RBC: Disney should get rid of ESPN (DIS)

December 05, 2016 at 09:12 AM EST

Ted S. Warren/AP Images

ESPN has a growing number of problems. Falling subscribers, increased costs for sports leagues' broadcast rights, and sinking investor sentiment are weighing on the sports network's financial future.

This has put Disney, ESPN's parent company, in a tough spot.

Steve Cahall, a media analyst at RBC Capital Markets, is now arguing that ESPN is holding Disney back to such a degree that it may be time for Disney move on from the network.

Cahall notes that the enterprise value for Disney, which takes into account market cap as well as debt, cash, and other assets on the balance sheet, has sunk to $176 billion today from $210 billion in June 2015. Most of this devaluation, the analyst said, is due to the sinking fortunes of ESPN. Cahall estimates that while Disney's EBITDA has been growing at a 12% annual rate, ESPN's is actually declining by about 3% annually.

"This all begs the question of whether Disney shareholders are better off without ESPN," a note from Cahall on Monday said.

Cahall gives three major reasons Disney may want to spin off or sell the sports network. They are:

Unlocking the true value of the rest of the company: The RBC analyst says ESPN's sinking business outlook is running counter to the rest of Disney's assets such as the movie studios and theme parks. Cahall estimates that the enterprise value of Disney is being held back by an additional $10 billion because of the inability of investors to properly rate the two sides of Disney.
"We also think there are plenty of long-term investors that want to invest in what has historically been viewed as the 'blue chip' Media stock that are simply scared off by the uncertainty at ESPN, preferring more obvious 'secular winners' such as the FANG group of stocks," Cahall wrote.
Spinning off ESPN would free up Disney for a more value-additive merger: Disney has been rumored to be interested in everything from Twitter to Netflix. By spinning off ESPN, the company would be more nimble, and less likely to be held up by regulators. Or as Cahall put it, a slimmed down Disney would be "smaller and more digestible."
A spin off frees up cash for financial activities: By selling off ESPN or raising capital from a spin off, Cahall believes that cash can be used for more fruitful investments. "More importantly, we think Disney could redeploy the capital into assets that would have more synergistic relationships with the various segments, i.e., movies, theme parks, consumer products, etc," said the note.

Cahall said that Disney could go one of three ways to get rid of ESPN: spin the company off into a publicly traded firm (interestingly, he estimates it would trade at $9 per share), sell it to a financial firm such as private equity, or sell it to another media company.

Cahall does note his argument would be met with a healthy amount of skepticism and there are transaction costs that could hold up such a deal. In the end, Cahall wrote, removing ESPN from Disney may make financial and operational portfolio of Disney stronger and may be the best path forward.

"M&A discussion may increasingly include the prospects of 'D' (divestiture), as the cash generated could go a long way toward assuaging fears around the price paid for a company with an internet multiple," concluded Cahall.

"We think that any major deal would be scrutinized heavily by investors, but we also think the bias is positive given the impressive deals undertaken under Bob Iger to create and leverage world-class intellectual property."

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