Description

Shares of Madison Square Garden, which were recently spun off of Cablevision, offer investors the opportunity to buy a collection of irreplaceable trophy assets (Knicks, Rangers, the Garden, MSG/MSG+) at well over a 50% discount to their private market value. Put another way, the current valuation implies a cheap valuation for the primary media assets alone (MSG/MSG+), providing a free call option on the sports franchises and other unique assets of the company that have significant earnings upside even in the face of a more difficult economy. Our sum of the parts analysis suggest that using a conservative, base case model, MSG is worth over $30 per share, and a true private market value that may be as high as $50  per share.

Below is a brief description of each of the segments followed by our sum of the parts valuation:

Media

MSG owns and operates three cable networks, MSG, MSG+, and the Fuse network.  These networks generate revenue through per/subscriber fees ("affiliate fees") from pay-tv operators (roughly 80% of segment revenue) as well as through advertising (roughly 20% of segment revenue). 

MSG/MSG+:  The most valuable of the Company's networks, MSG and MSG+ are regional sports networks (RSNs) that broadcast the New York Knicks, New York Rangers, New York Liberty, New York Islanders, New Jersey Devils, Buffalo Sabres and New York Red Bulls games.  Additionally, they carry Big 12 and Pac 10 college football games, ACC, Big East and Pac 10 basketball games, as well as other sports programming.  The first major non-Knicks/Rangers contract, with the Buffalo Sabres, ends in 2017.  Each network has over 8 million subscribers, primarily in the NY, NJ, and CT areas.

Regional sports networks command premium pricing power from the cable operators because they are essentially PVR (personal video recorder) proof as the overwhelming majority of viewers prefer to watch sports live. Though not disclosed, we estimate that the Company collected approximately $1.66 per sub per month in 2009, and with a modified, post spin off carriage agreement with Cablevision, MSG has disclosed that they expect to generate an additional $30 million in revenue from affiliate fees (bringing them to slightly above market rates from previously discounted rates when they were part of the same company), most of which should drop to the bottom line.

FUSE:  Fuse focuses on music related programming including coverage of premier artists, events and festivals, original content and high profile concerts.  The network has over 50mm subs but commands a very low per/sub fee, estimated at $0.07 per sub/month. Though not disclosed, we believe this segment currently generates slightly negative EBITDA, but with double digit top line growth in recent years, this segment is on the verge of generating positive EBITDA.

Sports

MSG owns and operates the New York Knicks (NBA), New York Rangers (NHL), New York Liberty (WNBA), and Hartford Wolf Pack (AHL).  This segment generates revenue from tickets and concessions, television (national TV contracts and local cable rights), sponsorship (including new flagship partner Delta Airlines), and merchandise. The two marquee teams, the Knicks and the Rangers, have underperformed in recent years, and as a result, these assets have generated poor economic performance. Each team is governed by their respective leagues and comply with revenue sharing, national TV deals, and collective bargaining agreements with the players unions.  In general, both leagues have very limited revenue sharing (which is better for MSG's big market teams) but have relatively large guaranteed player compensation percentages relative to other leagues. The collective bargaining agreements for both leagues expire after the 2010-2011 seasons, and these negotiations will obviously have a critical impact on the teams' financial performance going forward (more to follow on this topic).

Entertainment

MSG creates, produces, and presents a variety of live productions including the Radio City Christmas Spectacular featuring the "Rockettes" (35-40% of segment revenue), the Circque du Soleil's Wintuk (~10% of 2009 segment revenue, and expected to double this year), as well as other live entertainment at its various venues.  It earns revenue based on ticket sales on shows that it promotes, as well as license fees on non-promoted shows. 

The segment's value is underpinned by the venues it owns and/or operates under long term leases. The Company has 100% ownership of Madison Square Garden Arena, the Theater at Madison Square Garden, and the Chicago Theater (purchased in 2008 for $16 million). It also owns 50% of the 4.5 million square feet of air rights above MSG (Vornado owns the other half).  It has long term leases on the Radio City Music Hall and Beacon Theater, and a long-term booking agreement with the Wang Theater. In total, the Company's venues host over 800 events per year.

Valuation:

MSG has approximately 75 million shares outstanding, and with a share price of $18.82 (on close of 3.10.10), has a market capitalization of ~$1.41 billion. The Company has approximately $70 million of net cash in addition to a $190 million receivable from Cablevision which is due by mid 2010, and therefore has a current enterprise value of approximately $1.16 billion.

