Description

Here is a quick snapshot of the asset value of DVD:

Share Price: $1.81

Shares Outstanding: 36.7mm

Market Cap:  $66mm

Net Debt+Pension:  $40mm

Enterprise Value:  $106mm

ASSET                       EBITDA                    VALUE          METHODOLOGY

Dover Speedway        $24-28mm                   $169mm          6.5x EBITDA in-line w/ peers

Memphis Track           $-1.5mm                      $5mm              Carried at $3mm, had bid for $10

Gateway Track            $-1.5mm                      $2mm              Carried at $1.5-seems conservative

Nashville Track           $-2mm                         $30mm            Carrying value less revenue bonds; put $90mm into it-1500 acres of land

                                                                                              worth maybe $20-30k an acre

Asset Value:    $206mm                                                         

Less Debt:       $40mm

Market Value: $166mm

Per Share:      $4.52 or Upside of 150%

*not adjusted for $8mm change of control provision (which I gladly will pay) or for the scarcity value of asset

The Jewel of the Company: Dover Speedway

For the other $65mm you are paying for the company, you get Dover Speedway which has 135k seats and the rights to two Sprint Cup races and two Nationwide series events.  My best guess is that DVD does $15mm in EBITDA excluding the losses from the loser track and upwards of $23-$27mm on a Dover track-level basis taking out the corporate overhead.  Their maintenance cap-x is sub $1mm as you can see by this year which is going to come in at $500kish but they could spend more or less depending on the economy.  To sanity check these numbers, ISC does between $15-20mm of EBITDA per track and Speedway Motorsports does high $20'smm EBITDA per track.  Dover should have well above average track level EBITDA for three reasons:  1) it has two races per track and some tracks only have one race; 2) it has 40-50k more seats than the average track; and 3) it has the highest tier of broadcast rights payments from NASCAR.  Dover might be not be as savvy on the sponsorship side but I still believe track level EBITDA is close to $25mm or would definitely be if acquired. So, you are buying in at maybe 4.5x EBITDA consolidated ex losses and 2.2x track level EBITDA.

Does Anyone Want to Acquire DVD?

It is well known that DVD has been approached many times over the years by International Speedway and Speedway Motorsports to purchase the company, but they have always disagreed on price.  DVD disclosed that they were offered above $5.50 a share by ISCA and TRK jointly in 2007 but they wanted more (disclosure in a Mario Cibelli 13D filing).  Here is what ISCA said on a conference call on July 8^th, 2010:

"Q: So I could assume from that that there would be no chance of an acquisition anytime soon?

A: Well, that all depends on the sellers out there. We would be interested in an acquisition that would be of a benefit to our shareholders. But we're not interested in meeting the what we feel very overpriced multiples that have been paid for recent transactions over the last couple years for motorsports facilities and we don't feel like that would be a positive thing for our shareholders.  There's certain strategic value, there's only so many Sprint Cup race dates, and we weigh all of those things as we look at the opportunities. But we are always interested and always talking with potential dealmakers there, but just at this point we don't feel we've got something that really brings the value to our shareholders."

On September 30th, at a Wells Fargo conference, here is what management said directly about the DVD situation:

Q:  Hi. I'm sure you guys have seen the Dover Downs-Motorsports merger announcement. ISCA management in the past has talked about opportunistic acquisitions at the right price. I think that in an auction process, at a no premium to market price of Dover Motorsports and at a zero breakup fee, it seems like ISCA could easily top Dover Downs' bid.

A:  Well, we've been in discussion with the chairman of that company for several years. And when we were focused just on the motorsports component of that business, we never could come to an agreement on price. Dan can speak more to their financial situation. But we also believe it is still -- just the Motorsports piece of that business is challenged by some of the other properties that they have. It's a real drag on cash flow.  And so it doesn't preclude us from taking a look at it in the future, especially with a gaming partner. But we've just not been able to come to an agreement with price with those folks.

