|Shares Out. (in M):||78||P/E||0.0x||0.0x|
|Market Cap (in $M):||4,695||P/FCF||0.0x||15.4x|
|Net Debt (in $M):||-77||EBIT||0||0|
Madison Square Garden (“MSG” or “the Company”) has been the subject of several timely and cogent write-ups on this site over the years. Shares have performed well since they were spun off from Cablevision in 2010, advancing by 178% compared with a 79% increase for the S&P 500. Despite this strong performance, shares currently trade at a 30% discount to my estimate of their intrinsic value. In my view, the valuation disconnect is unwarranted and reflects the following:
Free Cash Flow Poised to Accelerate
MSG will likely generate $300 million (~7% FCF yield) in FY 2015. Over the next 2-3 years FCF should approach $400 million (~9% FCF yield) thanks to built-in rate increases for its contracted revenue streams and the re-pricing of below market rate affiliate contracts as they come up for renewal. It should be noted that FY 2015 will be the first full year the Company will capture all of the benefits of the Garden’s makeover. The arena was closed for ~5 months during each of the preceding 3 years to accommodate the renovation, which was completed in phases. Accordingly, only a portion of the arena’s improved economics have been realized to date. The new state-of-the-art arena will generate meaningful incremental revenues due to the following:
RSNs are MSG’s Crown Jewel with Further Opportunity to Expand Profitability
In my view, the crown jewel of MSG’s business is its two RSNs (MSG and MSG+), which each serve ~8 million subscribers in the New York Metropolitan region. MSG’s RSNs boast a number of attractive attributes including a strong base of recurring revenues (~90% from affiliate fees) and minimal capital intensity with capex averaging just 1.6% of revenues over the past three years. The Company’s RSNs boast superior profitability compared to peers due, in part, to MSG’s ownership of two of the sports teams (NY Knicks and NY Rangers) for which it telecasts programming. MSG Media's EBITDA margins (FY 2013: 52%) are more than double its RSN peers including Fox Sports (~24%), Comcast SportsNet (~24%) and ROOT Sports (~21%). Profitability within the MSG Media segment has expanded markedly in recent years thanks to a 10-year affiliation agreement signed with its former parent just prior to its spinoff accounting for 40% of its RSN subscriber base. Notably, the agreement represented a ~25% step up over the prior deal and also includes a ~7% annual rate escalator. In addition, MSG garnered a similar rate increase from Time Warner Cable (20% of MSG’s RSN subs) when that company’s agreement came up for renewal in 2012. These agreements have significantly enhanced MSG Media’s revenues, profitability and margins. Between 2009 and 2013, segment revenues and AOCF (MSG’s preferred method of EBITDA, which excludes stock-based comp) have increased at an 11% and 23% CAGR, respectively while AOCF margins expanded by over 1,600 basis points to 51.6% from 35.3%.
MSG Media – Summary of AOCF and AOCF Margins ($MM)*
*Note: MSG transitioned to a June 30th FY in 2011 therefore 2009 and 2010 results are calendar year results.
While MSG Media segment results have been impressive, multiple items will favorably impact future segment profitability including:
Iconic Sports Franchises, Improved Segment Prospects Not Reflected in Current Share Price
In my view, current market value of MSG does not fully reflect the private market value of the Company’s sports franchises or the improving prospects of MSG’s Sports segment (34% of revenues) due to the renovation. The Company’s sports franchises are unique assets that would be impossible to replicate. Wall Street historically has had difficulty ascribing an appropriate value to sports assets and I believe that MSG is no exception. MSG’s sports franchises serve a large, loyal, passionate and affluent fan base in the country’s largest metropolitan market. While recent profitability of the Sports segment has been uninspiring (EBITDA has averaged $27.5 million over past two years; 6% EBITDA margin), the arena upgrade coupled with league media rights agreements should help drive sustained and higher profitability for the segment going forward.
