July 20, 2016 - 4:43pm EST by
2016 2017
Price: 180.00 EPS -1.50 1.00
Shares Out. (in M): 25 P/E NA 208
Market Cap (in $M): 4,366 P/FCF NA 61
Net Debt (in $M): -1,450 EBIT -42 30
TEV ($): 2,913 TEV/EBIT NA 100

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I’m recommending a long on Madison Square Garden (MSG).  MSG operates through two segments: sports and entertainment. In sports, MSG owns the New York Knicks (NBA), Rangers (NHL), Liberty (WNBA), Hartford Wolfpack (AHL) and the Westchester Knicks (NBADL). In entertainment, the company promotes concerts and events (notably the Radio Christmas Spectacular) and owns the following venues – Madison Square Garden, the Theater at Madison Square Garden, The Chicago Theater, and the LA forum.
MSG was spun off from MSGN last year.  MSGN is the legacy regional sports networks company.


MSG has a bunch of great assets that don’t produce much actual income; however, there are significant opportunities for stock price appreciation because of a current lack of clarity around the economic earnings power of the company following their spin off into a free standing company that should become clearer over the next 3-12 months.

Cost structure is artificially bloated in historical financials – Prior to the spin, the old MSG would report segment level information.  Tracking back through 2011 (when the old MSG changed its FY end date), the company had good disclosure on the revenues, operating expenses, SG&A and D&A of each segment. From 2011-2014, the operating income/loss in either segment (sports and entertainment) was relatively small. Using the segment information disclosed by old MSG, in 2014 I have the entertainment business posting a $20MM operating loss (-6.6% margin) and the sports business posting a $13MM loss (-4.5%), which was a reversal from the two years prior where the sports business had contributed $13MM of operating gains.  While not inspiring, the operating performance was not dreary, especially when considering that the flagship asset, Madison Square Garden, had been under construction from 2011-2013.

However, in the forms at the time of the spin, MSG reported a $114MM operating loss for FY 2014, equating to a -13% operating margin.  The increase in the size of the operating loss was largely attributed to increased costs associated with being a standalone company, but many of the expenses were overstated compared to their actual economic impact. (2014 was the last year the company had to restate prior to the spin in accordance with regulations.)

Here are a series of charges that were overstated for economic purposes:

·   Waiver and Termination Costs: When the sports teams terminate personnel (players or front office members) the entirety of the contract is written off in that period, even though the payments due to that employee may be disbursed over a number of years.  From the filing “These transactions can result in significant charges as the Company recognizes the estimated ultimate costs of these events in the period in which they occur, although amounts due to these individuals are generally paid over their remaining contract terms.” In some walks of corporate accounting this may be conservative, but this practice results in overly depressed earnings for MSG.  Assuming that most fired personnel have 2 years left on their contract (any less than 2 years left and it would make more sense to just let the employee finish their contract and then not renew, also, using recent examples, Derek Fisher, coach of the Knicks, was fired with 3 years remaining on his contract) and that firings of personnel are not a regular, recurring part of this business (perhaps not a safe assumption), than this expense is massively overstated.  In 2014, MSG recognized $54.2MM of expenses related to this, but if we assume these people had two additional years on their contract over which they would be paid out, then the real cost in 2014 was only 1/3 of this, or $18MM, effectively adding back $33.1MM of operating income. (In 2015 waiver and termination costs were $25MM, not zero, but a significant reduction from the 2014 numbers).

·   Excessive Reserves will need to be released: As of FY 2014, the Knicks maintained approximately $30MM in provisions for the NBA luxury tax.  The level of the NBA luxury tax is tied to overall NBA revenue, which is going to increase massively over the next few years based on the new national TV advertising deal. (In October 2014, the NBA signed a new TV broadcasting deal, which will kick in for the 2016-2017 season, with Turner and ESPN that will bring in $2.6B per year, up from the $930MM per year that the broadcasters currently pay to air the games, a 180% increase.) Whereas this past season, the luxury tax (a fine for being significantly above the salary cap limit) kicked in if a team’s collective payroll exceeded ~$81.5MM, next year the tax does not kick in until a team surpasses ~$110MM and the year after not until ~$130MM.  With NBA free agency behind us, we know the Knicks payroll for the 2016-2017 season, they have committed ~$94MM.  This is just slightly above the salary cap and well below the threshold for the punitive luxury tax. The $30MM provision for luxury taxes is based on the fact that the Knicks used to be luxury tax payers, but on a forward looking basis seems highly unnecessary.  I believe at least $25MM will be released and will result in lower operating expenses as net provisions are reduced.  Indeed, we have already seen this happening as in their most recent 10-Q MSG announced a $5MM reduction in their net provisions.

