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Linear subscriber erosion to curtail Disney's operating income, analysts say


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Linear subscriber erosion to curtail Disney's operating income, analysts say

Benefiting from higher rates, Walt Disney Co. scored an uptick in domestic linear affiliate revenue in its fiscal fourth quarter. However, cord cutting could reverse that revenue course in the company's fiscal 2023 and beyond.

Disney CFO Christine McCarthy said on the Nov. 8 earnings call that total domestic affiliate revenue grew 2% during the period ended Oct. 1. The improvement was tied to five points of growth from contractual rate hikes, offset by a four-point decline tied to subscriber erosion.

"Looking ahead, we expect to see linear subscriber declines accelerate more in line with industry trends," McCarthy said.

Concerns around those declines prompted Wall Street analysts to lower their income forecasts.

MoffettNathanson analyst Michael Nathanson is now forecasting that operating profits for Disney's linear cable network segment will drop by 17% in fiscal 2023 versus an earlier forecast of a 4% annual decline.

Nathanson cited the negative economic force of cord cutting, while noting that Disney is coming up on a year removed from its omnibus carriage renewal with Comcast Corp. on Nov. 30, 2021. The Comcast deal included a subscriber boost from carriage of the ACC Network (US), the cable channel that airs Atlantic Coast Conference contests.

Kagan, a media research group within S&P Global Market Intelligence, estimates that ACC Network will generate nearly $419.0 million in affiliate revenue in 2022 from an average subscriber base of 47.8 million.

In a note, Wells Fargo analyst Steven Cahall also highlighted the ACC Network carriage in aiding the segment's fiscal 2022 affiliate performance. Assuming cord cutting manifests at a 7% rate per year, Cahall expects linear networks' operating income to decline by 6% in fiscal 2023 and 9% in fiscal 2024.

Morgan Stanley analyst Benjamin Swinburne said subscriber erosion and advertising headwinds combined with rising sports rights fees could result in further downside relative to the firm's expectations for an about 10% operating income decline at the linear networks segment in fiscal 2023.

"We were already expecting flat to down revenues [year over year] at the linear networks, but our estimate for low-single digit expense growth may be too optimistic," Swinburne wrote in a research note.

Top vs. bottom lines

Disney, like other media conglomerates, is trying to find the balance in managing its traditional linear business while growing its streaming operations.

In the fiscal fourth quarter, Disney's linear networks posted a 6% year-over-year advance in operating income to $1.74 billion. This growth came despite a 5% revenue decline to $6.34 billion.

The bottom line was aided by reduced programming and production costs, McCarthy said. The executive pointed to the timing of the NBA Finals, which, owing to the pandemic, played out in the final fiscal reporting period of fiscal 2021 versus the third quarter of fiscal 2022. ESPN (US) also televised fewer baseball games in its fiscal 2022 fourth quarter under its new MLB contract, but NFL programming costs rose via an additional contest in the period.

ESPN's ad revenue declined 23% year over year, reflecting the impact of the NBA Finals. Adjusting for that timing, its ad revenue was off about 2%.

Results in the first quarter of fiscal 2023 will be impacted by the shift of two College Football Playoff games into the fiscal second quarter. Quarter-to-date, ESPN's domestic cash advertising sales are pacing down, reflecting in part the absence of those marquee college games.

The advertising landscape remains fluid, according to McCarthy. The CFO said sports is delivering strong audiences across Disney platforms, with marketers in the pharmaceutical, insurance and restaurant categories continuing to display relatively stable demand. Other marketers, though, remain cautious in anticipation of potential economic softness.

Disney+ debut

Slated to launch Dec. 8, the ad-supported version of Disney+ has secured deals with more than 100 advertisers, spanning a range of categories, according to Disney CEO Bob Chapek.

"Strong base pricing reflects the value advertisers put on our audience, our brand-safe environment for their messages and our sales experience," Chapek said. "We also have proven technology to deliver a great advertising experience on Day 1 and importantly, we have the ability to scale and innovate for audiences and advertisers alike."

Chapek said the company has over 8,000 existing relationships with advertisers that could ultimately convey their messages on the new streaming platform.

Overall in the fiscal fourth quarter, Disney reported a 9% revenue increase to $20.15 billion. Net income from continuing operations totaled $162 million, or 9 cents a share, up slightly from $160 million, or 9 cents a share.