|Shares Out. (in M):||238||P/E||30.7||24.3|
|Market Cap (in $M):||7,522||P/FCF||30.7||24.3|
|Net Debt (in $M):||5,074||EBIT||440||510|
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Formula 1 isn’t for everyone. It’s a ‘story stock’ with just about everything on the come. It’s also a tracking stock with a huge balance sheet and lots of Liberty-style non-operating assets. It’s expensive, and it’s a hedge fund hotel.
For those of you still reading this – thank you. For those that stopped after the second sentence, I won’t blame you for a 2* rating (or less). While everything above is true, I believe FWON is extremely compelling here. The opportunity with the business / sport is enormous, and creates an interesting asymmetry at the current price.
My main focus of this write-up is to quantifying the upside opportunity – something I don’t think many have done. In terms of probability of success, that is harder to quantify. What we do know is that we have one of the most respected people in media running the business (Chase Carey) who is assembling what looks like a strong team to get after all the opportunities.
I’ll address the downside only briefly in the write-up given I think that it is easier for people to figure out. As always, I’m happy to take as many questions as you have.
To familiarize yourself with Formula 1 and Liberty’s ownership through FWON, here are a couple links:
The initial acquisition deck from 9/7/16:
Investor Day slides from 11/10/16:
Liberty Media Primary / Secondary Offering Prospectus from 5/16/17:
FIRST THINGS FIRST
There are a few things that make FWON unique
1. FWON is the only opportunity I know of in the public markets to own an entire sport
2. FWON is a tracking stock (this isn’t unique to Liberty, but is unique in general)
3. There are two separate value components of the security, the Formula 1 operating asset and a non-operating collection of legacy assets and liabilities that were inherited from Liberty Media (along with some Liberty overhead allocation)
Here is a look at the capital structure broken down between operating and non-operating assets and a brief operating history of Formula 1.
Its complicated. Its Liberty.
I prefer to look at it this way – you’re buying a share of FWON today for ~$31 and getting $6 / share of net other assets. That means you’re buying Formula One for $25 / share or a $6 billion equity valuation and $9 billion enterprise valuation. I try to keep it as simple as possible.
Here’s a look at the recent operating history of the business.
Promotion revenue is the money paid to Formula 1 by the venues that host the races. Broadcasting revenue is contractual, lasting 3-5 years depending on the contract. Advertising and sponsorship revenue are fees paid by brands to sponsor races and events. Other revenue is a mix of shipping and handling fees (F1 will transport cars for the teams) and some hospitality.
There are three buckets of costs. First is the “other CoGS”, which is the cost of revenues in the other segment. Historically this has been a roughly breakeven business.
Second is SG&A, which underlying runs in the high 6%’s of Race Revenue. This is essentially the cost of operating Formula 1.
The third and largest ‘cost’ is the allocation to the teams. This allocation is pre-determined based on a contractual agreement (called the Concorde Agreement) that runs through 2020. The percentage of the pie (or pre team EBITDA) going to the teams has been increasing in recent years. While I don’t have the exact details as to why that is, it is my understanding the current agreement was negotiated poorly, and a set of race outcomes has caused the number to jump from the low 60’s historically to the high 60’s today.
F1’s balance sheet, including both Operating and Non-Operating debt, requires roughly $206m (pro forma) of cash interest expense. There are no taxes or capex to speak of in the business. Running that through, FCF looks something like this.
Free cash is higher LTM on a pro-forma basis because of slightly higher EBITDA and lower pro forma interest expense due to the paydown from the recent primary offering. A higher share count from the primary offering offsets some of this.
A few things to point out about the business:
· Race revenues are contractual over a 3 to 5 year period, with escalators
· Margins are very high pre team allocations
· The cost structure is nearly all variable given the split with the teams
· There is no capital intensity to this business
· Free cash conversion is VERY high
· As a result, it supports a high level of leverage
· Nearly all of the debt is due in 2023 and 2024 (80%), with an average maturity of ~7 years
· Only near term maturity is a $350m margin loan due next year
· Management is of the highest quality
Quick look at the owners and management:
Liberty, run by John Malone and Greg Maffei, are the control shareholders of Formula 1. If you haven’t spent any time studying Malone, you should. He’s incredible. They are people you want to invest with – they will make you rich.
