I believe the risk reward heavily favors being long MSGE where there appears to be an upside opportunity of at least 100%. The stock dove 30% post the rumor & announcement of the MSGN merger which was universally panned by the investor community (as an example: https://youtu.be/nYCFvnZQVgA). However, after further review, the market has over-reacted and provided an appealing entry point for longer term investors.  I will try to simplify an extremely complicated business and base all my assumptions on FY24 (begins July 1, 2023) as that is my assumed first full year of Sphere operating performance. MSGE has been written up previously on VIC, so I will focus my write-up on the high level opportunities and will attempt to quantify the upside vs downside.

High Level Points:

 1)      The Sphere opportunity is massive as both a high value operating asset and franchise business

 2)      MSGE/MSGN merger will allow for a very unique omnichannel marketing opportunity through the licensing of naming rights

 3)      Additional non-quantifiable opportunities from the merger

 4)      Quantifiable benefits to the merger (NOLs, debt refinancing, synergies)

 5)      MSGE is still a substantial reopening beneficiary

 6)      Valuation upside vs downside – over 100% upside while downside is basically at the current stock price

Detailed Thesis

1)      The Sphere opportunity is massive as both a high value operating asset and franchise business.

The Sphere project in Las Vegas is by far the most controversial aspect of this thesis. There are investors on both sides of the fence here and understandably so; MSGE is spending $1.83 billion on a giant spherical entertainment hall in the back of the Venetian off the Las Vegas Strip (more info: https://www.msgsphere.com/). Not only is this an extremely expensive bet but MSG has been plagued with cost overruns and project delays. It is the single biggest growth driver and can completely change the way investors view this type of business.

MSG has had success transforming the Garden to what it is today as well as doing the same for the Forum in LA which sold for a handsome profit. So the company has demonstrated success with large scale projects previously, but none of them were greenfield/new concept offerings.  Clearly I am in the bullish camp here because I see the vision and feel it will be a unique offering that will become the #1 tourist attraction in Las Vegas. It will truly be a visual and immersive experience like no other and the content, branding, IP will be owned by MSGE which will allow for a future high margin recurring franchise model.  

To better understand the opportunity, I created a high-level back of the envelope model to demonstrate the potential profitability of the Las Vegas Sphere. I assume a full run-rate year for operating performance:

 

As you can see I expect the business to do close to $200 million of AOCF which would be a home run if they can execute at that level. This analysis is really illustrative and you can change my assumptions around as a lot of this is subjective today. If they are able to demonstrate that level of profitability out of the gate, there would be an extreme amount of interest in developing spheres in other locations – London/Macau/Sydney/Tokyo/Dubai – list goes on for major metropolitan areas where this offering could see the same level of success. If you assume a take rate of 5% of revenue @ 90% AOCF margins, each sphere franchise could generate ~$50 million of recurring profitability. FY30 franchise waterfall below:

Here is what the valuation for the Sphere business could look like:

2)      MSGE/MSGN merger will allow for a very unique omnichannel marketing opportunity through the licensing of naming rights

There is a large set of data points for naming rights to stadium assets. No stadium is as iconic as the Madison Square Garden which has not gone down this path. With MSGN’s assets, the company will have the ability to package naming rights to a real life in person asset being the Garden and virtual/digital world being the networks. This brings a very unique promotion opportunity for the NY area which isn’t available anywhere else. With the proliferation of online sports betting, and the likely legalization in NY, I would expect these naming rights to be highly coveted for online players seeking to get a first mover advantage in the market.

Below is a few naming rights deals that I aggregated together. The average deal is about $15 million/year, but heavily dependent on the size of the market: 

In terms of precedent deals for naming rights to a network, the only real comparable is the recent Ballys/Sinclair deal which was priced at $8.5 million/year for 10 years and included 5 million shares of warrants and a laundry list of performance based incentives which included more share warrants and options. Sinclair has a much larger network than MSGN, likely 10x the viewership as it is an aggregation of multiple RSNs across many geographies.

So in a scenario where MSG licenses the arena name and network, I believe $35 million/year is very feasible. Consider the average annual naming rights over the last 10 years (not an all encompassing list too) of $15 million + $8.5 million for the Sinclair deal ex the warrants = $23.5 million. Scotiabank Arena was the biggest naming deal ever @ $33 million/year and that was for the Toronto area arena only (3 million people vs NYC @ 8.5 million). In the context of those two numbers, $35 million/year is very reasonable and that would be completely incremental to profitability. 

3)      Non-quantifiable opportunities from the merger

A)  New network focusing on non-sports side of MSG, Sphere and other venues

     The existing MSG Networks is focused on the sports side of the house. MSGE has iconic  entertainment assets: concerts at the Garden, the Hulu Theater, Chicago Theater, Radio City music hall, Beacon Theater, Las Vegas Sphere, Boston Calling, Tao/Hakkasan and the Christmas Spectacular. There could be a huge direct to consumer opportunity to digitize a lot of this content into a new type of nightlife/entertainment network. There are countless artists and entertainment touchpoints coming through these venues. Licensing digital rights from content produced in these venues could both increase the bottom line for artists as well as promote a new type of offering that doesn’t exist today. This offering could open up all these iconic assets to others across the world – a much larger opportunity and would also serve to promote the assets themselves.