A:  Thanks, John. I think that we are as well -- point well taken. We are digesting the information that we saw there and what strategic opportunities may be available to us now and in the future.  So as John said, interested in the assets and in the properties, but that means at a price that makes sense for ISC and its shareholders. And in the past, we've had discussions with the Dover folks from time to time, kind of on a -- we have an ongoing dialogue. But nothing that has really made sense for us up to the point of the announcements we've seen the last couple days.

The Activist Investor, the Proposed DDE Merger, and is DVD in Play?

I think it is clear that ISCA and TRK would both be interested in DVD and it is a given that both would bid up to a fair price for the asset as the value of it is extremely transparent (i.e. no difficult merger integration discount).  Interestingly, the largest outside shareholder of DVD is Mario Cibelli who has been agitating for a sale of this company for a while and has a website called www.sellthecompany.com that goes through his analysis.  He owns roughly 10% of the company and has been very vocal against the management for some time.  He even offered to buy another 8mm shares in November 2009 from the controlling trust for $2.35 per share to wrestle control of this.  It is practically impossible to go after family controlled companies, but I am glad he is there right now.  A couple of months ago, the management of DVD and Dover Gaming (the same management controls both companies) proposed to recombine DVD and DDE once again in a merger of equals.  The bad news is that this was a near scandalous attempt to steal value from DVD to prop up DDE which looks like it is in trouble.  The good news is that given Cibelli's presence and the board is worried about getting sued they called off the merger within two weeks. 

The question this raises is whether Dover management has now lost all credibility with the founding family and/or if the chairman of Dover has run out of options.  The management and chairman convinced the board to merge the companies together instead of selling DVD and now have egg on their face given they turned tail so quickly and squandered away $500k in merger related expenses as both companies are struggling.  Dover Gaming is over-levered and facing declining cash flows due to problems in regional markets and other states allowing gaming.  The company looks like a potential disaster and may have to issue equity/raise capital.  DVD has also found itself in a precarious position where they have now shut down 2 of their 3 loser tracks and are trying to sell them off to stop the bleeding and get more cash to pay down the debt.  It would not shock me if they decided to shut down Nashville as well.  DVD has too much debt relative to current cash flow post corporate overhead, so they don't have much financial flexibility to pursue anything as an acquisition.  In summary, DVD and DVD management seemingly have no strategic options beyond selling the company so it seems it is all about price.

Acquisition Multiples and Transaction Data Points

-in 2008, Speedway Motorsports paid $340mm for New Hampshire speedway, which had 35k fewer seats than Dover and one of the two races they have gets slightly lower broadcast fees than one of Dover's.  This is the best comp but was clearly a high bid.  This would value DVD at an unrealistically high $9 per share.

-TRK bought Kentucky Speedway in 2008 for $80mm without any NASCAR races.

-DVD was offered over $5.50 in 2007 by a combination of TRK and ISCA.

-Races used to sell at crazy 16x EBITDA multiples but now that ISCA and TRK trade so cheaply at circa 6.5x EBITDA this is obviously a moot point.

-If you look at what TRK and ISC trade per race, ISC traces at an EV of about $75mm per Sprint race and TRK at $85mm per race.  Once again, DVD has two Sprint Cup races.

It would seem reasonable, that if TRK trades at $85mm per Sprint race, DVD would be worth between $150-200mm, or $4.75 per share, roughly 150% higher than the current price assuming no premium valuation for the scarcity of the asset.  At $175mm or below, acquiring Dover is a no-brainer for ISCA or TRK because it is financially accretive, gives them more scale, increases their power in the sport, and allows more flexibility to move races between tracks over time depending on future opportunities.  Thus, it would seem a floor value is $150mm-this would be maybe 5x track level EBITDA.

The Scarcity of Dover

Of the 38 Sprint race dates, 33 are owned by ISC and TRK and five are independently owned.  Two of these five races are owned by Dover, two are at the Pocono Speedway, and one is owned by the company that owns the Indy500.  The owner of Pocono put the track in a trust and has said he isn't a seller.  Additionally, he loves the France family and so is only willing to sell it to International Speedway in all likelihood.  This is from an interview of the founder of the Pocono track a few years ago:

"JM: Yeah, it's going down fast. People wonder if we'll sell out, but the track is left in trust. We don't owe a penny, I've got money in the bank and we're going to do whatever we want to do. We don't have the stockholders to answer to and if we didn't make 10 cents this year, I wouldn't have any complaints.

