“The last thing we’ll be thinking about is margins ,you know if you make cars or washing machines or something like that, I guess you have to focus on margins. That’s not the way I view the entertainment business.”

-          SFX Entertainment CEO Robert Sillerman as quoted in Forbes

Investment Thesis – SFX Entertainment common stock is a short because:

¦ The business model is broken and at best SFX will earn a small fraction of street estimates

¦ The current price is 250% what the company (over)paid to acquire their business in the past year

¦ SFX’s target market is likely a fad

Business Overview and History

In this business every once in a while you see something and your first reaction is “wait, this can’t possibly be as ridiculous as it first appears” and then you dig for a while and realize it really IS that ridiculous. Well that’s what happened when I looked at SFX Entertainment.  SFX Entertainment is a nonsensical business model that has somehow become a public company with an enterprise value of over $1.1B. You don’t need to look much further than the business description to know that SFX is a short. In the company’s own words SFX is a roll-up of “live events and entertainment content focused exclusively on the electronic music culture (EMC)”.  So basically SFX is spending a bunch of money to buy festivals and other businesses related to dance music. Industry roll-ups have proven problematic enough, the roll-up of a music genre is as foolish as it sounds.

Despite routinely grossing over $100 per person in tickets and concessions, SFX's festivals don’t really make much money. This doesn’t seem to worry SFX's executives and they provide three primary reasons to believe these festivals will soon be highly profitable: First, SFX will be able to run the festivals more efficiently then the operators they purchased from. Second, by owning a large number of festivals they will become more attractive to major advertisers than the festivals were individually. And finally, SFX will be able to monetize their digital content and on-line viewership. While this may initially sound plausible, when you actually look at the numbers and talk to people in the industry it just doesn’t add up.

SFX was founded in mid-2012 and has since acquired 8 festival operators, a night club management company, a ticketing company, an online music store and a few ancillary businesses. Pro forma for the acquisitions (though October where numbers are available) SFX had 2012 sales of about $239mm and adjusted EBITDA before acquisition costs about $21mm. Total attendance was about 2.8 million at the company’s 883 events. SFX plans to make many more similar acquisitions.

Figure 1: 2013 Major Acquisitions (through October)

SFX’s Business Model Doesn’t Work

SFX’s business model is broken for two primary reasons:

1)      Ex-advertising the festivals will never earn significant profits while advertising opportunities are not nearly enough to get to street numbers or come close to justifying the company’s enterprise value

2)      Over 85% of SFX’s business is in mature markets outside North America where there is little opportunity for profit or growth

Ex-advertising the festivals will never earn significant profits

It should not be surprising that dance music festivals don’t really make money since a festival is really nothing more than a tent, a DJ and a bar - not exactly massive barriers to entry.  In fact, live music events really never make money for the promoters. Just look at Live Nation – the concert business is about break-even and unlike SFX, LVY owns or has favorable leases on the actual venues.  Management points out that festivals are more profitable than traditional concerts, and while this may be true, the margins are still razor thin. For 2012 SFX’s festivals and events only had EBITDA of $18.5mm (total EBITDA was $21mm if you include Beatport), if you take out the advertising these guys were already doing EBITDA without advertising is about $9mm.

Management will also tell you that they can run these businesses more efficiently then the people they acquired them from, but my research suggests otherwise. According to several industry participants I spoke with the festivals SFX acquired are competitive, low-margin events that were previously run by highly involved owner-operators with years of ‘on-the-ground’ experience. These entrepreneurs needed to be extremely cost efficient to make a profit. Indeed, one contact who was previously an independent dance music festival promoter and now works in a senior role at a large company noted “Promoters who are not extremely efficient do not survive long enough to get acquired” and “now everything seems to cost two times more than when I was independent”.  As such, significant cost savings appear unlikely. 

A good analogy here is the restaurant business. Without exception, the margins of franchise restaurants are always higher than corporate units. This might be surprising since a company like McDonalds is clearly more sophisticated than a small franchisee. However, restaurants are a competitive, low-margin business and the benefits of being managed on a daily basis by the business’ owner far outweigh a lower level of business sophistication.

Advertising opportunities not that big

I recently attended IMFCON, the largest conference focused on the business of live music. I was one of the only securities analysts in attendance and was able to have candid one-on-one discussions with senior contacts at the world’s largest live music companies. According to these contacts, a well-run dance music festival in North America can expect total sponsorship of around $3.00 - $6.00/per person. As I will show, using even numbers above this range, SFX does not come close to meeting Street estimates or justifying the company’s stock price.

Furthermore, the industry contacts I spoke with did not believe there was a significant benefit to advertisers from SFXE’s scale. Management will tell you that these festivals are desirable to advertisers because they attract a sought after demographic of young people who can afford $100 concert tickets and offer the opportunity to interact with customers in a unique way via so-called experiential marketing.  However, individually these festivals have neither the scale nor marketing savvy to appeal to major advertisers. As such, SFX will buy the festivals to achieve a scale that will attract advertising dollars.

In reality, for even large advertisers, live event sponsorship decisions are mostly made on the local level. On the national level, there can be some benefits as an advertiser may decide to sponsor a multi-date tour or festival which the advertiser can then integrate with other promotions or media to create a full marketing campaign.   However, while a major touring act or traditional music festivals can play 30+ gigs during a national tour, none of SFXE’s festivals have more than a few dates per year. As such, they are not large enough to support an entire media campaign. Even if one or more of SFXE’s festivals are ultimately able to achieve this scale the expected increase in sponsorship dollars per person would only be about 10-20% - not enough to materially change the overall economics of this business.   

