Description

Stock Price: $24.5/share

Market Cap: $1.85 b

Avg Value Traded: $7 mm / day

Note: see the prior 2 VIC writeups for additional color, however our framework is different.

Thesis

MSG is a long because it trades at < 10x FCF pro-forma for the Garden renovation project. MSG is a collection of trophy assets and while a sum of the parts valuation would suggest $50+/share, we use 15x FCF to justify a $37 price target by EOY 2012 which is a 50% total return in 24 months or a 23% IRR.

Business Description

MSG owns the Knicks and Rangers sports teams, The Garden arena, the MSG regional sports network (cable channel), and has a smaller entertainment business whose biggest component is putting on the Christmas Spectacular each year at Radio City Music Hall.

The RSN, in conjunction with the sports segment content, produces all the profits in the business today. RSN's are incredible businesses because they are "must-have" channels for cable/satellite providers which afford MSG the ability to extract high pricing (~$3.50 sub fees) with ~5% escalators built into their contracts.

The entertainment segment has historically been profitable but recently has bled significant EBITDA because of an ill-timed expansion of the Rockettes to a national tour during the financial crisis. Management continues to believe the Rockettes have significant potential and has not reigned in spending in this segment thus we are currently assuming continued EBITDA losses of $30 mm per year.

Bear Case

• Sum of the parts analysis is meaningless because the Jim Dolan will never sell these assets to realize value.
• A "Dolan Discount" is necessary given voting control and past actions that were shareholder unfriendly (Newsday). There is the potential that all the cash flow is spent in an uneconomic manner and the market trades MSG like toxic waste for the foreseeable future.
• The renovation will run dramatically over budget and produce little incremental profits. Some investors simply assume the $850 mm of cash disappears.
• Entertainment is bleeding cash and management doesn't seem concerned about it.
• A potential NBA lockout could significantly impair value.

Variant View

• Valuation framework - we agree that you shouldn't use a SOP analysis and have chosen to look at consolidated free cash flow. The only time the SOP will matter is if Jim Dolan decides to offer to take MSG private; at that point minority shareholders will lobby to see an offer that reflects the potential value that these trophy assets represent. On FCF, we believe MSG is trading at less than 10x FCF PF for the Garden renovation, and that it should trade at more like 15x FCF given the quality of the assets.
• Corporate governance - While there is a discount required, the Dolans own $400 mm of stock and are trying to make money for themselves at the end of the day. Most of their strategic decisions have been good enough. More importantly, in the past 18 months we've seen an inflection point in the Dolan's behavior as it relates to shareholder value. First we saw the spin of MSG, then a dividend and share repurchase at CVC, and recently CVC announced that they are spinning off Rainbow. The "Dolan Discount" will amortize away over time if we continue to see shareholder friendly decisions like these.
• Renovation Project - the renovation budget has already been increased once to ~$850 mm. The project is incredibly complicated and could very well run over this adjusted budget but to put this in context, every $100 mm is 75 cents/share of lost value after-tax. Thus the risk of significant value impairment is unlikely. More importantly, people are too skeptical on the ROI of this project. We have put together a detailed view (see below) of what the incremental benefit will be from the investment and conclude that there is ~$100 mm of incremental EBITDA the first full year that the project completed and that it is only slightly NPV negative at a 12% discount rate. The key drivers are increased ticket prices, suite sales, and sponsorship. Material progress has already been made on the suite sales as the entire lower-level suites have been sold in multi-year deals. MSG also recently signed up JP Morgan as the key sponsor for the new MSG in a deal worth $300 mm over 10 years which is huge relative to the cost of the entire project and what they were getting before in sponsorship support.

• Entertainment segment - we assume continued losses in the segment and incorporate a $30 mm headwind to consolidated EBITDA which is how we value the stock. In all likelihood we are being conservative on our assumptions and there is 10% upside to our estimates if they simply get Entertainment breakeven.
• NBA lockout - the bark is bigger than the bite. We've gone through each line item for MSG that would be affected by a full season lockout and conclude the loss would be $60 mm after-tax or 80 cents/share. A lockout might very well be NPV positive if it gets the % economic split with the players re-cut lower.

Catalysts

• Milestones on the renovation project and ultimately the transparency that the ROI on the project actually isn't that bad.
• The Knicks win a few games. This is actually more important than you might think because there is a lot of upside to ticket prices (haven't been raised for 8 years and demand > supply) but the team has been reluctant to raise them given the lack of a play-off berth. Ratings and therefore advertising spend would also go up on the MSG channel.

Risks

• We're wrong on the corporate governance and Jim Dolan blows our cash.
• The Garden renovation is an utter disaster.

Catalyst

Milestones on the renovation project and ultimately the transparency that the ROI on the project actually isn't that bad.

The Knicks win a few games. This is actually more important than you might think because there is a lot of upside to ticket prices (haven't been raised for 8 years and demand > supply) but the team has been reluctant to raise them given the lack of a play-off berth. Ratings and therefore advertising spend would also go up on the MSG channel.