SCR: Haven't you been tempted to take a pile of money and sit on it?

JM: Not a bit. I made a statement a couple of years ago that if a guy came down through the garage area with a billion dollars in a wheelbarrow, I'd show him the gate. I've got no interest in money. I've got more than I've ever needed or wanted and over the past few years, I've been giving it away in leaps and bounds.

The company that owns the Indy500 could theoretically be purchased but that would get you only one Sprint race and would be cost prohibitive given that ISCA or TRK would have to pay a trophy premium for the Indy500 asset that they have no interest in owning.  Realistically, DVD is the last track for sale for a while and one of the last three tracks for sale ever.  Speedway Motorsports' last option may be DVD and they love to acquire and get bigger to combat the power of the France family.

The France Family, NASCAR, and How Tracks Make Money

The power dynamics of these relationships are very interesting and a book could be written about them, but here is a quick summary to bring you up to speed.  NASCAR is owned 100% by the France Family, who also controls and owns over 50% of International Speedway.  Speedway Motorsports is controlled by Bruton Smith.  Bruton and the France family aren't especially friendly with each other and Bruton has alleged that NASCAR has acted as a monopolist many times over the years to keep the France family's power in check.  The France family clearly has some conflicts of interest to deal with in controlling both ISCA and NASCAR.  Every track has only a one year agreement to carry a Sprint race, although no races have been pulled to my knowledge.  Additionally, the biggest driver of track profitability now is broadcast rights fees for NASCAR.  The tracks are given a majority of the broadcast rights fees after a cut is given to NASCAR and to the drivers.  Theoretically, NASCAR could unilaterally change the allocation of these broadcast rights in a way to hurt track owners but once again they have thus far never done anything malicious or transferred value to NASCAR.  They have always treated the ISCA shareholders more than fairly and in fact have continued to purchase ISCA shares constantly over the past few years so I would not be shocked if they wanted ISCA private over the long-term.  They also have to tread lightly because NASCAR is the only sport not owned by team owners and the driving team owners, Bruton Smith, and others over the years have publicly declared their view that the sport should transform into a team model like all other sports.  In summary, although theoretically NASCAR stealing value from tracks is a risk, I view this as a low likelihood because: 1) they have always been extremely fair and ethical; 2) they have continued to buy in ISCA stock; and 3) they have looming allegations of having too much market power that any small amount of economics they could transfer without killing the tracks and the sport would be irrational in the grand scheme of things/lead to DOJ pressures.