There is also really no possibility of significant monetization of the digital content. People are never going to pay to watch Youtube videos or concert streams.  While you can make a few dollars from advertising, it not much more than the costs to produce the content and as such its unlikely on-line video will ever be much more than a means of fan engagement and event promotion.

Most business is in mature markets with little growth

In 2012, 62% of SFX’s festival attendance was in Europe and only 13% was in North America.  In Europe, SFX’s festivals are 10-20 years old. Attendance and revenue are not growing and there is no reason to expect material growth in the future. As such, even if U.S. growth continues at its rapid pace, total growth will be much lower than people expect.  

SFX Will Not Come Close to Street Numbers

SFXE’s 2012 adjusted EBITDA was about $21mm. 2013 will likely not be much better given EBITDA through the first 3 quarters was only $7.6mm. However, Street estimates call for EBITDA of ≈$75mm and $135mm for 2014 and 2015, respectively.  To get there, in 2014 the underwrites assume 40% festival attendance growth over 2012 and sponsorship revenue growing to approx. $75mm.

These estimates are not realistic. For one, given SFXE’s geographic mix, in order for attendance to grow by this amount, SFX would need to see very significant growth outside North America, which as stated earlier is not likely. Furthermore, even if SFX did achieve this attendance figure, to get to $75mm in sponsorship SFX would need to get >$20/per person in sponsorship which is multiples of what even the absolute best festivals (such as Coachella) do (by comparison Live Nation does <$4/per person).

Even if we generously assume SFX can grow historical EBITDA by 25% through operating efficiencies and synergies (as discussed earlier, there’s no reason to think this is likely) and can triple US festival attendance while commanding sponsorship above the current market, total EBITDA is still less than half of 2014 estimates.

Figure 2: 2014E EBITDA Estimate

What does this mean for valuation?

Using the above assumptions, even if you generously assume that beyond 2014 SFXE’s North American festival attendance grows 20% annual for 10 years, tax this at 35% and discount it at 7%, I get a fair value of $3.50/share or 70% below the current price.

SFX Paid $435mm for Acquisitions vs. Enterprise Value of > $1.1B 

Through the IPO in October, SFX made 9 acquisitions. Excluding contingent consideration, SFX paid cash and notes of about $265mm and 14.4mm shares with a value of $169mm at today’s stock price.  As such, despite the high multiples SFX paid for their acquisitions, public stockholders are paying over 250% of SFX’s cost. 

Figure 3: SFX Enterprise Value vs. Acquisition Cost

The US Dance Music Craze May Not be a Fad, But it Sure Looks Like One

The type music of SFX’s events feature can trace its roots back to disco music in the 1970’s and has been around in its current form since at least the mid-1980’s.  Until recently electronic dance music was a rather niche music genre in the US, but had a much larger following in western Europe (particularly the UK and Germany) where top DJ’s are major celebrities and dance music is featured prominently on mainstream radio. In the last several years, dance music has rapidly gained popularity in the US. As evidence of this SFX cites a 41% annual attendance growth for the top 5 US dance festivals from 2007-2012, but this trend can also be seen in music sales, the popularity of mega clubs in Las Vegas  and the amounts paid to top DJ’s.

Few cultural elements are as fickle as young people’s taste in music. In the last 15 years once-popular genres such as grunge, alternative metal, teen pop and emo enjoyed souring popularity (and ticket sales) among SFX’s target demographic only to quickly fade away. While this does not necessarily mean that dance music is a fad, it sure looks like one. More importantly however, I think we can be reasonably certain that the explosive growth has past and at best future growth will be slower.

Acquisitions Becoming More Competitive

SFX is no longer the only major party looking for acquisitions in this space. Live Nation has already acquired two major electronic music festivals and formed a partnership with a third.  It was widely reported in the press that Live Nation’s recent acquisition of the long-running Creamfields festival was a competitive process which SFX lost. This dynamic will force SFX to pay higher acquisition prices if they want to execute on their roll-up strategy.

But Isn’t Sillerman a Genius?

"Sillerman is a lousy operator and not a very good buyer, but he knows when to sell, and he's the best stand-up salesman I've ever seen," said William Steding, a former radio broker and managing partner of Dallas-based Darwin Group, a private investment firm”

-          Los Angeles Times, March 2000

"Says former Bill Graham Presents CEO Greg Perloff: ‘They (the original SFX Entertainment) overpaid for us and they overpaid for everybody”

-          Ticket Masters, p. 169

Probably the most common pushback I’ve received on this idea is that people don’t want to bet against SFX’s founder & CEO Robert F.X. Sillerman. Indeed, Sillerman did very well for investors in his previous entertainment-focused roll-ups;  the original SFX Entertainment and its predecessor, SFX Broadcasting. In the late 1990’s SFX Entertainment spent about $1.9B to acquire concert promoters and venues. At the height of the tech boom in February 2000 Sillerman sold SFX Entertainment to Clear Channel for $4.5B.  While this was clearly a good deal for SFX, Clear Channel shareholders were less fortunate. Clear Channel divested these assets only a few years later into what is now Live Nation and 13 years later Live Nation’s enterprise value is still below $4B. Sillerman’s subsequent ventures have had mixed results. As such, I’d caution against viewing a couple good deals in what in hindsight was a ridiculous market bubble as evidence of ability to create value.

Figure 4: Gems From SFXE IPO Roadshow (I know this is a bit of a cheap shot, but I couldn’t help myself)

“Electronic music for the millennials is to entertainment as texting is to communication”

“Why festivals? Because there are huge barriers to entry” (you think carrying that sound equipment is easy?)

”those people that are actually spending 150 million minutes every single month, every month… Those people are the tastemakers. They are the influencer group, the alpha influencer group” (I guess everyone wants to be like the kids who spend their time watching Youtube –  I feel old)