Description

Formula One (FWONK) Investment Case

“Whoever sells their F1 team now, must be crazy. The team will be worth much more in one year, and even more in two years. F1 is booming” Toto Wolf, CEO of Mercedes F1 Team, October 2021

Investment Summary

The world today is dominated by streaming services, and content has become king. The value of assets such as sports teams have skyrocketed, and we think Liberty Media Formula One Group (FWONK) represents a unique opportunity to benefit from these mega trends whilst also investing in a sport that is booming. Formula One’s global reach is incredibly attractive; each race draws an average of 87 million viewers and the combined global TV viewership is close to ~430m people according to Statista.  In addition, in 2020, followers on online social platforms were up 36% to 35m, video views up 47% to 4.9bn and total engagement up 99% to 810m (according to F1 website).

We are bullish on F1 today for several reasons. Firstly, excitement around the sport over the last 1-2 years has massively increased due to the success of Netflix’s show “Drive to Survive”. This engagement from a new and younger audience has come at a perfect time for F1. The sport itself is exiting an era of Mercedes dominance and entering a much more competitive environment with teams such as Red Bull and McLaren fighting for the top spots more often. This has resulted in many more gripping moments, fierce rivalries, and races that aren’t decided until the very end.  There are several large broadcasting contracts coming up for renewal next year, and we believe the company is in a much better position to negotiate broadcasting fees (42% of revenues) higher. Furthermore, with the success of Drive to Survive, we would not be surprised to see Netflix (or Amazon) eventually enter the bidding process for certain rights, putting further upward pressure on prices.

Secondly, in 2020 F1 group completed the new Concorde agreement, which sets out the terms under which teams will compete until 2025. This agreement was signed in the middle of the COVID crisis, and FWONK came out significantly stronger, negotiating a higher % of profits once the group EBITDA (pre team payments) reaches $1.5bn. In addition, the agreement managed to significantly cap the costs of team spending from the 2022 season onwards, allowing for an even more robust competitive environment. Finally, the company’s balance sheet is under levered due to the sale of its LiveNation stake during the COVID crisis and will come down to 2.7x net debt to 2022 EBITDA. F1’s historical leverage target has been 5x, and therefore there is significant headroom for the company to start a substantial share buyback programme. 

Ultimately, we think FWONK could be worth between $75-95 per share by the end of 2023, 40-75% upside at today’s price of $54. We expect the company to grow comfortably at a 5% CAGR post 2022 (first normalised year post COVID), in line with its 2014-2019 revenue CAGR of 4%. We expect FWONK to see operating leverage on top of this growth and a re-leveraging of its balance sheet back to ~5x EBITDA from 4x today. This results in a much more explosive FCF/share growth from $1.2 in 2021 to $2.4 in 2024, fuelled by stock buybacks and margin expansion. Our valuation implies a 30-40x 2024 FCF/share, a reasonable ask for a company with a wide competitive moat, growing its cash flow per share double digits.

Brief Business Description and History

F1 is a relatively simple business and generates revenue in 4 ways:

1) Race Promotion Fees (30% of 2019 Revs)- Fees paid to F1 for hosting a Race.

2) Broadcasting Fees (37% of 2019 Revs)- Fees paid to F1 in exchange for the Broadcasting rights in a region.

3) Advertising and Sponsorship (15% of 2019 Revs)- Ads and Sponsors of Formula 1.

4) Other (18% of revs)- Mainly Paddock Club, sold as an exclusive experience at the track side.

Between 2006-2016 F1 was run by CVC capital who bought the business for an EV of $2bn. Over their decade of ownership, CVC made significant returns from the business, eventually selling the company to Liberty Media for $4.4bn equity and $8bn EV in 2016.  

When Liberty took over the business in 2017, they had grand aspirations to grow advertising and sponsorship revenues, as they felt this business line had been ignored under Bernie Ecclestone. However, this plan turned out to be too ambitious. Selling big ticket sponsorship deals was incredibly difficult, especially when the ROI for the brands was hard to measure. Thus, total revenue has been growing at a CAGR of 4% from 2014-2019, and this was mainly driven by Broadcasting fees growing at a 7% CAGR with the rest of the group growing in the low single digits. Going forward, we believe the main drivers of growth are going to come from increased Race promotion fees, as the race calendar expands from 21 to 23 races and growth in broadcasting fees.   