 NASCAR's Secular Prospects

The biggest variable with regard to the value of these tracks is what you think of the value of NASCAR long term.  Ratings are down over the past five years roughly 25% from the mid 5's to low 4's and attendance is down 20% as well.  I am not a NASCAR fan so take these thoughts with a grain of salt, but from a higher level there may be some secular and some cyclical problems.  On a cyclical front, clearly a weak economy hurts a business like this as fans drive hundreds of miles to these events and pay over $100 a ticket.  If fans are less engaged and buying less gear, they seemingly would be less into watching the sport on television.  On the secular front, I think NASCAR made a lot of changes very quickly that have hurt them and some of them may be due to the fact that the sport's founder, Bill France, passed away and is no longer in control of the sport.  In the past five years, the cars have become almost identical for safety reasons and to lower costs, a championship series was introduced, and the sports lost its Tiger Woods when the Dale Earnhardt accident happened.  From a fan's perspective, this has been a disaster.  They used to like following whether a Ford or Chevy did better at an individual track or which got better gas mileage and now the cars are more or less the same.  There is no differentiation at all between car models so they are working to change this back.  NASCAR has seemingly heard everyone loud and clear and is soliciting ideas from anyone and everyone to get the sport back on track (pun intended).  NASCAR then put in a race for the cup which is ten playoff races at the end of the season which could be a good idea for ratings and the value of the NASCAR franchise but they have to make changes to it to make it catch on.  Additionally, the same guy has won for the last few years so fans are less engaged for that reason.  After Dale Earnhardt Sr. passed away, there hasn't been as big of draw from any of the drivers.  Is all of this fixable?  Maybe.  My gut says that if they do some smart things like allowing the cars to become more differentiated, fixing the race for the cup, continuing to making improvements in the race dynamics, etc. and then at some point another great driver emerges the sport should pick back up.  Golf was dying before Tiger and other sports go in and out of favor depending on the athletes involved so I don't see why this should necessarily be different, although the bear case would be this is going the way of the WWE.  From a more practical standpoint, I don't see any reason why racing should have been in a bubble five years ago and now be in secular decline.  Admittedly, though, I have little conviction as I don't follow the sport myself.  Either way, I think you are protected for the next five years as this won't melt quickly and there are value drivers that I believe will cyclically drive up the value of NASCAR over the next 3-5 years.  Quite simply, broadcast rights now make up virtually all of the profits of a race track and represent a very high quality contracted revenue stream.

 THE VALUE OF SPORTS BROADCAST RIGHTS

Although this write-up is getting rather long, I wanted to spend some time on the exciting part of the NASCAR story and why DVD is even cheaper than it looks and ISCA and TRK are not no brainer shorts and could even be arguably cheap.  Almost 100% of profits of the tracks now come from broadcast rights fees, which are a long-term contracted revenue stream with 100% incremental margins and triple A counterparties.  Importantly, even though ratings have declined 25% I am predicting that the NASCAR rights will go up in value during the next contract negotiation and may go up significantly; this is completely non-consensus.  This is an extremely important dynamic to understand because the broadcast rights flow through at a 100% incremental margin.

The current broadcast rights deal for NASCAR is 8 years long with an average rate of $550mm per year; it was signed in 2005, goes through 2014 and the new agreement will likely be done in 2013. Dover gets about $30mm in revs from broadcast rights which are contractually going up 3% a year for the current term. Before delving deeper into the numbers, what makes sports broadcast rights incredibly valuable is that people like to watch them live (diminishes the threat from DVRs), they look great in HD and on big televisions, and people are incredibly passionate about them.  Consequently, people are willing to pay more to watch sports than anything else on television.  This manifests itself in the fact that ESPN is by far the most dominant cable network and right after them are the regional sports networks like YES (this has also been proven with Sky in UK, and other countries around the world).  The history of the value of sports rights are that at first broadcast networks made money on them, then Rupert Murdoch started using them as a loss leader to get Fox viewership of news and primetime shows, then cable networks started to pay up for them, and now we are to a point where cable networks will pay anything for them in order to hold the cable operators hostage.  The defining characteristic that represents the value of a cable network is if a cable operator pulls the plug on a network if subscribers will switch to another operator.  This is precisely why ESPN is so valuable.  They can charge $4-5 per sub per month because Comcast, DirecTV, etc. would lose tons of subs were ESPN to get pulled off the air.  This has become quite a problem over time for operators as ESPN has used its dominance to launch ESPN2, ESPN News, ESPN Deportes, and others.  Then, TNT, FX, the Speed Channel, Golf Channel, NFL Network, NBATV, and regional sports networks want some rights to protect themselves as well so they bid for the NBA, NASCAR, MLB, golf, the Olympics, log cutting, etc.  Once cable networks started bidding for sports, the value of broadcast rights went vertical. 