Following the Garden renovation, approximately 80% of the revenue within the Sports segment is now secured under long-term contracts (corporate suites, sponsorship and league revenues) or is derived from sources that have proven to be historically stable such as season ticket sales. The segment’s largest revenue source is ticket sales, which account for approximately 30% of segment revenues. Season tickets, which account for the vast majority of ticket revenues, have been sold out for the Rangers for the past 7 years, while Knicks season tickets have been sold out for the past four years. Notably, for the most recent season, the renewal rate of season tickets for the Knicks and Rangers was 97% and 92%, respectively. The strong season ticket results coupled with the high ticket prices for Knicks (average price of $123 a game, which is highest in the NBA) and Rangers ($233, which ranks 8th of 30 NHL teams) also helps to reinforce my view of the team’s passionate and affluent fan base.
In addition to the improved arena economics, the Sports segment should also benefit from the robust environment for sports media rights due to league revenue sharing of national broadcast contracts. In 2011, NBC signed a $2 billion, 10-year agreement with the NHL to broadcast games in the U.S. nearly double the amount of the prior contract. Meanwhile, in late 2013 the NHL reached a 12 year, $4.9 billion deal with Rogers Communications for the Canadian broadcast rights that was nearly six times the amount of the current agreement (the new agreement takes commences with the 2014/2015 season). There is also the potential for upside from the NBA’s future media contract. The current NBA league media contract was signed in 2007 and runs through the 2015/2016 season. It should be noted that the current NBA contract was signed in the midst of challenging ratings for the league and before the surge in sports media rights. According to a recent Forbes article, the NBA’s next broadcast deal is expected to be at least double the current yearly average of $930 million that it receives from its current partners including ESPN/ABC and TNT.
Hidden Assets: Development Rights Offer Significant Long-Term Value
MSG discloses very little information about the development rights that it holds above its flagship arena in Manhattan, which sits above Penn Station, the busiest transportation hub in the country. However, based on my extensive primary research, I believe that these development rights could represent a significant source of long-term value for MSG shareholders – potentially worth nearly $900 million or 20% of MSG’s current market cap. Notably, a recent conversation that I had with an MSG investor relations representative revealed that there is currently no value ascribed to these rights on MSG’s balance sheet (a true hidden asset!). Based on the current dimensions of the property (542.64 feet by 455 feet), which can be located by searching the NYC digital tax map for the property at Block: 781; Lot 9001, and the current zoning for the neighborhood, MSG holds roughly one million square feet of development rights directly above the arena. I estimate that the Company could potentially unlock an additional 2.5 million square feet of air rights/development rights if the area surrounding Penn Station is re-zoned to accommodate a redevelopment of the neighborhood. In 2007, the city proposed re-zoning the area as part of a plan to upgrade Penn Station. While the proposal was not adopted, the station will likely need to be upgraded soon to meet increased passenger volume, which is expected to double over the next 20 years. The Municipal Arts Society of New York City (MASNYC), which a non-profit devoted to intelligent urban planning that is backed by a number of high profile donors including real estate developers Vornado and Forest City Ratner, is leading a charge to build a new Penn Station in order to bolster the city’s competitiveness and ensure long-term economic health. A 2013 article by MASNYC entitled “Unlocking Penn’s Potential” notes: “The district [around Penn Station] is dominated by aging office buildings, and hasn’t had the significant, new Class A construction of the type that has occurred in the nearby Times Square submarket. Given appropriate transit, public space and infrastructure investments, the area could accommodate substantially higher density.” The potential for higher density zoning in the area would be a boon for MSG.
Vornado, which is viewed as an astute and patient long-term real estate investor, has accumulated ~13 properties (7 million square feet) surrounding MSG/Penn Station over the past 20 years and recently stated that it plans “significant” investment in the area. In May 2014, Marriott announced its intention to build a Renaissance hotel in a 38-story tower currently under construction in the neighborhood. It should be noted that Marriott made a similar move during the 1980s when it opened its Marriott Marquis in the troubled Times Square area just before that part of New York City underwent a major resurgence. In my view, these developments should go a long way towards upgrading the neighborhood surrounding the arena and unlocking the value of the Company’s overlooked real estate assets. With the area poised for redevelopment, I would not be surprised if real estate developers become increasingly interested in MSG’s air rights (note: in New York City, air rights are generally transferrable to nearby properties). The value of air rights in Manhattan has soared in recent years. According to a recent report from Tenantwise Inc., a NY real estate services and advisory company, the average price paid for a square foot of air rights in NYC during 2013 increased by 47% to $305 compared with $207 in 2012 and $244 in 2007, just prior to the 2008/2009 downturn.