Netflix- A new era for Formula One

The extremely successful Netflix show “Drive to Survive” has showcased F1 in a completely different light, exposing it to a much younger viewer in a more exciting “reality TV show” type format. The TV series follows the F1 teams behind the scenes throughout the season, giving viewers a more holistic view of what the sport is about and the personality of the drivers. The show also successfully increases interest in the mid field of the sport, as rivalries between the drivers and teams are highlighted. Netflix has ~210m subscribers globally, and although we don’t know the exact number of views for Drive to Survive, according to FlixPatrol, “Drive to Survive” ranked No. 1 for TV series worldwide shortly after Season 3’s release in March 2021.

We cannot emphasise enough how important we think Netflix has been to the momentum of F1. Zac Brown, CEO of McLaren Racing, was quoted in a New York Times article written July 2021 as saying “I think it’s got to be the single most important impact for Formula 1 in North America…Almost every comment you get from someone out of the U.S., they reference ‘Drive to Survive.’…People are going from ‘I’ve never watched a Formula 1 race in my life’ to ‘I’ll never miss a Formula 1 race again.’” It’s clear that Liberty’s focus on improving F1’s perception is working. In the US, ESPN average TV viewers per race have risen from 547k in 2018 to 928k. By comparison, first round NBA playoff games average 3m viewers. As shown below, the momentum from Drive to Survive, on top of an extremely focused digital strategy has led to the greatest increase in engagement versus major sports leagues in the US.

Even in more mature markets such as the UK, Formula One is seeing significant growth. Sky have seen a 27.8% average increase on their viewing figures for race days this season, with an average of 1.56 million viewers watching each race, compared to 1.22 million in 2020. The 2021 Bahrain Grand Prix saw the highest viewing figures in the history of Sky Sports’ F1 coverage, with an average of 1.94 million viewers.

Bringing in a younger audience to F1 was incredibly important to secure growth for the business in the long term. Under Bernie Ecclestone’s leadership, F1 was mostly focused on an older and wealthier demographic. The sport was seen as exclusive and part of a luxurious lifestyle, with key sponsorships from brands such as Rolex. This however, led to F1 becoming less relevant for the next generation of viewers. To make matters worse, under CVC capital’s ownership, the business continued choosing to put Formula One behind paywalls in more countries, exacerbating the decline in global viewers at the expense of short-term profit. Ultimately, F1 has faced a particularly difficult problem to solve. If too many countries broadcasted the sport behind PayTV, the number of viewers would continue to suffer. On the other hand, broadcasters such as SKY are able to afford much larger fees compared to free State TV channels and doing more deals with them has been helpful to top line growth. We think cheap streaming platforms such as Netflix and Amazon Prime are the clear solution to this dilemma. Both streaming services boast a significant audience and are flush with cash to spend on content in order to keep subscriber count growing.  

We think this newfound momentum in F1 will prove to be an incredibly positive force on all of the business’s revenue lines. Most importantly, we see significant opportunity for fee inflation in the upcoming broadcasting rights renewals this year and next. In 2022, F1 faces major renewals in countries including: France, Italy, US, Australia, Brazil, Latam (exl Brazil), and Poland. If any of the streaming platforms enter the bidding process for these rights, the price increase could be dramatic. As a good example of this, in the Netherlands, Ziggo sport was outbid this year by Nent (owner of the Nordic steaming service ViaPlay) for the rights to broadcast F1 from 2022. Nent will pay as much as €30m, and although we do not know the value of the previous contract, Ziggo was quoted saying “the asking price for the rights were too high”. Netflix has even hinted at acquiring the whole of Formula One. In a recent interview with Der Spiegel, Netflix CEO Reed Hastings said “A few years ago, the [commercial] rights to Formula 1 were sold. At that time, we were not among the bidders, today we would think about it.”