I am sure everyone is familiar with the cable network model, but the basic math is that if TNT charges $1 per sub per month and ESPN charges $4.50 then ESPN earns $3.8B more in revenue per year than TNT not including additional revenue from advertising highly viewed events.  In other words, ESPN could lose $3.8B more on broadcast rights than TNT and still be as profitable.  For $3.8B, you could purchase almost all the entire broadcast rights combined and $3.8B is more than ESPN spends on rights a year.  ESPN has been very smart and strategic about structuring the contracts with the sports leagues to be very long dated and staggered.  Comcast and Fox have talked of challenging ESPN but have not been able to make a crack at it yet; the reason is that they would have to be willing to lose a lot of money at first until they got full carriage.  It is pretty amazing that ESPN has little proprietary content and is the most valuable network in the world; they have become increasingly aggressive in locking in all rights so I expect this trend to continue.  The key to broadcast rights is that if leagues are willing to move a lot of events to cable they will make a great deal more money!

To get to the value of the NASCAR rights, would you be surprised to learn that NASCAR is regularly the second highest rated sport on television and that the Sprint Cup has twice the ratings of NBA Basketball (whose regular season ABC ratings are only 2.5) and 3-4x the ratings of MLB?  They have roughly 40% of the ratings of the NFL.  Even the Nationwide NASCAR series has as high of ratings as the NBA and higher than MLB.  Here are some numbers to give you a point of reference:

Network         Price               Event                          Notes

ESPN              $1.1B              18 NFL MNF games   ABC was paying $550mm for MNF before

                                                                                    moved to cable

FOX                $712.5mm       Sunday NFC games    Up from $550mm last contract

CBS                $600mm          Sunday AFC games    Up from $500mm last contract

NBC                $600mm          Sunday Night NFL     ESPN paid $600mm last time and NFL has

                                                                              to throw in two Super Bowls to hold price

DirecTV          $1B                 NFL Sunday Ticket    Up from $700mm last contract

TNT/ESPN      $930mm          NBA games                20% increase from last contract

ESPN              $300mm          82 MLB games

NBC                $2.2B              Combined value of 2010 and 2012 Olympics

Clearly, there is a trend going on here.  You can see for instance that when the NFL moved Monday Night Football to ESPN they charged twice as much as their last contract and took away the Super Bowls that came with it while when they moved Sunday Night Football from ESPN to ABC they kept the price the same but had to toss in two incredibly valuable Super Bowls; which means they reduced the price while all other NFL contracts went up in value.  Additionally, the leagues have also increased their value by starting the NFL Network, NBA TV, MLB TV, Big Ten Network, etc.  There are lots of ways for these leagues to figure out how to make money.

The most important factor governing what the NASCAR rights will sell for is how many races NASCAR will put on cable.  Last time around, they didn't maximize the value of their rights as they wanted to continue to expand the fan base by being on broadcast television.  They were only willing to put 1/3 of the races on cable as cable only had low 80's% penetration.  Since then, ESPN penetration has gone way up and NASCAR let ESPN move 8 of the 11 races that were airing on ABC onto ESPN because NASCAR felt ESPN would promote the sport better.  Now, over 50% of the races are on cable and likely moving more that way.  This should at a minimum put a floor under the value of the races. 

