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A fun question to ask of Penn Entertainment’s quarterly earnings call last Thursday is how to read the tea leaves of Penn’s disappointing first two quarters with ESPN Bet. Penn is struggling with sports betting: Last February, it closed an acquisition of media company Barstool Sports for around $500 million to build a sports betting service. It soon sold it back to Barstool founder Dave Portnoy for $1 and a long list of contractual covenants because regulatory obstacles related to Portnoy had become too expensive to resolve.
Last August, Penn signed a 10-year licensing deal with Disney and ESPN to rebrand the sports betting app “ESPN Bet.” Penn is licensing the ESPN brand, ESPN will promote the sportsbook to its massive audience across platforms and both parties are projecting market share scenarios of between 10% and 20% for online sports betting in the U.S. in 2027. The cost to Penn is a $1.5 billion annual licensing fee paid per year to Disney/ESPN. ESPN will also get $500 million of warrants to purchase 31.8 million Penn common shares that vest over the same decade-long period, bringing the deal total up to around $2 billion.
The app launched in November and quickly rose to the top spot in Apple’s iOS app store. More than one million customers signed up through the first two months, many driven by a promotional signup offer of $200 bonus bets (later reduced to $100 ahead of Super Bowl LVIII).
In recent earnings calls, the substance has not matched the optics. In February, Penn Entertainment reported its interactive gambling division lost $333.8 million in the fourth quarter of 2023 due to costs related to ESPN Bet’s Nov. 14 launch. The losses were higher than investors had expected and the stock dipped 15%. On Thursday, it reported the division posted an adjusted EBITDA loss of $196 million. It substantially missed its goal of a hold of 7 to 8%—a margin that sportsbooks take on both sides of a bet—and reported a 4.4% hold in Q1.
The divination question here for our figurative tea leaves is, is this news ominous for ESPN's direct-to-consumer future?
Key Takeaway
Wall Street has plenty of reasons to perk up and pay closer attention to whether Penn Entertainment's struggles with ESPN Bet are a barometer of success for ESPN’s future pivot to direct-to-consumer.
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Wall Street’s Current Take
Wall Street investors think only two fiscal quarters ahead. So, the fact that Disney’s stock is up 2% and Penn’s stock is down 10% since Penn’s earnings call suggests that Wall Street is not thinking about ESPN’s planned launch of a direct-to-consumer service in 2025 yet. That may be because Penn projects losses until 2025, and ESPN will still be Disney’s cash cow, having generated $2.5 billion in operating income in 2023.
But, as I wrote in an August 2023 Medium Shift column for The Information: “Disney doesn’t have a great record of success from investing billions in digital media ventures for its post-linear future.” Its attempts at adding retail-first digital media businesses to its nearly 70-year-old flywheel have fallen short. Even Disney’s recent partnership and $1.5 billion equity stake in Epic Games appears to have more style than substance: It is not yet clear how Disney’s approach to micro-management of its brand will change once it is an investor but not the actual developer.
All ESPN streaming viewing continues to be low at 0.13% of all TV viewing in the U.S., according to Nielsen's most recent The Gauge for March 2024. Wall Street has plenty of reasons to perk up and pay closer attention to whether Penn Entertainment is a barometer of success for ESPN’s future pivot to direct-to-consumer.
LaBearish?
One reason to pay closer attention is the surprise departure of Aaron LaBerge, the chief technology officer for Disney Entertainment and ESPN, to take a job in June as CTO of Penn Entertainment. The official press release from Disney was the departure “for personal reasons related to his family.” Whatever the actual reasons, the timing and the move are head-scratchers.
LaBerge had been a key figure in developing Disney’s streaming services, including ESPN+. He also has led the integration of advertising into Disney+ and efforts to unify Hulu and Disney+ within one streaming application. In short, he has been *the guy* CEO Robert Iger has been relying upon to guide his pivot to streaming, and he is leaving a year before ESPN’s direct-to-consumer offering will launch.
For people looking for a bearish signal for Disney’s long-term health in an increasingly consumer-first, retail-first marketplace, that’s as strong as any.
Why LeBerge Made The Move
The spin in Penn’s earnings call is where they expect to be with ESPN in Q1 2025, and why LaBerge is key to that:
“...when we get to the point where we've been able to link accounts between the ESPN ecosystem and ESPN BET, the opportunities for personalization are endless. And they're also going to be highly differentiated because we'll be able to do things with ESPN and within sports media that no one else can do.”
This answer also suggests LaBerge’s likely reasons for the move: There will be more “wins” for him to solve Penn’s tech stack than Disney’s tech stack. That may imply a bearish take on Disney’s competitive streaming future. Or, it may simply be that Disney moves slower as a larger media conglomerate and Penn offers much needed agility for direct-to-consumer success. Either way, in addition to the “personal reasons”, LaBerge was eager to jump on the opportunity.
One also has to wonder whether LaBerge’s move was related to the opportunity for product design. DraftKings is the #1 app in sports betting and its Co-Founder, Chairman & CEO Jason Robins told investors last November that its success reflected the company’s belief that “the heart and soul of the organization is product and technology.” Penn has obvious problems that need to be solved, and there is a lot more upside. Analysts like Oppenheimer agree, having concluded that “[C]ompetencies in product development and customer acquisition that [DraftKings] utilized to become the daily fantasy sports market leader will allow the company to be a critical player in accelerating the shift in US sports betting from [around] $150 billion wagered illegally/offshore to licensed domestic operators.”
If LaBerge can make Penn as competitive as its management is promising investors, the upside for him personally and professionally is significant. Meanwhile, Disney is “working more for less” growth in streaming, according to research firm Antenna. The upside in streaming seems significantly lower for LaBerge.
What About Bob?
Then again, why would anyone leave the C-Suite of a company with a market capitalization of over $200 billion for the opportunity to compete for a fraction of a marketplace with a total addressable market worth $150 billion? And that market already has a clear market leader in DraftKings?
There seem to be no sour grapes between LaBerge and Disney management, who wrote in an internal memo: “It is a silver lining that he will continue to help Disney and ESPN win, as he transitions to a role at PENN Entertainment — where he will be a key partner in the continued growth and success of ESPN BET (and the rest of their Interactive business).”
Iger recently told investors at the Morgan Stanley Technology, Media & Telecom Conference, “we need to be at [Netflix’s] level in terms of technology capability.” He also claimed that when Disney+ launched in 2019:
“our goal was to have basically robust video projection or video experiences at scale…. What we didn't have was the technology that we needed to basically lower customer acquisition and retention costs to increase engagement to essentially grow our margins by reducing marketing expenses.”
This conveniently rewrites history, as in 2019 he was on the record with The Wall Street Journal ruling out building technology that increased engagement: “I think if people are clicking on Mickey Mouse, they mostly want Mickey Mouse.” For all its extraordinary accomplishments and benchmarks, Iger had hamstrung Disney’s streaming business to succeed from the get-go.
So, for Iger, LaBerge’s departure is a mixed bag. He now has an ally to help improve the execution of a deal worth $15 billion over the next 10 years, and is a cornerstone of ESPN’s post-wholesale, direct-to-consumer future. But, he has lost the head of his streaming initiative months after activist investors like Nelson Peltz poked holes in its success story, and before ESPN pulls of a promised pivot from wholesale linear to retail direct-to-consumer. One also has to wonder whether LaBerge has opened the door to a new candidate for Iger's succession to replace him, one who has a computer science degree.
There is more than meets the eye to tomorrow's Disney FY Q2 2024 earnings call.