·   Change in Depreciation Method: There was an additional $2MM of depreciation expense due to a change to accelerated depreciation.  (This was relatively minor in the FY ending in June 2014, but in the 6 months ending Dec. 2014, depreciation increased 52% primarily due to a switch to accelerated depreciation, which impacted the reporting of FY 2015).

·   One-time SG&A charges: SG&A, after increasing by 2.5% from 2012 to 2013, skyrocketed by 26% the following year, with at least $13MM of one time charges related to “management transition costs”.  Some additional increases in SG&A in the entertainment segment were attributed to the one-time re-opening of the Garden after a mass renovation (assuming 33% of that segment’s SG&A increase was related to the re-opening results in another $4MM of one-time costs).

When accounting for all of these one-time or non-cash charges in FY 2014, MSG goes from $114MM operating loss to a $34MM operating loss, an improvement of $80MM.

The point of all of this is to say that the expenses are lumpy and sometimes not as impactful as they may appear at first glance.  This has not been baked into the share price yet due to the limited operating history and lack of good comps in the marketplace.


Improving Core Business: In 2015, with the refurbishment Madison Square Garden fully behind it, MSG’s operating segments actually showed some promise with the Entertainment business posting $17.5MM of operating income (4.2% margin) and the sports business posting $75MM of operating income (18.1%).

Under MSG sports, the revenue is largely tied to the Knicks and Rangers businesses. The NBA is increasingly dominant global brand that seems poised to continue to take share domestically as issues with the NFL continue to propagate and the NHL has been a chronically mishandled league that, since their lockout a decade ago, has struggled to gain national TV contracts but now seems to finally be getting some footing.  (NBC pays ~$200MM annually for the TV rights, the deal is locked in through the 2020-2021 season).  That is to say nothing of the pressures facing linear TV and classic media and the increased demand for live programming by cable and broadcast operators which should be a major tailwind for sports franchises that derive meaningful revenue from their broadcast rights.

Under MSG entertainment, this is a great cash flow business on account of its negative working capital nature.  Customers pay up front, sometimes months in advance, for the concerts and events that they want to see.  MSG owns venues ranging from 2,000 seats to 20,000 seats, essentially meaning they have vertically integrated the live-act talent development process.  They can contract new, up and coming bands at the Beacon Theater one year, Radio City the next, and then Madison Square Garden the last.  Combining this with their now national scope of venues (New York, Chicago, and LA) they should have bargaining power with talent representativesThrough 2015 and the first nine months of 2016 the entertainment business has been able to post mid to high single digit operating margins.

However, all these built in advantages aren’t yet manifesting themselves on MSG’s financial statements.  This will change though, and, in fact, is already starting to. The two operating businesses, ignoring for now the unallocated corporate expenses, reported operating income of $93MM in 2015 and $124MM through the first nine months of 2016.

Turning a profit becomes a major key to this company as it currently has $160MM of DTAs which do not show up on the balance sheet.  These only show up in the tax footnote because they have valuation allowances against them on account of the new standalone businesses lack of operating history. Using the $160MM of DTAs left, assuming a 35% tax rate, that means that the next ~$450MM of pre-tax income can flow through to the bottom line untouched.

Understated Book Value of Assets:  While most of the sell side focuses on the fact that MSG’s assets are trading at a discount to their private market value, the assets, as captured on their books, drastically understate their value.

I’ve already mentioned the valuation allowance against the DTA, this should result in MSG producing operating incomes which fall straight down to the net income line, until eventually the accountants determine that it is more likely than not that the company will be a profitable going concern, at which point they will do a one-time reversal of the valuation allowance which will result in a major one-time negative income tax provision and a large EPS jump, somewhere between $4-$6 per share depending on how much of the DTA they use before reversing it.

