Description

Overview:

In their ongoing quest to unlock shareholder value and eliminate the so-called “Dolan Discount”, The Dolans recently separated their Sphere initiative (and regional sports networks) from their traditional live entertainment businesses. The separation occurred in April with parent MSGE Entertainment (Old MSGE, which is now known as Sphere Entertainment) spinning off the Company’s traditional live entertainment assets as MSG Entertainment (New MSGE) on a 1 for 1 basis. The New MSGE entity boasts iconic assets including the Garden, which is the number one grossing venue of its size globally while its other venues (Theater at MSG, Radio City Music Hall, Beacon Theater and Chicago Theatre) are consistently ranked among the top grossing venues of their size in the world. These businesses are expected to be the beneficiary of continued pent up demand for experiences and long term touring trends within the music industry. In addition to its venues, the Company’s proprietary production of the Christmas Spectacular, starring the Rockettes has been a holiday tradition for 89 years running. Sphere Entertainment retained a 33% interest in New MSGE, giving it financial flexibility to fund the Completion of the first MSG Sphere (a next generation entertainment venue set to open up later this year) in Las Vegas and future contemplated spheres. For those interested in Sphere Entertainment, there was a recent and excellent VIC writeup on Old MSGE authored by MarketEuphoria in April of this year that focuses on that business. We believe New MSGE represents a compelling investment opportunity thanks to its large base of recurring/repeatable revenues which will enable the Company to reduce leverage while simultaneously positioning it to return a significant amount of value to shareholders via repurchases and/or dividends/special dividends. 

 ****Note: I have submitted the idea on New MSGE with the ticker MSGE* because MSGE was submitted in April, but that Company is now known as Sphere Entertainment with New MSGE being the spun off entity.****

Why Does this Opportunity Exist: 

Share Overhang: Sphere Entertainment has retained an ~33% stake in MSGE however the Company expects to dispose of its stake within a year according to New MSGE’s information statement. In June, Sphere filed to sell about a quarter (~5.25 million shares of its ~17 million shares) of its stake in MSGE via a secondary offering. The share sale was priced at $31 a share or 23% below where shares were trading before news of the offering. As part of the offering, MSGE expects to purchase  $25 million of MSGE shares (pursuant to a $250 million buyback announced just prior to its separation form Sphere Entertainment) at a price of $29.76 representing an ~4% discount from the secondary offering price and ~26% below where shares were trading before the secondary was announced. In addition, Thomas Dolan (brother of MSGE Chairman/CEO James Dolan) expects to purchase ~$10 million worth of MSGE shares offered by Sphere Entertainment at the public offering price of $31 a share. Although MSGE’s share price has been under pressure, we view both purchases as a strong vote of confidence in MSGE’s future prospects. Upcoming/future share offerings may continue to weigh on the MSGE’s shares in the near term, however we believe the improved liquidity bodes well from a longer term perspective and should ultimately help MSGE garner a wider investor base and, in turn, a higher multiple.  

Dolan Discount: New MSGE’s association with the Dolan’s Sphere endeavor prior to being separated has likely pressured its valuation due to the project's uncertainty and cost overruns (the projected cost to build the first sphere has increased by over $1 billion since 2019 and currently stands at ~$2.3 billion). Shares of Old MSGE were a strong performer in the months leading up the spinoff, increasing by 50% from their December 2022 lows (vs. an increase of just 3% for the S&P 500). Although the pre-spinoff performance was strong, Old MSG was still trading down about 50% from their all-time high reached in 2021 of nearly $120 a share at the time of the spin off.

In addition to the frustration over the Sphere’s capital allocation, Old MSGE chairman/CEO James Dolan have been featured in the press recently surrounding MSGE’s use of its controversial facial recognition policy to bar from its venues holders of tickets (even season tickets) who are associated with firms that have represented certain ticket resellers in lawsuits against MSGE. The use of the technology to flag individuals prompted the New York State Liquor Authority to consider taking away the Company’s liquor license. Although the resellers’ suit was recently thrown out, the controversy around the Dolans/MSGE’s measures and related retaliatory actions has given James Dolan another black eye, handing his critics further ammunition.

Underlying Profitability Masked by Sphere Investment: The profitability of the traditional live entertainment business has been masked by the spending on the Sphere initiative. However, the true level of MSGE’s profitability and free cash flow generation is starting to become apparent. Maintenance capex is minimal and expected to remain that way for the foreseeable future (the Garden was renovated in 2015 and other venues have recently received facelifts) while the Company is not expected to become a material cash tax payer until FY 2026. 

Leverage Concerns: MSGE was spun off with leverage (net debt/EBITDA) at approximately 4.0-4.5x  and we believe the outsized leverage coupled with macro economic uncertainty could also be weighing on its shares. However, we believe that these fears are overblown for a number of reasons including the Company’s large base of recurring revenues (discussed in greater detail later) which provide meaningful revenue and cash flow visibility and the fact that consumers continue to prioritize spending on experiences over durable goods in the wake of the pandemic. According to global payments firm Fiserv, spending on experiences was up 25% in 1Q 2023. Management also expects MSGE to delever “rapidly” which should help ease concerns over the Company’s current financial position.

Pent Up Demand For Live Entertainment:

MSGE has benefited from the pent up demand for live entertainment on the part of artists and consumers and these trends show no signs of abating. Artists generate a significant amount of their income from touring (currently about 80-90%) as other revenue streams have declined (physical music sales etc.). Meanwhile, consumers have shown a strong preference for experiences vs. durables in the wake of the pandemic. 