Chase Carey is the Chairman and CEO of Formula 1. Chase is the current Vice Chair of Fox and former COO of News Corp. He is a stud and all around nice guy. Fox Sports and Fox News were created and implemented under him. When he was the CEO of Direct TV, shares compounded at ~8% versus -2% for the S&P 500 (from early 2004 to mid 2009). Chase is exactly the type of person you want running a league. A strong manager who knows what they are doing.
To run the sport and manage the teams, Chase and Liberty brought Ross Brawn back to Formula 1. Ross spent his entire career in the sport working up from the bottom. In 1997 he took over the Ferrari team and took them to an unprecedented six consecutive titles. In 2009 he orchestrated the buyout of the Honda team and won the Constructors Championship that same year. He then sold the team to Mercedes Benz, who has been strong ever since (leading this season I believe). In 2014 he retired from the sport, but came back when Liberty purchased Formula 1 in January. Brawn is a legend. Here is a great ESPN interview with him from earlier this year:
To run the commercial side of the sport, Chase and Liberty brought in ESPN veteran Sean Bratches. Sean was with ESPN for 27 years, most recently as EVP of Sales & Marketing. Sean put together distribution deals with cable / satellite providers for ESPN, with a particular focus on ESPN HD, and ran the ad-sales group. If you google him, a bunch of stuff will come up, but I thought this was insightful:
As best I can tell, Sean has hired four new outside executives to run Digital, Strategy, Sponsorship, and Research. All of which were either with ESPN or Sky at some point. He’s retained four Formula 1 employees to work in Communications, Media Rights, Hospitality and Business Relations.
It’s a strong team.
To wrap this up, here’s where Formula 1 stands today:
1. High quality business
2. Stagnant results
3. Great management
4. Lots of leverage
If nothing changed from today, the valuation in my view would look something like this:
· $1.00 / share in recurring free cash flow worth ~20x = $20.00 / share
o MANU, MSG, WWE all higher but FWON is a tracker with more leverage
· $6.00 / share of net “other assets”
· $50m / year of allocated costs from Liberty at 10x = $2 / share of overhead
o I do not believe F1 will be part of Liberty in 10 years (maybe 5 years)
· Fair Value = $24 / share
In my view, status quo is your downside risk.
Liberty talked about Formula 1 being under monetized when they acquired it. They say that F1 was essentially a one man shop for 50 years and was managed with an intense short term focus. As other sports squeeze value out of broadcasters and sponsors, F1 just kind of took what came their way. F1 has almost no presence in digital or merchandising / licensing, which has hurt their monetization versus other sports.
Best way I know to show this gap is put up a graphic from Formula 1’s registration statement (linked above):
Essentially what this shows is that F1 is watched over 1B times per year versus the Premier League at 679M times. F1 believes they have about 390M fans, which would imply the average fan watches F1 about 2.7x per year (or 13% of the races).
I did some digging and found ratings for the NFL, NBA and NASCAR to add to the mix, and it looks (approximately) like this:
Formula 1 is popular, clearly.
The question then becomes, how do each of the sports monetize those viewers? Howmuch.net estimated the revenue for several sports as of July 2016 (seasons vary btw ’13, ’14, and ’15 depending on the sport):
Some simple math here, take the revenue and divide by the viewers and you get revenue per viewer. Not surprisingly, F1 is on the low end:
Another way to think about this is to compare F1 to the WWE. World Wrestling Entertainment has 36M fans and generates $730m in revenue. That is $20 per fan per year. That same metric for Formula 1 is $4.60 per fan per year. Admittedly there are differences in the economics of each of these sports, but it does give a framework for the opportunity at Formula 1.
So what can be done to improve the monetization? Liberty / Chase have identified several things:
1. Better monetization of Broadcasting rights
2. Add races
3. Increase sponsor count
4. Grow fan base in the US / China
5. Digital / OTT
6. Merchandising / Licensing
7. Hospitality / bigger events
9. Renegotiate team contracts / economics
My sense from Liberty is that their main goal is to grow the sport and close the monetization gap. One of the key ingredients to growing the sport is to make it more competitive, interesting and approachable for new fans. It needs to be more entertaining. Ross Brawn talks about that in the interview above. Making the sport more appealing benefits everyone in the ecosystem. I bring this up because I think its important to understand that all of these pieces are inter-related; one thing working benefits another thing and so on.