Additionally, their amortizable intangible assets have been netted down to under $30MM. This includes the suite holder relationships being netted down to $2.5MM as of June 2014 (from their spin disclosures).  However, when digging into their improved revenues for FY 2014, MSG attributes $18.6MM of increased revenue to increased suite rental fees.  Assuming a conservative 30% margin on these revenues (this is the ultra-high end consumer) that means that they derived ~$6MM of additional operating income on $2.5MM of assets, accounting for taxes, that would be a 150% ROA.  Also, in talking with sales reps with the company, long standing suite relationships are actually much better business than new suite relationships (implying that rather than depreciating, relationships actually appreciate, at least from an economic perspective).  Long standing relationships tend to be price takers and less elastic to increases in prices and they require significantly less legwork from sales reps than new relationships require. Marking up these suite relationship assets so that their ROA is more reasonable (~10%), means that these assets should actually be held on the books at $40MM, adding $37.5MM to their book value. The suite holder relationships have been subsequently written down to zero despite clearly delivering economic value to the company. This same argument could be extended to many of the season ticket holder relationships.  It can also obviously be extended to other areas, such as land, which is held on the balance sheet at $91MM, a clear discount to its replacement value.

Sell-Side is myopic on actual drivers: Most of the sell side reports I see simply look at a variety of measures to get to a private market value (Forbes estimates the Knicks to be worth $2B, the Islanders just sold for $500MM and the Rangers require a premium to that, Madison Square Garden was assessed by the NY dept. of finance at $1.2B, etc.)  and they come to a private market value well in excess of the current market cap.  They then assign some discount for the fact that the company is controlled by James Dolan (he controls all of the Class B shares and 70% of the voting rights) and they know that he will never sell the company, so the PMV will never be realized.  However, as I look at the actual earnings power of the company I believe this is an incomplete way to approach valuing the stocks as an ongoing business venture.

Lastly, the sell side continuously makes the point that the fate of the company is highly levered to the on-court/ice results of its sports teams. This may be fundamentally true, but this provides upside opportunity, but very little downside risk.  The Knicks have sold out every single game for the last 5 years, the Rangers for the last 9 years; this is despite very mediocre performance from the Knicks and the reverberations from the financial crisis.  The playoff revenue/profits that come with successful teams will be additive to the value of  the stock, I doubt that a continued track record of crappy on court play (at least for the Knicks) or a deterioration of success for the Rangers will negatively affect the market’s view of the company. Admittedly there are confounding variables, but in the 2014-2015 NBA season the Knicks suffered their worst win-loss record in franchise history, yet the stock of MSG (at that time still combined with the cable network business) advanced from ~$65 to ~$80 over the course of that season. While there are a number of reasons that the stock could advance, if it was that highly levered to the on-court performance of the team it would be hard to see how it would appreciate over the course of the worst season in franchise history.

Valuation:  The valuation of the company is a tricky matter due to its relatively short operating history and its lack of pure play peers. But I take a triangulation approach using a SOTP, PMV, and normalized earnings power.

Traditional sports franchise valuations apply a 4-5x multiple on revenue (as user slim did in his Liberty Media Braves Group idea a couple weeks ago).  Applying a 5x multiple to projected 2016 revenues for the sports franchises gets a value of $3.6B.  While this valuation is based mainly on PMV, it’s worth noting that the sports segment produced $75MM of operating income in 2015 and has accrued $97MM of operating income through the first nine months of 2016 FY.

I value the entertainment business using a normalized earnings power method. MSG entertainment has taken direct operating expenses down to the mid-70’s as a percentage of revenue. (For the first nine months of 2016 FY direct operating expenses were 81% of revenue; however, that included expenses of $40MM for a discontinued production.  It’s not truly one-time since the entertainment business will clearly have shows with more and less success, but it would also be a misrepresentation to include the entirety of the expense in that year, as I would highly doubt that ~20% of direct operating expenses would be related to discontinued plays. To that point, however, MSG is going to write down another $7-10MM in the 4th quarter because of its interest in another Broadway play. But if you back out that $40MM discontinuation expense, which should really be amortized/depreciated across several years, then direct operating expenses stayed relatively flat from the first nine months of 2015 and 2016, while revenue increased by 3% over that time, implying that there is operating leverage in the business, consistent with the pricing power that a business like this should possess.)  Using an EPV valuation, assuming they can keep operating expenses as mid 70% of revenue and can get SG&A down to mid-teens percent of revenue (LYV ran SG&A at 14-15% of revenue prior to the consolidation of Ticketmaster), based on 2015 earnings, would assign a valuation of ~$325MM.


Alternatively, the MSG entertainment business can be comped to Live Nation (LYV) which commands a 10x EV/EBITDA multiple.  Applying the same 10x multiple to MSG entertainment’s 2016 estimated EBITDA of $30MM gets a value of $300MM on the entertainment business.  While it isn’t a perfect comp because LYV has more profitable ticketing operating which generally has generated HSD operating margin over the past 3 years, MSG has outperformed LYV in the core concert business. 

