Description

Overview:

Madison Square Garden Entertainment is the Spinco from MSG that comprise the venues and entertainment businesses formerly housed within MSG. It spun in April of this year and has subsequently drastically underperformed the equity markets since. It has returned a negative 25% total return (most of the decline in the first few days) versus a positive 23% for the SPX and similarly positive return for Live Nation.  It is controlled by Jim Dolan, an owner who has been despised by New York area sports fans, but through spins and sales of his empire has been relatively investor friendly. 

MSGE’s core assets are Madison Square Garden in Manhattan (and the associated air rights), Tao Hospitality Group, Radio City Christmas Spectacular and the Las Vegas Sphere (under development). Madison Square Garden has a long-term contract with MSGS (Knicks and Rangers), which are also controlled by Dolan. Beyond the long-term contractual cash flows with the sports teams, MSGE primarily makes money by holding live events at MSG and other venues.

MSGE trades at a $400mm enterprise value (despite MSG being worth multiples of that) because investors are scared about a giant development project in Las Vegas called the Sphere. We think while concerns about ROIC on the Sphere are warranted, there is little to no possibility of value destruction that justifies the current stock price. 

I will leave the background relatively short with the goal of not regurgitating the info that is in the Form 10 from earlier this year. But I am happy to engage in the comments section on any questions anyone has on the business. Would appreciate anyone who finds value in this writeup to vote to allow me to rejoin the VIC community. 

Investment Thesis:

Looking two years out, we believe that MSGE has a NAV of $120 per share, or 80% upside from here. While that is healthy upside generally, we also like the fact that at MSGE you are doing it with an unlevered cap structure (effectively unlevered post buildout of Sphere, currently huge net cash position), large insider ownership and a downside protected by the valuation of Madison Square Garden which we expect to be resilient in most outcomes. 

We note that even a couple of years out, that this could continue to trade a discount to NAV but don’t believe there is justification for it being significantly larger than 10-15%. While Dolan has been a terrible owner of the Knicks, after spinning out MSG from CVC, spinning AMCX out of CVC, spinning MSGN from MSG, Selling Cablevision and then spinning out MSGE from MSG, we think he is a fairly active steward of capital who doesn’t show a lot of the characteristics of a manager whose stock should trade at a large and persistent discount to NAV. We believe broadly that Dolan will continue to take actions to close a large discount that persists.

 In terms of our industry level assumptions to drive to our base case NAV, we believe the live events space will be one of the strongest areas of rebound once there is a vaccine. All industry data (forward bookings, tours scheduled) suggests there is huge latent demand from all parties for a return to live events. While we do not think a rebound back to CY 2019 is appropriate for all COVID impacted industries, we forecast CY 2022 to look a lot like CY19 here. Live Nation EV is down 20% YTD despite huge amounts of cash burn in the near term; so we are not sure that the idea that the events space comes back strong is especially contrarian (EBITDA estimate for LYV higher in 2022 than 2019) . 

With that backdrop, and reasonably conservative assumptions around the Sphere (assume a 20% haircut to their cost, which equates  to a larger haircut once you factor in cost of capital) and you get to $120 per share. We show the NAV math below, which includes various other assets including Air Rights (assumed at 30% discount to the JPM Grand central 2018 transaction), TAO, Christmas Spectacular and some small equity positions. 

We underwrite a downside scenario as well, which includes a 20% permanent haircut to EBITDA from COVID, lowering all-in multiples by 3 turns, a 40% destruction of cost at the Sphere and a shutdown that lasts an incremental 6 months (November 2021). That downside scenario gets us to an NAV around the current stock price. 

We find that risk/reward very compelling.

Why Does this opportunity exist?:

There are several reasons for MSGE’s underperformance and understanding them helps frame the opportunity

• General spin dynamics around indices (this is smaller of the two assets)

• Selling from large funds primarily invested in MSG for the Knicks assets (Silver Lake etc)

• Impact of COVID on its core events business

• Style shift away from NAV based investments

• Concern over development risk from on the Sphere

• General Dolan concerns (which we believe to broadly unwarranted, except as it relates to being a sports team owner)

We believe these issues to be broadly transitory in nature and to some extent are the opportunity. The combination of special situation dynamics along with COVID impact means that this has been left without a natural investor base. Investors who are trying to bet on a COVID rebound have gravitated to cleaner stories, while special sits investors may not want to play the cyclical rebound.