The US stands out to us as a potentially large swing in revenues for the group. In 2019, ESPN signed an extension for the rights to F1 for a shockingly low $8m a year for 2 years. This compares to the average contract value for large European countries of around €60-80m. The contract was purposefully cheap and short in nature, so that Liberty could develop the relationship with ESPN, prove F1’s value, and come back with a stronger hand in 2022 once the product was improved. Not only has the company made significant strides with the product since then, but this contract renewal also comes at the same time as Liberty introducing another US Grand Prix in Miami. We think the extra race in the US could prove to be a further catalyst in increasing the number of F1 fans in the country.

Lastly, we think its important to note that viewership numbers could also indirectly impact Race Fees and Sponsorships. With more fans, Race Promoters can sell more tickets, making hosting an F1 race more desirable. For sponsors, the payback on a Formula One contract might not be easy to measure, however increasing engagement and viewership with a more relevant demographic could also help in clinching larger deals.  

The 2020 Concorde Agreement

Although the exact terms of the Concorde agreement have been held secret, it is widely understood that Liberty has managed to increase its share of Formula One EBITDA once the 2019 threshold has been met. Under the old terms, the teams received ~68.5% of F1 EBITDA, but under the new agreement the teams will earn less than 50% of any incremental EBITDA above the 2019 base of $1.5bn. For every $100m of incremental EBITDA that Formula One makes above $1.5bn, FWONK will be making ~$20m more than it would have in the old framework, a roughly 5% uplift on 2021 consensus EBITDA numbers.

Another benefit to come from the new agreement was the more aggressive cap on team spending for the next few years. In 2021, team spending has been caped at $145m, going down $5m a year to $135m a year from 2023 onwards. According to the group, “The aim of the new cost cap is to deliver a more competitive championship, promote a level playing field and ensure the long-term financial stability and sustainability of Formula 1’s 10 teams.” We think the budget cap will be successful in achieving its goals. In a recent City AM article, Aston Martin team owner Lawrence Stroll has been quoted as saying “this budget cap levels the playing field and also gives a road to profitability…A lot of these teams have won historically by outspending the competition, without the budget cap I would be dreaming”. We think that if the teams in the midfield become more competitive due to the budget cap, races will become more unpredictable and thus more exciting for fans to watch.

Potential for Buybacks

In the middle of the COVID crisis in April 2020, the Formula One group was facing significant strain under a massive $5bn debt pile and revenues going to 0 due to lockdowns. In order to unlock liquidity, FWONK sold its $2.6bn stake in LiveNation along with other assets for $2.8bn to Liberty Sirius XM in a fairly convoluted (but typical Liberty) way. In exchange for these assets, Sirius XM took on $1.3bn of FWONK’s liabilities and paid the group $1.4bn in cash and a call spread on LiveNation stock that paid out $165m. We feel this deal ended up being a double-edged sword. Although it allowed the Formula One group to reduce its Net Debt from 5bn to ~2bn, the LiveNation stake was sold at the bottom and would be worth close to $7bn today. However disappointing this might be, it does allow for the group to add some leverage back to the balance sheet. Pre-Covid, the business had a leverage target of roughly 5x Net debt to EBITDA. We conservatively assume the business gets back to this leverage target over the next 3 years and buys back $900m of stock each year. This should reduce the yearly share count by roughly 7.5%. We expect the buyback in FWONK to start once the business has fully normalised in 2022.

Conclusion

There are no other listed businesses in the world that we know of that give you the economic rights to a whole sport. Formula One is a unique asset with no direct competition and significant momentum behind the sport. Under Liberty’s stewardship since 2017, the business has successfully increased its engagement with a younger generation of viewer. This has come through a more focused digital strategy, and an extremely successful Netflix show, “Drive to Survive”. We think this momentum will help fuel growth in all of FWONK’s business lines for years to come, in particular its broadcasting revenues. Lastly, the business should see margin expansion (new agreement with teams) and a lower share count (re-leveraging of BS) which should fuel FCF per share growth of 23% CAGR between 2021-2024. A 30-40x FCF/share multiple for such a business does not seem unreasonable to us, and therefore we see upside to $75-95 per share in ~2 years.    

Catalyst

• Renewal of Broadcasting Rights at higher prices
• Sponsorship wins 
• Amazon or Netflix bidding on content