B)      More efficiencies for ad sales & better data targeting

     There is likely an opportunity to squeeze more efficiency out of the advertising sales teams and sell more to the same customers. Potential bundled offerings to target within the 4 walls of the entertainment venues as well as on TV & Digital. Increased tracking of customers who visit the venues, engage with the network, or engage w/MSG’s digital sites. Opportunities to promote special offerings to the customers through better targeting will lead to more effective ad sales. 

C)      MSGN can provide MSGE an ability to further monetize their offerings inside and outside of the venues

     I mentioned a potential new network at MSGN, but it doesn’t stop at that offering alone. MSGN has a history of developing apps to better engage consumers with the networks. There can be more development of in stadium mobile food ordering, offering rewards for recurring visitation, or offering gamified content to keep the customer engaged with MSGE assets. This will also lead to further ad/promotion opportunities as the company increases touchpoints with the consumer. In addition, MSG can gain further insights into consumer behavior and recommend upcoming live events. 

 D)      Sports betting

Further partnership opportunities and better monetization of the 6 million households reached at MSGN and the 10 million guests between the garden and nightlife assets. MSGE can create branded nightlife sportsbook offerings (Ie: Tao presents Draft Kings Sports book) and promote it on the network. MSGN can create new types of programming highlighting gaming content partners or new signage opportunities around Penn Station. There may even be new performance based revenue opportunities to promote gaming app sign ups. 

4)      Quantifiable opportunities from the merger

 A)      Accelerated usage of net operating losses (NOLs)

As of 3/31/21 MSGE had $350 million of NOLs. I would expect the business to likely add another $100 million of NOLs before the business fully reopens. The sphere will also see accelerated depreciation in the first full year of operation of at least $600 million. Combined that is over $1 billion of tax benefit that can be used to offset MSGN income as it is a full federal tax payer. The company has disclosed that the present value of these NOLs is ~ $200 million (however this is net of interest savings on debt refi, so would value the NOLs closer to $190 million).

B)      Debt refinancing

MSGE issued high cost debt of $650 million @ 7%. Even though MSGE has a high cash balance, COVID and the increasing cost of the sphere project forced management to take out money in an abundance of caution. This debt is secured against the Christmas spectacular and other MSG assets but not the garden which is why the interest rate was so high. This also helps frame what the debtholders felt the non-arena assets could be worth especially since the timing of the raise was during the heart of COVID.  This debt can be called in May 2022 and would likely be refinanced at a much lower rate. I use a 4.25% refi rate which would lower interest expense by $10 million/year assuming no debt pay down. 

C)      Cost Synergies

The company has disclosed $10 million of synergies which look to be low as I am sure they can cut more overhead. Synergies come from de-duplication of public company costs as well as consolidation of the employee base.

5)      MSGE is still a substantial reopening beneficiary

The stock has essentially been flat since the spin owning largely to the announcement of MSGN which wiped out a significant gain as this was a pureplay reopening story. Given NYC reopening fully in September with Broadway being allowed to operate at 100%, I would think the 2H of FY22 (ends June 2022) would resemble more normalcy. I would expect MSGE will move forward with a Christmas Spectacular this year which is very profitable (in a typical year: 200 shows annually w/1 million attendees).  Of note is the recent 10Q which disclosed that the Christmas Spectacular did $128.5 million in rev vs $50.5 million in direct costs = 60% gross profit margin – ex allocated corporate costs and other marketing costs its not crazy that this is a 35% AOCF+ business. That would be $45 million+ of incremental AOCF when that returns.

The Knicks/Rangers next season will also likely pay the full $40 million fee for renting the facility during game days which should also carry with it sponsorship/F&B/licensing opportunities for MSGE. 

6)      Valuation Upside vs Downside Case 

Upside Scenario

Putting it all together I come up w/a SOP framework for FY24 (first full year of Sphere):

Downside Scenario

In a downside scenario I assume sphere is a complete failure and MSGN continues to be a melting ice cube. I then defer to asset valuation for all of MSGE’s assets:

Concluding Thoughts:

I think the risk reward is compelling because at the current stock price the market is not only assuming MSGN continues its secular decline but also the sphere won’t amount to much. There is a ton of upside if MSGN stems its decline – if so MSGE stole MSGN paying $1.9 billion EV (pre-rumor) for a $200 million/year FCF annuity. There is upside to my assumptions if this were to be the case, which could add another $25+ to my upside scenario SOP. In general I designed this write-up to really leave a lot of topics open for discussion and to lay out the bull case for the sphere which I haven’t seen represented properly. The Dolan family has created shareholder value in the past with multiple spins out of CVC and ultimate sale of that asset. Time will clearly tell if the merger was the right path to take, but I laid out some reasons why this could be much more than just financial gimmickry.

Risks:

1)      Sphere cost continue to go up – execution risk

2)      Valuation relies on Sphere success

3)      Clearly self-dealing involved w/MSGN transaction

4)      MSGN operating performance worsens relative to my expectations