The Company has approximately $750 million of cap ex remaining related to a major renovation at Madison Square Garden. In the models below, we choose to create a range of NPVs for the project in addition to valuing each of the business segments based on current cash flow, which do not incorporate any incremental income directly related to the renovation in any of the segments.

Although some might believe it's best to look at MSG's business as one unit and ascribe a multiple to it, we believe a sum of the parts is a better way to approach the Company's valuation. Below we model each of the various businesses with a bear, base, and bull case valuation model:

                MSG and MSG+, which have the bulk of the value in the media segment, operate under highly profitable, long term contracts, and command premium pricing from the cable operators due to the fact that they are largely PVR proof. As a result, they command higher cash flow multiples, and there are a handful of post crisis transactions as evidence. For example, the estimates for the vend-in of its RSNs as part of its acquisition of 51% of NBC/Universal in December of 2009 valued the RSNs at 17.2x EBITDA or 3.6x revenue. In November of 2009, Liberty Media merged its stake in DirecTV along with its RSNs, and as part of a fairness opinion associated with the transaction, the middle end of the valuation for the RSNs valued them at approximately 11x EBITDA. Though not disclosed, sources close to the deal have indicated to us that the RSN portion of the Chicago Cubs sale was valued at 12x EBITDA (team & stadium were valued at ~25X EBITDA). There is no reason to believe why MSG and MSG+ aren't worth similar multiples.

                The entertainment business is perhaps the most tricky to value in that it is by far the most economically sensitive segment and has had particularly volatile performance in recent years. In 2006 and 2007, this segment produced over $40 million of EBITDA and EBITDA margins of 16.6% and 14.9%, respectively. In 2008, MSG expanded the Christmas Spectular to larger venues and to more cities at a very difficult time, and the other businesses in this segment also came under pressure. As a result, EBITDA declined to marginally positive levels. MSG has made significant adjustments across this segment for the new economy and our valuation assumes relatively low EBITDA multiples and partial recovery in EBITDA margins to approximately 8%. It's also worth pointing out that this segment includes the Company's ownership and long term leases of their various venues, which clearly have some value.               

In valuing professional sports franchises, normal valuation principles are less applicable.  These are trophy assets with a finite supply that buyers pay huge price tags for at valuations that have little to do with cash flow.  Forbes annual team valuations are considered to be quite credible, and recent transactions have priced at or near Forbes estimates.  As detailed in our scenario analysis, we choose to apply various haircuts to the Forbes 2009 team values in determining our bear, base, and bull case price targets. 

Over the past decade, three U.S. based professional sports teams previously traded publicly (Boston Celtics, Cleveland Indians, and Florida Panthers), each of which shared similar attributes: 

• They were taken private at sizable premiums to their public market value
• Each team was either bleeding cash or marginally profitable, translating into stratospheric (or not meaningful) take-out multiples of operating income or EBITDA
• They were in smaller, less attractive markets relative to New York
• They were single-team transactions

MSG's unique portfolio of sports, media, and entertainment assets makes relative valuation a difficult exercise given the absence of pure play publicly traded competitors.  Our discussions with a prominent sports financier and investment banker, who has been an advisor on several high profile sports team and media transactions, has helped to reinforce our conviction that MSG is trading at a substantial discount to fair market value.  Our contact points to the sale and recent valuation of Maple Leaf Sports & Entertainment, the Company which owns the Air Canada Centre, the Raptors (NBA), Maple Leafs (NHL), and the regional sports networks which broadcast the team's games.  In December of 2008, a 7.5% minority interest was sold in Maple Leaf Sports for $90 million, valuing the whole Company at $1.2 billion.  He cites this as the best transaction comp because it included an arena, an NBA team, an NHL team, and the regional sports networks, but emphasizes that this sale represented a minority interest in far less valuable assets near the height of the economic crisis, all of which point to significantly more value (likely >2X) for MSG's similar assets, with potential additional value from MSG's entertainment assets, Fuse network, MSG air rights, etc.

As for the bull case coming to fruition, MSG undoubtedly has significant earnings power upside, which we believe is being grossly underestimated by the market. It's worth pointing out that in the 2007 Cablevision fairness opinion related to the attempted management buyout, 2011 pro forma EBITDA was estimated at $304 million, nearly double the current run rate. While this projection was made before the economic crisis, we don't believe that it is out of the realm of possibility in future years. There is a misconception in the market that MSG's core sports and entertainment business is highly sensitive to the economic environment, particularly the New York consumer. Undoubtedly, there is some sensitivity, but the Garden is a one of a kind facility in the biggest market in the U.S. with a capacity of just 20,000 spectators, and essentially sells out for every Knicks and Rangers game despite the poor on court/ice performance. There is a waiting list for season tickets for both teams, and when the economy worsens or fans become more disgruntled by poor performance, this list becomes smaller, but the games continue to sell out.