Should 18 Monday Night Football games be worth twice as much as 80 NASCAR races?  Football fans are passionate to be sure but there are plenty of other games to watch during the week and if your team is playing you can go to the local pub if you had to.  If ESPN got the rights to all 80 NASCAR races, would they pay more than $550mm to have a monopoly on some of the most loyal fans in television?  There are many ways to think about this; you could do dollars per rating points or you could look at cost per event, etc.  However, the main point is how much leverage does acquiring rights give you over the Comcasts of the world, and NASCAR's fan base is EXTRAORDINARILY passionate.  Let's say NASCAR sold all of the rights for a 50% increase, this would raise the rights to $825mm.  To figure out the fee you need to cover this, you have to figure out how much the network gets back from advertising revenue.  These aren't the right numbers but here is a shot in the dark about thinking about the advertising revenue from the events.  Let's say there are 80 events, 60 spots per race, and an average price of $80k per ad spot (I believe Sprint races are over $100k).  That would be roughly $385mm in revenue.  The point is that when broadcast networks are paying $550mm for a series that does less than $550mm in advertising revenue; this is a loss leader.  However, if the loss of money on the rights minus the advertising is only $200mm right now or whatever that is only $.17 per sub per month for a cable network.  I would think having all the races would be worth more than ESPN than $.17 per sub per month especially because they can put the Nationwide Series on ESPN2 and raise fees there.  Do you think ESPN would be able to go to Comcast and ask for a 4% fee increase for taking over the entire NASCAR series? Then, you have to remember that all the other cable networks want sports as well.  On top of this, now broadcast networks are starting to get $1.00+ per month in retransmission fees so they are turning into cable networks and can now pay more for broadcast rights.  Finally, NASCAR may start a channel at some point with a great deal of background content that may also be worth a lot of money.  There just seems to be many ways to win on these rights and not a lot of ways to lose.  Interestingly, these will be among the first rights available after the Comcast and NBC merger; I would not be shocked to see NBC/USA in the bidding as a first shot at ESPN.  And, if the NFL goes into lockout, this could theoretically be a bonanza for NASCAR.  NASCAR competes with the NFL for part of the year and presumably sports fans would shift some of their viewership to NASCAR at the very same time that NASCAR starts to negotiate its new contract.

Back to the Investment and What if there is No Deal

The simple fact of the matter is that if DVD doesn't hit the bid then this could remain dead money for a while and even worse management could continue to destroy value.  DVD should have been sold a long time ago, but this could finally be the time in the sun for DVD shareholders. 

Perhaps I am dreaming, but it seems to make a lot of sense that DVD management tried their last possible outlet for "creating value" in merging DVD and DDE and that failed.  They have shareholders up in arms and who are calling for shareholder friendly actions. The board is clearly worried about getting sued as it backed off from the merger.  It sure seems like it is time to sell.   For years, DVD management could say they didn't want to sell at a low price and thought DVD was worth much more.  In the proposed merger, they were valuing DVD at $1.80 per share so if a bid is offered at $3, $4, or $5 a share then the board will have the fiduciary duty to strongly consider it.  It is clear that ISCA would buy this at $3 per share, but it is not clear what DVD would sell at.  Management stands to earn $8mmish in a change of control situation so they may be enticed by a reasonable bid of $4ish per share, especially if management and the board is confronted with taking $4 or having to deal with shareholder lawsuits.

Even if they don't sell, DVD is silly cheap based on current market valuations of the company and especially so if you believe my broadcast rights hypothesis.  Over the next couple of years, DVD's free cash flow should go up as the broadcast rights portion continues to increase adding $1mmish to the revenue line and they make progress on stemming losses from 2 of the loser tracks they have shut down.  I think they might be able to do $5-7mm of FCF if a couple of small things to their way.  So, you are getting an 8-10% depressed yield and if they sell off the losing tracks FCF will spike as losses from the loser tracks evaporate and they are able to pay down debt with the sale proceeds.  So, FCF trends up, the company derisks, and then the new contract is negotiated two years from now so the stock should still work.

To summarize my thoughts on the entire situation:  DVD is ridiculously cheap with two bidders who would love to own the asset at over 2x the current share price.  If management is open to a reasonable bid, then a deal may happen very soon.  If not, you ride their rationalization of money losing assets and delevering until the new broadcast rights contract is signed.  Either way, you want to be long consolidation and sports broadcast rights so a good solution would be to short out TRK to hedge your NASCAR risk if you are more worried about it being in secular decline.  TRK is a better hedge than ISCA in my opinion because the France family is very wealthy and I would not be shocked if they tried to take ISCA private at some point given that they own over 50% of it. 

Disclaimer:  This does not constitute a recommendation to buy or sell the stock.  We currently hold shares in this security and may buy or sell shares without notification.  While we have tried to present facts and a write-up we believe to be accurate, we make no representation of the accuracy or completeness of any information contained in this note; ie. you should do your own due diligence and not rely on this note.  We undertake no obligation to update anything should new information arise at a future date and the reader should assume we might change our mind, buy, or sell without any further disclosure. Once again, this is not investment advice.

Catalyst