We think with a 2-3 year time horizon, therein lies the opportunity.

Sphere:  As anyone who has spent time on MSGE knows, the Sphere is the biggest risk and point of diligence here. If you assume Sphere is worth what they are putting into it, MSGE is an absolute home run no matter what else happens.

The Form 10 goes into detail in describing the Sphere, as does this website put out by MSGE:  https://www.msgsphere.com/ , but to summarize the Sphere is a $1.66B live entertainment venue being developed on land adjacent to the Venetian. It was originally supposed to debut in CY 21, but with COVID has been pushed back to CY 23.  The Sphere is shaped like a Sphere and seats 17,500. It is a venue like any that has ever been created; it attempts to combine multimedia (interior display surface of over 160k sq feet) with a concert venue with acoustics that will be unmatched.  I can’t totally do it justice, go to the website and read some of the press on it. 

It is expected to be used for concert residencies, corporate events, conventions as well as touring acts to a degree (some debate on that because of the difficulty of adapting touring acts to fit the venue).  

There is little doubt that the Sphere is groundbreaking and will be an awesome place to view a show. But there is a lot of doubt that it will generate the double digit returns that mgmt expects. And I would say among most of the investor community there is strong doubt that they will be able to create a venue that is worth even as much as the money they put in. We share some of those concerns, but believe the downside destruction within the Sphere will be minimal.

We spoke to several ex-execs involved in the Sphere as well as other industry players. Our takeaway was that the Sphere will be a truly best in class asset that will be a huge driver of traffic to Vegas. We believe that the Sphere is likely to establish itself as the premier destination for both residencies and touring acts and that broadly the numbers do work to generate in $100mm of EBITDA. While that is a large discount to what we believe management assumes, we think it will deserve a relatively high multiple and even at $100mm of EBITDA should be worth what we assume in our base case. If we are wrong on that $100mm, we think we have built in enough conservatism on the multiple for Sphere (implicitly 13x) and  also in the margin of safety of the investment overall. If we are off on EBITDA by 20%, that would bring our base case value down to $109 per share and missing by 40% on EBITDA would bring us to $96.  We note that modeling this out is an inexact science, but we are working from a starting point that we believe is relatively conservative and there is a ton of margin of safety in the security.

Base Case and Downside NAV:

The NAV’s are fairly self-explanatory, but will walk you through the most important assumptions:

18x EBITDA  for the Garden, getting to a valuation of $1.7B. As a sanity check, MSG spent $1B to renovate the Garden in 2013 and when you think about strategic assets with locked in, growing cash flows in a low interest rate  world, 18x doesn’t seem unreasonable (similar to other very high quality real estate assets). We use such a high multiple because the barriers to entry of building competitive space are so incredibly high with the location in the middle of Manhattan (even compared to Sphere in Vegas). 

We ran the air rights at a 30% discount to a close comp from December 2018 (JPM/Grand Central).

We assume the Sphere ends up being worth 20% less than what they put into it (without accounting for cost of capital). We note that they have already spent $383mm of the cash to date. This equates to about 13x what we think it will earn. 

While we frame this NAV as end of FY 2022 (July 2022) and  the Sphere won’t be in operation yet, it will be months away and we believe the bookings will give the market insight into its earning power at this point (and the build will be derisked).

Risks:

• COVID drags on significantly longer than expected (no vaccine)

• Post-COVID consumer preferences around being crowded into large  indoor arenas change the economics

• The Sphere destroys more capital than expected

Catalyst

-Stablization of the spin-off dynamics; fund that own MSGE because they wanted to own the Knicks finish selling

-Progress/Insight into the Sphere build

-Vaccine/resumption of Live Events

- Opening of the Sphere (2023)