This puts a combined valuation on the operating businesses of MSG at ~$3.9B.  (Note that this is a significant discount to a private market valuation of MSG’s assets.  Based on a PMV, I get a valuation of $7B – $1.4B of cash, $3B Knicks based on precedent transactions, $.925B for Rangers based on precedent transactions, $1.2B for MSG based on NY dept. of finance assessment, $200MM for LA forum based on cost plus renovation and the Radio City Christmas Spectacular Show at $200MM; those are the major assets. MSG should trade at a discount to its PMV, as the sell side will point out, because control is dominated by Jim Dolan who, on account of a massive inheritance and a windfall from the sale of Cablevision, shows no signs that he’s interested in breaking up the company.)

Lastly, there’s the corporate overhead expenses that are unallocated to the operating businesses and the non-operating assets, including the $1.4B in cash and estimated $160MM of DTA left which has a valuation allowance against it. 

The cash I value at 100%.  About $500MM has been earmarked for share buybacks which IR has said will be used judiciously over the next year and a half.  There’s an argument to be made that you should take a haircut to the cash position as they have stated that it will be mainly used to fund acquisitions in the entertainment segment, which has historically had a very low ROIC (I don’t have LYV coming close to earning its cost of capital even once since it’s gone public).  And I am sympathetic to that view; however, I tend to wait to see what they do with the cash, and I will evaluate any uses of cash in the future and adjust value accordingly.  (At the end of May, MSG announced that it will be building an arena in Las Vegas that will be exclusively devoted to concerts, I’m waiting for the Q4 call to further assess the viability of this investment.  MSG says that it will be filling a niche similar to what it did with the LA forum and it appear that they are getting pretty good terms, LVS is giving them the land for free, for what it’s worth).

Then there’s the matter of unallocated corporate expenses. MSG reports $95MM of operating loss through the first nine months of 2016 (up from $75MM of operating loss through the first nine months of 2015) attributed to unallocated expenses.  I am not sure how much of these costs are truly economic costs versus simply accounting creations, especially since the operating segments of MSG seems to have margins in line with peers, allocating these sizeable, additional costs to the operating segments give the appearance that they are very inefficient.  Nevertheless, I have assumed that MSG will have a constant $70MM of unallocated expenses, a haircut to what it currently reports, and I have tax effected and capitalized it (at 10%) to account for the negative impact of these expenses on the valuation.  (This is admittedly a swag, these corporate expenses are something I will update as more quarters go by.) This results in a subtraction of $455MM from market value.

Lastly, I have included the $160MM of DTAs which currently have a valuation allowance against them due to the company’s limited operating history, but will most likely be able to be reversed (MSG has already started using the DTAs).  I have not discounted them over their likely life because I believe the reversal will be in the near future.

This valuation implies that MSG, as an ongoing business is worth $209, or 17% upside from the current price.


However, I think there are numerous catalysts to the upside.  First, there could be a sale of any of their premium assets.  Additionally, the company currently has zero debt and could get create value by borrowing cheaply and creating a tax shield (LYV has 4x debt/EBITDA for example on the entertainment side).  MSG could discontinue some of its unprofitable businesses (MSG has shown a penchant for shutting down unprofitable businesses in the past), notably they could reduce their $300MM of equity investments in Tribeca enterprises, Fuse, etc.  Alternatively, the NBADL franchise in Westchester may have significant room to ramp in the future.  The Westchester Knicks play in the Westchester County Center in White Plains, NY (5,000 seat capacity) and actually seem to have pricing power.  Average ticket price is north of $20 and player salaries are significantly below the NBA level. (The D-League uses a 3 tiered salary system where the bottom players are paid $13,000 per season and the best top, top tier players are paid $25,000; and there is a limit on the number of NBA contracted players that can be on any one D League team).  The D League today plays 50 games (NBA plays 82), and it is still in its nascency.  MSG could successfully lobby to get a new festival license in the NY area. The Knicks could actually make a meaningful playoff run and contribute significantly to revenue and operating incomes. And, lastly, the Las Vegas expansion could fill a market niche and turn out to be accretive to the bottom line in a significant way.


I believe that MSG should, at a minimum, trade ~20% higher than it is today. And if any of a bevy of possible catalysts occurs it would justify a still higher target price.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


10-K comes out

Reverse valuation allowance

Las Vegas deal details

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