One caveat – these estimates aren’t meant to be precise, they are meant to be directional. I think precision here would miss the point (and frankly, would end up being totally wrong). And I use 2020 as a guidepost, but the numbers could just as easily be 2021.
This sounds easy, but I’m sure its pretty tough. F1 needs to negotiate better terms with all of their distributors. Contracts are up pretty much all the time, but I believe the heavy lifting will be done by 2020. F1 cites two deals in their registration statement, the Olympics which resigned with NBC for 1.2x the prior terms and the NBA which resigned for 2.9x the prior terms. According to Barclays the NFL resigned recently for 1.5x. It seems logical that if F1 is so popular and under-monetized in the past, they could be at the high end of that range. To be conservative I’ve used 1.5x:
Another tough one because everyone has to agree and you have to find the right venues to pay to host the events. I’ve heard others talk about 25 races as a goal – lets say the number is 23 instead up from 21 this year.
As recently as February of this year at an investor conference in San Francisco, Greg Maffei talked about the opportunity in sponsorships by comparing the F1 to the MLB. At Formula 1 there is something like 17 sponsors today versus 75 at the MLB. For F1, sponsorships had been a ‘lean back’ revenue stream – Liberty plans to make it ‘lean in’. For the sake of quantification lets assume they can increase the sponsor count from 17 to 35.
have no idea how to increase the popularity of a sport in the US, much less China. The math I think longer term is just to increase the # of annual views by a certain amount relative to what you think the sport could achieve in terms of penetration, and multiple that number by the revenue per viewer. That said, because I don’t know where to start, I’m assuming nothing.
Digital / OTT
Its surprising really given how data-intensive F1 is that they don’t have a robust direct-to-consumer offering for the super fan today. Seems like easy money to me. Best way I know to calculate what this could mean is to look to another entertainment company that has already done this – WWE. The WWE charges $10 / month for an all-access OTT product and has 1.4m subscribers (and growing). That is roughly a 3.9% penetration rate of its 36m fans. The margin on that offering by my calculation is low 30’s percent. For F1, 4% seems like a big number, so I’m running the numbers on 2%.
Again, looking to the WWE here as a benchmark. The WWE generates $108M of merchandising and licensing revenue annually on a fan base of 36M. That’s about $3.00 per fan per year at a margin of 53%. Assume F1 can get just $1.00 per fan per year and the numbers are material.
I’ve not done anything here since I’m including some of this in the Merchandising bucket above. But it could be material to F1 longer term. Need for Speed is a billion-dollar franchise with 150M copies sold, and FIFA / Madden are also 100M unit games. Its unclear exactly what the licensing splits would be, but it is clear that sports franchises and motorsports make for popular video games.
Hospitality / Bigger Events
Another area where I haven’t put a pen to paper. It seems very logical that there would be much to do in this department, but I haven’t figured out how to think about the numbers behind it. Will leave this one in the ‘free option’ bucket.
These are all the “grow the pie” buckets. And using my assumptions above, I think they can essentially double the Pre Team EBITDA number in the next three or four years.
What I’d point out here is that even after they double the size of the business, the revenue per view is still less than $4.00, or roughly half what the NBA and Premier League are able to achieve.
Splits with Teams
Liberty and Chase both hope to renegotiate the contracts with teams either on or before the new Concorde agreement for the 2020 season. The sport has challenges today, many of which they believe can be attributed to a flawed incentive system set by the prior Concorde agreement.
Those challenges broadly are:
1. The sport isn’t competitive; only 3 teams ever win
a. Ross Brawn says this is because the relationship between money invested and speed is too steep; the more you spend, the faster you go; the best capitalized teams have structural advantage
2. Teams don’t make any money
a. The contract is structure so that the rich get richer; winners make more. And we know that the more you spend the better you do, so the incentive is to invest as much as possible
b. Worse, teams like Ferrari, McLaren and Mercedes can use the spend as a subsidy of their R&D efforts in their core business, so they don’t need to make money to justify the investment
What this means is that races are mostly pre-determined which makes them less-interesting, particularly for new fans entering the sport. It also keeps new teams from entering, which is a problem because teams bring fans.