We also believe that despite the economy and poor performance by the teams, there is room for significant ticket price increases. While premium ticket prices for both teams are among the highest in each league, we believe that non-premium tickets are significantly below supply-demand equilibrium. In the case of the Knicks, the team has a policy of not raising ticket prices unless they make the playoffs, which hasn't occurred since they snuck in during the 2003-2004 season with a 39-43 record. As a result, weighted average non-premium ticket prices for the Knicks are roughly $70 per ticket, ~30% lower than  the Lakers. If the Knicks were to charge a weighted average $93 per non-premium ticket, the same as the Lakers, they would generate nearly $20 million of incremental revenue from the regular season, most of which would flow to the bottom line. In the case of the Rangers, non-premium ticket prices this season are 8th highest in the league, below many smaller market teams, and less than half of the prices charged for similar tickets for the Maple Leafs. If we were to assume that they could raise these ticket prices by half of the difference between current Ranger and Maple Leafs prices, this would generate an additional $20+ million of incremental revenue.

On top of ticket pricing power, there are a number of other ways in which MSG would benefit from better team performance. Playoff games have substantially better economics than regular season games as player wages are minimal relative to the regular season while ticket pricing goes up compared to the regular season. A consultant with intimate knowledge of both leagues estimated that each playoff game produces slightly more than $1 million in cash flow for the Knicks and slightly less than $1 million for the Rangers (not easy to estimate with very little recent data!). This is on top of all the other ancillary benefits from better team performance, including better sponsorship deals, higher merchandise sales, TV rights, and future pricing power.

Finally, there are a number of other potential levers that MSG can pull to generate incremental revenue and cash flow that are mostly not related to team performance. Although they have never done so and it seems unlikely, there is huge potential value in selling the naming rights for the stadium, and there are a number of less prestigious stadiums that have locked in long term naming rights sponsorships at 8 figure numbers. Even if they don't sell the naming rights, sources indicate that MSG has historically underutilized its general sponsorship capacity, but they are finally starting to improve this program, and have cited the recent long term agreement with Delta to become a main sponsor as a good example. Personal seat licenses, which effectively provide owners the right to buy certain season tickets as long as the team stays in the venue, represent another opportunity for substantial incremental revenue and cash flow. A handful of teams in each league have successfully initiated these programs. Finally, a top executive at one of the leading sports food service concessionaires estimates that the Garden, which self operates in this area, could generate $5-$10 million of incremental EBITDA if they were to operate more efficiently in this area (by all accounts the food service is terrible at MSG), both on the revenue and cost side.

Given that Madison Square Garden has such recognizable assets, why does this opportunity exist? Below we speculate on a number of reasons for this massive dislocation and begin with the negatives, followed by our assessment of why ultimately each of these factors is not overly concerning and may actually be positive for the story:

