Is Dan Loeb Right About Disney?

On Aug. 15, activist investor Dan Loeb sent a letter to Walt Disney (DIS) CEO Bob Chapek indicating that Third Point LLC had taken a nearly $1 billion stake in the entertainment giant. 

While the investment represents a mere 0.4% of Disney’s stock, Loeb felt compelled to tell Chapek precisely what was wrong with the company and what it should do to fix the problems. 

The most prominent suggestion was that Chapek spins off ESPN, the company’s cable sports network. 

Dan Loeb’s a bright, not to mention incredibly wealthy investor. If he has ideas to get Disney back to days gone by, it makes sense for Disney management and the board to at least listen.

However, before buying DIS stock, it’s important to remember that the argument to spin off ESPN is not new. It’s been around for years. 

Maybe now is a good time to make a move. Perhaps it’s not, but spinning off ESPN has pros and cons.

Hulu Plus Disney+ Is a Home Run

As part of Loeb’s plan, Disney would accelerate its purchase of the 33% of Hulu from Comcast (CMCSA) that it doesn’t already own. As it stands now, Disney has until early 2024 to buy the remaining 33%. 

Once it has acquired the remaining stake, the company would merge Hulu with Disney+, creating a massive video streaming platform capable of overtaking Netflix (NFLX) and its other competition. 

In May, Puck floated the idea that Chapek wanted to spin off ESPN so that it could then merge with Electronic Arts (EA) to form a sports entertainment colossus. The thinking was that since EA had held negotiations to merge with NBCUniversal that failed, it would be open to new talks with Disney, Amazon (AMZN), and Apple (AAPL). 

For starters, it’s unlikely that EA CEO Andrew Wilson is willing to play second fiddle to any other executive in a merged enterprise. Wilson would either run the show or no deal. Amazon, Apple, Disney, and Comcast have very strong-willed leaders, so any agreement with EA would take a significant amount of arm twisting on the acquirer’s part. 

Secondly, ESPN+ has been doing well under the Disney umbrella. Why threaten that with a loss of focus as Disney management works on a spinoff? It seems it doesn’t need to spin off ESPN to line up a sale. 

Lastly, this is an argument that’s been around for years.     

The Spinoff Argument’s Been Around for Years

In December 2020, Reuters published an article that suggested that Chapek – just one year as CEO -- should spin off ESPN. 

“To reduce Disney’s reliance on cable distributors and further change within the group, he should set ESPN free,” wrote Reuters contributor Jennifer Saba. 

“Disney doesn’t own the channel’s core content: It pays princely sums for the right to air sporting events, such as National Football League matchups. Overall, Disney is on the hook for more than $40 billion in sports programming commitments – more than triple the amount a decade ago.”

In other words, to Loeb’s point, ESPN doesn’t generate enough income and cash flow to justify the debt load it brings to the table. As a separate company with its own debt, ESPN would be far less a burden on Disney’s balance sheet. 

The spinoff idea goes back much further than 2020. 

Speculation surrounding ESPN existed as far back as 2006. I know that I proposed in 2012 in an article for another publication that Disney spin-off, but that was long before it got into the streaming business. 

The ESPN brand has never fit into the Disney model despite joining the company by acquiring Capital Cities/ABC for $19 billion in 1995. 

To me, it would make more sense to spin off ESPN and the entire Linear Networks business, which includes ABC. However, that would dramatically reduce Disney’s overall revenue and profitability. 

Why It Doesn’t Make Sense

The argument to spin off ESPN fails to make sense even with all of Third Point’s entire slate of suggestions being implemented.

Not only does Loeb want ESPN gone, but he also wants to create a more robust Disney+ offering by fully integrating Hulu into the company, cutting costs, disposing of underperforming assets, suspending the dividend to pay down debt or some other capital allocation lever, and getting board members that understand technology, advertising, and consumer engagement.

It’s a tall order.

A 2021 CNBC article estimated that ESPN generated approximately $9 billion annual revenue from domestic carriage fees. Meanwhile, as of July 2, ESPN+ had 4.79 million subscribers, up 6% from a year earlier. Based on $9.99 per month for the ESPN+ subscription, we’re talking about $575 million in annual subscriber revenue.

Barclays estimates that all of Disney’s sports networks -- ABC Sports and ESPN -- will generate $12.4 billion in annual revenue and $3.9 billion in operating profits in fiscal 2022.

To give up some or all of this revenue and earnings before Disney+ is profitable -- expected to start making money in early 2024 -- would be a tough pill to swallow for Chapek, the board, and even most of its shareholders. 

I think it makes much more sense once the direct-to-consumer business prints cash. We’re not quite there yet. 

It's a nice thought, but Loeb’s idea doesn’t stand a chance of happening, especially when he only owns 0.4% of the company. Check back in 2024, Dan.      

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