Capital Allocation Uncertainties Overblown
MSG has frustrated investors recently by not returning its excess capital to shareholders via dividends or share repurchases. The Company boasts a pristine balance sheet with $77 million of cash (~$250 million pro forma for Fuse sale) and no debt with meaningful free cash flow generation potential on the horizon. Rather than return value to shareholders, management is currently focused on pursuing growth opportunities. MSG invested $120 million (net of tax benefits and loan forgiveness) as part of its 2012 acquisition and subsequent renovation of the LA Forum. Over the past 11 months the Company deployed nearly $200 million for three investments including purchasing a 50% stake in Irving Azoff’s artist management business ($150 million), a JV with Brooklyn Bowl to establish a music venue in Las Vegas ($25 million) and a 50% stake in the Tribeca Film Festival ($22.5 million). While the LA Forum investment makes strategic sense and is located in an underserved entertainment market, the other investments appear somewhat questionable (I’m being kind). I don’t believe the artist management business is a great business, but note that the Company’s prior investment with Azoff proved to be a profitable endeavor (MSG realized a gain when Frontline was sold to Live Nation).
Although shareholders may be uneasy with the investments and potential for sizable future acquisitions, I would note the Dolans, contrary to popular belief, have a successful history of implementing shareholder friendly initiatives. Supporting this view are Cablevision’s spinoffs of MSG and AMC and the family’s robust buyback (albeit ill-timed) and dividend policy at Cablevision. In addition, I believe the Company to be a disciplined acquirer and MSG’s recent proposal to secure development rights for the Nassau Coliseum helps reinforce this view. While MSG agreed to invest more in the project than the winning bidder, the amount of total revenue the Company was willing to share with the county was significantly lower and therefore MSG was not awarded the contract. In addition, the recent sale of the unprofitable Fuse cable network helps further demonstrate my view that the Dolan Family is interested in creating shareholder value by shedding underperforming businesses. While the Company’s current focus on driving growth may irk some investors, management has previously stated that that growing the Company and returning value to shareholders are not mutually exclusive events. In addition, recent comments by MSG CEO Tad Smith provide a reason to be hopeful that shareholder friendly initiatives could be on the horizon. During the Company’s 3Q FY 2014 earnings call held in May 2014, Mr. Smith stated “So for the time being – and only for the time being, our priority is to find new opportunities that enhance our Company’s growth and asset value over the long term.”
FOX’s acquisition of a controlling stake in the YES Network during early 2014 at an implied valuation of $3.8 billion provides a good comp for MSG’s RSNs. The valuation translates to $422 per sub (~9 million YES NYC Metro Subs) and nearly 20x EBITDA. The YES network also has approximately 6 million additional national subs, but these subs do not have access Yankees or Nets games so I believe their monthly per sub fees are significantly below the YES Network’s NYC Metro subs. Applying a discounted $300 per sub value to the 8 million MSG RSN subs and $275/sub to the MSG+ RSN subs (fewer Knicks and Rangers games), I derive a value of $4.6 billion (approximates MSG’s current market cap), which implies a 13x multiple based on MSG Media’s 2013 AOCF. I believe that this represents a conservative approach given that the average monthly affiliate fee for MSG’s two networks is at a ~18% discount to the monthly affiliate fee for the YES Network while the per sub value applied to MSG's RSNs represents over a 30% discount to the YES Network comp. The EBITDA multiple implied by the per sub valuation is at the lower end of the range of precedent cable network transactions even though MSG commands superior profitability and meaningfully higher free cash flow conversion vs. cable network properties. (As an aside, I estimate that MSG as a whole will convert over 80% of its EBITDA to free cash flow, which is substantially above the FCF conversion of its media peers including Discovery Communications (~49%), Time Warner (~38%) and Disney (~51%). Looked at on a free cash flow basis, which provides a better comparison, MSG trades at just 15x FCF, representing a nearly 30% discount to the aforementioned peers, which trade at an average of 21x).
Risks and Mitigants: