Description

Trader Talk: hold co with solid downside asset protection from the MSG arena and multi-bagger upside from Sphere, MSG Networks, and sports betting

Description

MSGE is a Dolan family controlled holding company with a portfolio of live entertainment assets originally spun from Cablevision in 2011. While the company has many interesting assets, including the iconic Rockettes, the key valuation drivers are the MSG arena, the Sphere development in Las Vegas, and MSG Networks. Of note, the MSG arena is owned without leverage, providing considerable downside support.

Thesis

MSGE is a skewed risk/reward investment with significant downside protection from the MSG arena and two large upside growth opportunities in the Las Vegas Sphere and an MSGN turnaround, along with a smaller upside opportunity from the legalization of online sports betting. To the downside, our investment is anchored by MSGE’s unlevered ownership in the iconic Madison Square Garden arena. Per NBA rules, MSGE is not allowed to take out leverage on the arena, as the Dolans already have leverage on the Knicks at MSGS. In our experience, it is rare to find a trophy asset anywhere near a conservative valuation on an unlevered basis. We can debate what exactly the MSG arena is worth, but it’s certainly worth “something,” and we take great comfort in having a high-quality, unencumbered asset to anchor our investment should shares fall. We value the MSG arena at $55 or more per share, or roughly $2.0B. To the upside, the Las Vegas Sphere is a $1.9B theater development that could redefine the live concert experience, and the emergence of direct-to-consumer local sports media strategies could reinvigorate the MSG Networks. We also believe online sports betting is set to be a significant driver of revenues for MSGE at the RSNs and as well as the stadium. If the company successfully executes, we value shares over $300.

We believe the completion of the Sphere will be a significant catalyst for the stock, as the company goes from a Sphere-driven cash burn to a FCF machine with a portfolio of iconic live entertainment assets. Once the Sphere is completed, we believe MSGE will generate close to $10 in FCF/sh., with our estimates approaching $15/sh. if the Sphere is a strong success. Given management’s history of share purchases, we believe the majority of FCF will be returned via buybacks starting in 2023.

NAV

Risks

Sphere Is a Bust – If the Sphere is a disaster and the Dolans commit to another Sphere build, it will likely weigh on shares.

Dolans Invest in Other Pet Projects – Given the Dolans reputation, if the Dolans take the cash flows from existing MSGE assets and reinvest in what are viewed as speculative or pet projects, shares will lately flounder.

MSG Networks Fail to Recover – The legacy RSN business model is in decline and must be restructured, both financially and, more importantly, operationally. While the MSGN term loan is non-recourse to the rest of MSGE assets, if the Dolans recap MSGN and no legitimate business model emerges, the market is unlikely to approve.

Moving MSG Arena – The arena operates under a zoning permit with NY City and State that expires in 2023 and is thus subject to political debate and urban planning ideas. While the permit was renewed for 10 years in 2013 and we believe will be again, there are proposals aiming to move MSG to an area near the current site or possibly Hudson Yards. Frankly, given the glacial pace of urban development in NYC, particularly development requiring the extension and expansion of subway lines as a Hudson Yards move would, we are doubtful anything occurs but it’s worth considering. Depending upon the incentive package, a move might be a benefit anyway and moving MSG would take years to complete regardless.

Dolans

Despite their reputation, the Dolan’s are quick to point out that they have actually created shareholder value in the last decade. They sold CVC to ATUS, which until recently investors hated even though the Dolans cashed out a nice premium, and the original MSG spin and related assets have outperformed the market, despite MSGE and MSGS both arguably trading at large discounts to NAV.

MSG Arena

Madison Square Garden is one of the world’s most iconic venues, nicknamed “The World’s Most Famous Arena” or simply “The Mecca.” The asset includes the Hulu Theater next door, made famous in Eddy Murphy’s Raw, along with air rights. Despite the asset’s excellent utilization – MSG had ~320 shows in 2019, far above most live entertainment venues of its scale – the Arena’s earnings can be difficult for investors to nail down, as MSGE’s disclosures and the Las Vegas Sphere spend obfuscate the arena’s profits. However, MSGE has disclosed that it was earning >$100MM in post-tax profits pre-COVID, with ~$43MM coming from effectively triple-net rent from MSGS for Knicks and Rangers home games. Using some rough math off Note 4 in the MSGE 10k and after incorporating MSGS’s split, we assume profits of $5-$20MM in food and beverage, $25MM in signage, $20-$40MM in non-sports tickets, and $10MM in other, in addition to the triple-net payment, to confirm management’s disclosure.

We value the asset at 25x EBIT, which we feel is warranted given its trophy quality and substantial pricing power. As a sanity check, the Barclays Center sold for ~$1,530 PSF in 2019, which yields ~$1.7B for MSG arena, despite the MSG arena’s higher capacity and vastly superior location for commuters. In addition, MSGE sank ~$1B in remodel capex into the asset in 2013, which has achieved a double-digit IRR, and the air rights above the building are worth $300-$500MM using peer transactions. Finally, in 2016, NYC city planners estimated replacement costs of ~$1.6B and a 5+ year timeline to redevelop, and pre-COVID commercial real estate prices had appreciated at ~5% a year.