The pitch to the teams is simple. Lets make the pie bigger, lets make the sport more competitive, and lets make the teams profitable. How to go about that is a little tougher, but one of the things being discussed now is to put spending caps on the teams, and lower the financial benefits of winning. Depending on the cap, that could make even the last place team profitable. This isn’t a new concept – its existed in other sports like the NFL for years, and leads to the sport being more fun for everyone (how much fun would it be if the Cowboys won the Super Bowl every year? Without spending caps that might be the way it goes).
It seems logical that 70% of the teams would want this – less so that the other 3 would. That said there is benefit to everyone in making the sport better, including the top teams. My guess is they will be able to get something done (Ross thinks they will anyway).
I’ve broken the numbers down this way. First, lets say you grow the pie, but the teams continue to get 68%; here’s what happens to your owners economics:
Notice that I’ve deducted an incremental $45m in annual expense as a “cost to achieve” these results. Chase has said he’s going to hire 75 more people, that’s $600,000 per year per person (I’m trying to be conservative).
In this scenario, FWON generates nearly $3.00 / share in cash (I have leverage dropping to sub 4x, then share repurchase beginning, but its isn’t super material to these numbers). This number could be conservative.
What would it look like if the economics to the teams drops? I used 65%, 60% and 50% as proxies.
Free cash flow per share jumps to $5.00 in a 50/50 split. Again, this could prove to be conservative.
Just for fun, lets run the numbers as if F1 was able to capture all of the gap between where they sit today and where other sports leagues are.
Here’s where you’d end up:
Taking all of those #’s to what I see the benchmark levels are would increase the monetization per view to about $6.60, still lower than where the NBA & Premier League are. And presumably they are growing that number. This equates to growing the ‘pie’ at F1 4x. That is a huge number.
Here are the #’s pre and post a “spending cap” on teams.
Free cash flow absolutely hockey sticks when the broadcast contracts are negotiated and the sponsors are added (in both cases I jumped them up big in 2020). There is a scenario where FWON generates $12 / share in free cash flow.
I haven't taxed any of these numbers, and clearly there could be some drag in the future as these numbers grow (they pay virtually no taxes today). We know the tax structure is "extremely efficient" and that they are able to repatriate cash with minimal leakage, if any (according to Albert Rosenthaler). I would not expect the addition of taxes to have a material impact on the thesis here. A 10% tax rate on incremental earnings would lower my base case by <20c / share.
As stated before, I think it’s hard to argue shares are worth much more than $24 today if nothing changes. I think that is your downside.
Base case I’m using $3.00 as the ‘steady state’ cash earnings of the business. That gives something like 1/3rd credit for everything good I think could happen. At 20x that’s a $60 stock, discounted back three years at 15% the operating company is worth ~$40 today in my view (if it takes 4 years that’s $35). To that I add $6.00 for the net assets and take out $2.00 for the Liberty allocation. In my mind the stock should be $44+ today.
Best case the numbers can get crazy, particularly if the path to $10+ / share of earnings becomes visible. I prefer to look to the $5.00 / share of earnings as a best case scenario. At 20x that is a $100 stock. Discounted back 3 years at 15% and accounting for the non-operating items, I think shares could get to $70 +/-.
On both of those numbers the value compounds at 15%.
At the current price the risk reward is $7 down, and ~$40 up (5.5 to 1), with room to run if they do better.
· Earnings are NOT a catalyst in the near term as the 2017 season is already baked
· Upcoming catalysts include
o Renegotiating / fixing the Concorde Agreement; there is talk of doing that this summer
o New Broadcasting agreements; starting in 2018 with Sky coming in 2019
o New Sponsorships; could come at any time
o Digital / OTT offering, likely a 2018 event
· Longer term catalysts include
o Spinning F1 into an asset backed security
o Rationalizing non-operating assets
o Share repurchases