Non-Income Producing Hidden Assets:

MSGE holds valuable development rights over The Garden in NYC, which sits above Penn Station and is the nation’s busiest transportation hub. Redevelopment discussions about the area around Penn Station are ongoing and New York's current governor is a big proponent of revitalizing the neighborhood, which would be a boon for MSGE and its air rights. In addition to its air rights, there have been recent press reports that MSGE could be looking to sell the Theater at MSG to help facilitate additional Penn Station improvements. The rumored sale price of the asset is $1 billion (which represents nearly 45% of MSGE current enterprise value), which would go a long way toward unlocking shareholder value. 

Strong Base of Recurring Revenues:

During FY 2023, MSGE is expected to generate $850 million in revenue from four key sources including its bookings business (42%), sponsorship, signage, & suites (28%), the Christmas Spectacular (15%) and its MSG Sports Agreements (15%). Although the Company’s sports agreements account for only ~15% of MSGE’s revenues (primarily rent collected from the Knicks’ and Rangers’ use of The Garden), they represent a very high-margin source that is expected to increase over the deal’s 35-year term at 3% annually. The agreement began in FY 2021, but revenue was adversely impacted by COVID-19. During FY 2023, the Company is expected to generate $42 million in annual revenue pursuant to its arena license agreements, with this figure increasing to $107 million at the end of the deal’s 35-year term.

The largest source of MSGE’s revenues is its bookings business (which hosts concerts or licenses its venues for a fee to outside promoters who put on events/concerts at The Garden), which is expected to generate ~42% of the Company’s revenues in FY 2023. Although the bookings business does not generate revenues pursuant to multiyear agreements, much of its business tends to recur at increasing annual amounts. Sponsorship, signage & suites accounts for 28% of revenues and this is primarily generated via multi-year agreements with annual escalators. Meanwhile, MSGE’s Christmas Spectacular, which has been a fixture at Radio City Music Hall for the past 89 years, has seen attendance remain steady at ~1 million visitors annually over the past decade (except during the COVID-19-impacted FY 2021 and FY 2022), a trend that has helped the event increase revenue from $84 million in FY 2010 to $132 million in FY 2023.

Industry Tailwinds:

MSGE stands to be a long term beneficiary of the concert touring, which is responsible for a significant amount (80%-90%) of an artists’ income as other revenue streams have dried up giving them added incentive to tour. Other industry tailwinds include the globalization of the industry, aided by streaming and social media (makes it easier for stars to be discovered) and consumer trends that have resulted in increased spending on experiences relative to physical goods. 

Growth Opportunities:

Increased Venue Utilization: MSGE has a long term track record of increasing the number of events hosted at it venues. Since the Garden was renovated in FY 2015, the Company has experienced a mid single digit growth rate in the number of concerts held at the Garden and its other revenues. Management believes that there is a “significant” opportunity to increase venue utilization by hosting more multi-night residencies, hosting more events per day in its venues and opening its arenas to new content types (shows, expos, theatrical opportunities, etc.).

Improved Team Performance: Since MSGE shares in certain revenue streams of the Knicks and Rangers, the improved team performance during the 2022/202i3 bodes well for the prospect of this revenue stream. During the most recently completed seasons the Knicks and Ranger both made the playoffs, with the Knicks advancing to the second round of the NBA playoffs for the first time in 10 years.  

Outdoor Advertising: MSGE offers its corporate advertisers expanded reach through outdoor signage around the Madison Square Garden Complex and Pennsylvania Station. MSGE is currently pursuing additional opportunities for external signage that could increase its existing sponsorship packages and attract new sponsors. 

Sponsorship and Premium Hospitality: During MSGE’s 3Q FY 2023 earnings call (May 2023) management noted that revenues from sponsorship and premium hospitality are both on pace to exceed pre-pandemic levels in FY 2023 benefiting from its hosting of a full year of events, the first since the onset of the pandemic. The Company’s sponsorship revenues are secured primarily via multi-year agreements while the Company’s corporate suite business also generates revenues most of its revenues pursuant to multi-year contracts with both revenue sources also containing annual escalators in their agreements. MSGE’s premium hospitality business benefits from The Company’s substantial presence in NYC, which is home to the greatest number of Fortune 500 companies. 

Valuation:

MSGE’s depreciation and amortization exceeds its annual capital expenditure requirements by a wide margin. In FY 2022 D&A was $69.5 million compared with $15.8 million in capex. With the Company’s flagship arena being renovated within the last 10 years and its other venues having undergone fairly recent facelifts, we don’t believe there will be any material increase in capital expenditure for the foreseeable future. Due in part to its low capital requirements, its strong growth prospects and the fact that MSGE is not expected to be a material cash tax payer until FY 2026, we believe that MSGE’s FCF annual could exceed $100 million in the next couple years. Applying a 20.0x multiple to this free cash flow amount and factoring in our projection for the Company’s various non-income producing assets including its air rights (at $700 million) and the Theater at MSG ($500), we estimate a value of $54 a share or 66% upside from current levels. It should be noted that we have not ascribed any value to the Garden itself ($1 billion was spent on its recent renovation), which could provide additional upside. 

Catalyst

• Continued consumer preference for experiences over durable goods

• Improved team performance of Knicks and Rangers should bolster profitability

• Potential sale of the Theater at MSG

• Strong free cash flow generation becomes apparent post spin off

• Increased share liquidity as Sphere Entertainment sells down its stake in MSGE

• Continued share buybacks pursuant to $250 million authorization

• Continued growth in events at its venues