While reasonable investors may disagree with our multiple for the arena, we believe our base case is strongly supported and not far above replacement cost.

Las Vegas Sphere Development

The MSG Sphere is a “revolutionary” new entertainment venue under construction in Las Vegas with a planned opening in 2023. Essentially, MSGE is building a more immersive and large-scale entertainment facility than most new stadiums and theaters imagine. For instance, the venue will have a fully programable LED display spacing over three football fields worth of walls. For comparison, it is ~70x the size of an Imax. The basic bet is that MSGE can attract top acts, build fully owned and thus higher margin shows, and drive a higher asset utilization than most venues to achieve a superior IRR on a large budget of ~$1.9B. The variability of mix – owned content, tours, residencies, convention business, etc. – makes estimates of future profits difficult, which, combined with MSGE’s refusal to provide details on planned economics besides “hitting a double-digit IRR,” has created significant investor skepticism.

While we understand investor hesitance at a “build it and they will come” business plan, we believe MSGE is reasonable in their assumptions. Las Vegas had over 40 million visitors annually pre-COVID, and they come to the city to spend money and attend special events. Conceptually, the Sphere has the opportunity for owned shows – think economics similar to the Rockettes but in Vegas and using the Sphere’s unrivaled audio-visual technology. Some original content promos can be seen here. In addition, we believe there is significant opportunity to tap in the residency market. Entertainers such as Lady Gaga and Adele routinely perform for sold-out venues with average ticket prices over $500 versus a national average of ~$90. These entertainers can create one-of-a-kind shows, only possible at the Sphere, and reach nightly audiences of 20,000 instead of the smaller 5,000 person theaters they currently play, and MSGE could receive a higher percentage of ticket sales than the 10% or less take rate most casino theaters currently receive. If the Sphere is a success and achieves double digit IRRs, or >$200MM in profits, we believe the Sphere will receive a premium multiple as a new and growing asset with a significant pipeline of additional Spheres planned.

However, we understand this is a speculative investment, and in a worst-case scenario, we believe the Sphere will achieve at least $100MM in annual profits, with ~$50MM driven by high margin arena naming rights and advertising fees. For refence, UBS is paying ~$18MM per year for naming rights to the Islanders new stadium in New York City, despite the fact that few New Yorkers are even aware the UBS Arena exists. We suspect a few of you reading this are just finding that out. The Staples Center was also recently renamed the Crypto.com Arena for ~$50MM per year. As the Sphere will sit in the middle of the Las Vegas Strip across from the Venetian, we expect robust naming right and advertising revenues from the asset.

MSG Networks

Media assets have a way of generating significant VIC comment section chatter, so we will not opine on the media landscape too much beyond saying linear cable is in secular decline, and the legacy business model of MSG’s regional sports networks (RSN) is unraveling. Having said that, we do not believe all is lost and compare them to music labels prior to the emergence of streaming. It’s not a matter of shifting preferences for the underling media, as New Yorkers still follow the Knicks just like Beatles fans still liked “Hey Jude,” but a new distribution model is needed. The leagues recognize the need to figure out a direct-to-consumer (DTC) strategy, and numerous proposals and plans are underway. Frankly, we do not have a particularly strong view on how exactly the future will look. In a reasonable worst case, we think the Dolans will paydown the term loan with the current ~$100-$150MM of levered FCF MSGN generates and then recap it with less debt when the loan is due in 2024. If the business is still in decline then, that’s not an ideal outcome and might remove ~$500MM, or $14 per share, off our base case estimate. In a best case, two years from now the addition of DTC revenues will offset linear declines, further boosted by growing online sports betting advertising, and the asset will return to growth and trade at its previous 15x EBITDA multiple.

We are not sure exactly what will happen, but we think we are getting significant optionality in our MSGN investment and think a bad outcome is more that offset by the value of MSGE’s other assets.

Online Sports Betting (OSB)

OSB has recently been legalized in NY State and is off to a strong start. If the US is anything like the UK, OSB will soon become a top ten advertising vertical and we believe MSGE is ideally situated to benefit at both the arena and the RSNs. To demonstrate the potential going forward, we encourage people to look at the ESPN app on your phone, or any sports related app supported by advertising, and see what kind ad is being shown. On ours, the current banner ad is for Allstate. Now consider if instead the ad were for Draft Kings advertising 10:1 odds that Brady throws four touchdowns, and clicking the ad immediately brings up your Draft King account with the wager ready for approval. Which company do you think would pay more for that impression?

We share this example to highlight the significant monetization opportunity sport betting represents for sports media assets. Not only are a wave of ad dollars about to enter the market, but traditional sports media assets are also by far the best place for sports betting platforms to advertise. At present, MSGE is commenting that sports betting is already in-line with current top-tier revenue agreements, specifically pointing to their relationship with JP Morgan which is rumored to be over $30MM annually. Longer-term, we believe the NY metro area iGaming and OSB market could be close to ~$3.5B, assuming the UK’s $180 per person spend. European gaming operators typically spend 20-25% of sales on advertising, and we believe MSGE is well positioned to capitalize as the market emerges.

Catalyst

Completion of Las Vegas Sphere

Resumption of buybacks

Launch of DTC RSNs