights have been cobbled together, this area has been a real headache for people trying to access sports content outside of their home. This isn’t good enough. There’s an opportunity to fix this broken system.

This is where ESPN+ comes in. With this product, I think Disney sees a significant opportunity over the long term to address these legacy issues (it probably doesn’t hurt that they’ve learned a lot from being disrupted by Netflix in entertainment programming). They can offer broader and deeper access to sports rights and analysis than was feasible in the traditional linear TV world.

The key piece of the puzzle is sports rights. While the premier sports rights are locked up for the next couple of years, I don’t think that’s a huge problem for ESPN+. In fact, I’m not sure that’s where they should be focusing most of their attention -- at least not at first. As opposed to fighting for a handful of marquee events, I think ESPN should acquire as many niche sports rights as they can. They’ve already started down this path, with rights for Major League Soccer, rugby, cricket, the Canadian Football League, combat sports and a handful of soccer leagues (to name a few).

I think going after the long tail makes a lot of sense. It reminds me of what Netflix did in the early years after launching its streaming service. If I was ESPN, I’d go further. From my perspective, any sporting event being (professionally) recorded around the world should be considered.

I’ll use soccer as an example to show why I think that’s the appropriate strategy. Currently, U.S. consumers have decent access to the English Premier League through NBC Sports, but much less coverage of the other top leagues (like Bundesliga, Serie A and La Liga).

There isn’t much competition to air these events, which puts ESPN+ in a position to acquire these niche rights (at least in the eyes of your typical U.S. sports fan) at a reasonable price. That takes a market that has been nearly inaccessible for U.S. consumers and gives them the option to watch any game they want. Importantly, the cost to do this should be relatively low: The games are already televized outside the U.S. (so there is a video feed for ESPN to use), and the business is largely incremental for the leagues. It's a win for all parties involved.

That’s what ESPN+ should focus on: acquiring a significant amount of sports rights at reasonable prices, then using the data from the OTT service to make intelligent business decisions over time. As it relates to rights acquisition, the structure of the UFC deal (with content going to ESPN+ and traditional ESPN) could serve as a model for the future. Over time, as the service adds subs and engagement increases, this gives it flexibility to compete for premier sports rights as well.

ESPN+ also has a significant opportunity beyond sports rights. The constraints of a linear TV channel influenced the development of shows like SportsCenter. The time dedicated to any sport had to meet the realities of a 30-minute or 60-minute window, with hockey and soccer getting the short end of the stick (as an example). That doesn’t have to be the case in today’s world. Since launch, ESPN+ has aired shows specifically focused on the MLS and NHL. In addition, they’ve had a show where Kobe Bryant breaks down NBA action (Detail). Finally, the library of on-demand content also includes the entire "30 for 30" documentary series. These are a few examples of how ESPN+ can deliver incremental value for hardcore sports fans.

Among the flood of niche sports rights and new shows, the average user will probably conclude that they could care less about most of what’s being offered. Of course, the same is true for your average Netflix or Hulu subscriber. The beauty of an OTT service is that it removes the constraints of a traditional TV channel; the unique needs of millions can be met simultaneously.

There’s an opportunity for ESPN to become the Netflix of sports. Importantly, building a large audience would influence discussions with the leagues. Starting with a large installed base for the ESPN app should be helpful in this regard. As an example, could a service with millions of subscribers help expand the audience for the MLB or NHL? They’re running a test of sorts right now, with both leagues having one out of market game on ESPN+ each day. It may take some time for the top leagues, but you could see some bold moves from the others in the near future (note that a recent deal with the MLS moved its entire out of market package, which used to cost $80 per year, onto ESPN+).

Capitalizing on this opportunity will take years to come to fruition. It will require ESPN to spend aggressively on sports rights and to continue improving its consumer-facing technology (another area where Netflix has changed the game). Consumers need to be able to easily access ESPN+ on whatever device they choose – and it needs to work. They need a best in class experience on smartphones, set top box platforms (like X1), video game consoles and other connected devices (Chromecasts, Fire Sticks and so on). Finally, Disney must be willing to accept the short-term hit to the P&L that will come with a major investment in ESPN+.

Time will tell if ESPN is willing to commit the resources necessary to turn this vision into reality. If they do, ESPN could truly become “The Worldwide Leader in Sports.”

Disclosure: none.

About the author:

The Science of Hitting
I'm a value investor with a long-term focus. As it relates to portfolio construction, my goal is to make a small number of meaningful decisions a year. In the words of Charlie Munger, my preferred approach to investing is "patience followed by pretty aggressive conduct." I run a concentrated portfolio, with a handful of equities accounting for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

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