• Technical Risk: The spin off was part of the product of a long battle between Cablevision and its shareholders, which blocked the Company's numerous attempts to take Cablevision private, and according to the spin off filing, some investors 'historically expressed concern for Cablevision's funding of strategic investments by its Madison Square Garden segment'. There appear to be a number of investors in Cablevision that are more interested in owning the larger cap cable assets of CVC rather than the small cap sports and media assets of Madison Square Garden and as a result, have put selling pressure on MSG with little regard for valuation. Since it began trading on a when issued basis on January 25th, the stock has traded down precipitously, from a high of $23.04 on the first day of trading, to as low as $16.35, and shares now trade for $18.82.
  • Our take: Since MSG began trading on a when issued basis, roughly 32 million shares have traded, so presumably those that wanted to sell are mostly out at this point. However, somehow MSG continues to trade under Wall Street's radar based on our discussions with other managers who didn't know about it and volume has been very light. It's also worth pointing out that the Company has yet to file a 10k (due by the end of this month) and according to investor relations, they believe some analysts are waiting for this report to initiate coverage. Discussions with the few analysts that cover MSG suggest that much of their calls have been from CVC shareholders deciding what to do with their new shares of MSG. Also, although many of the analysts who cover Cablevision put out detailed reports on MSG before the spin off, none of those analysts have officially initiated coverage on MSG, and we believe it is just a matter of time. For example, in a CVC report dated October 14th, 2009, well regarded media analyst Jessica Reif Cohen from BofA/Merrill valued MSG at approximately $42 per share on a break-up value basis and $28 on a conservative, discounted basis. We would be surprised if BofA/Merrill doesn't officially initiate coverage with similar price targets at some point in the near future.
• Tax Disadvantages: In order to maintain the tax free nature of the spin off, MSG is not able to return capital to shareholders for a couple of years, either via dividend or stock buyback. The same goes for a take private transaction unfortunately.
  • Our take: This is clearly not a long term concern, and eventually MSG is likely to pay dividends and/or repurchase stock, as they have historically with CVC. Also, in the long term, we would not be surprised to see the Dolan family make a bid for MSG as they have multiple times for CVC.
• Liquidity Risk: Also, as previously mentioned, the Company has approximately $750 million remaining in its renovation of Madison Square Garden, and upon completion, is likely to swing from a net cash position to a net debt position.
  • Our Take: We think the market is overreacting to the huge capital spend at the garden, and even in a bearish performance scenario, net debt to EBITDA is unlikely to exceed 2x upon completion of the project.
• The Dolan discount: MSG shares receive a discount for insider control given the split capitalization structure (Dolan's have ~20% economic interest but ~70% voting interest and therefore control), and some investors/analysts argue that there should be an additional discount for how poorly the Dolan's have run the teams over the past decade. Both teams have consistently underperformed expectations and relative to their payroll, but the Knicks in particular, have had shockingly poor results. Despite consistently spending amongst the top teams in the league (and in 2008-2009 they paid the highest luxury tax in the league), the team has not produced a winning record in a decade. It's humorous that espn.com's historical standing don't even go back that far!
  • Our Take: Although an insider control discount of 10-20% is warranted, we see little reason to apply any further 'Dolan discount'. Say what you want about the family (and James in particular given that he works most closely with MSG), but they clearly offered investors in Cablevision a liquidity event with their multiple take private offers, and in retrospect, their final offer of over $36.23 per share, was clearly within the realm of fair private market value. There has been plenty of speculation that this spin off was part of their estate planning, and that in the end, James Dolan would like to take MSG private. Some research reports have even gone as far to suggest that there is a 'Dolan put' in MSG that should offer investors downside protection.
  • As it relates to on court/ice performance and their impact on financial performance, one thing is clear: IT REALLY CAN'T GET ANY WORSE!!! Instead of choosing to focus on how bad the past decade has been for the Knicks and Rangers, we choose to look at this as more of a call option on the teams improving performance. After years of incurring amongst or at the top of the highest payrolls in the league, the Knicks have essentially cleaned house beyond this season and have the flexibility to go after not one, but two, max free agents, and regardless, appear unlikely to pay luxury tax similar to the ridiculous levels experienced in recent years. The Rangers haven't been nearly as bad as the Knicks (mediocre by most accounts...I am not a hockey fan so please chime in if you have thoughts), but have failed to make it out of the second round of the playoffs every year since 1997.
• The collective bargaining agreement expires for both the NBA and NHL after the 2010-2011 seasons, and a work stoppage in either case could have a major short and long term impact on the value of MSG.
  • Our Take: In both cases, league sources that we've spoken to feel that it is unlikely that there will be a work stoppage, and a resolution is more likely to positively impact team economics relative to the current collective bargaining agreements. In the case of the NBA, there are a number of players still in the league that remember the strike shortened 1999-2000 season, and although the players association has taken a tough stance to the NBA's initial proposal to lower player compensation significantly, it appears likely that some middle ground will be reached, most like to the benefit of the teams rather than the players (the current 57% of basketball related income for the players is likely to come down). The NBA also has minimal revenue sharing versus other leagues (6% of ticket sales for reg season, 45% post season), and sources indicate that is unlikely to change much, if at all. In the case of the NHL, the players have a powerful recent memory of the lost 2003-2004 season, and a work stoppage here appears unlikely as well.

Concluding points: Madison Square Garden is a classic deep value special situation, with informational inefficiencies surrounding a spin off, and more negative headlines in recent years than positive headlines, masking the true underlying intrinsic value and earnings power of the business. Over time, as the Company gets more institutional coverage, we see very little reason why the Company shouldn't trade to a more realistic valuation, and would not be surprised to eventually see the Company taken private at a substantial premium to today's price.

Catalyst

Increased recognition from the institutional investment community

Fading technical overhang

Lebron James