Connor Haley's  Instablog

June 22nd, 2010

In this write-up, I will first give all the reasons why I like MSG and think that it is conservatively worth $32/share with upside over $50. Then, I will thoroughly address the variant view.  

There are many reasons to like MSG:

Reasons to like MSG

• Recently spun-off of Cablevision (spinoffs tend to beat the market)
• Every recent U.S. publicly traded sports team has been bought out at a substantial premium (Boston Celtics, Cleveland Indians, and Florida Panthers).
• MSG has a collection of irreplaceable trophy assets (The Garden, Knicks, Rangers) that are trading at a serious discount to private market value
• The NBA summer free agency period is a near-term potential catalyst

Thesis

Shares of Madison Square Garden (MSG), which were recently spun off of Cablevision, offer investors the opportunity to buy a collection assets (Knicks, Rangers, the Garden, MSG/MSG+) at a serious discount to their private market value.

My sum of the parts analysis suggests that at the current price, there is little downside, but significant upside. Specifically, I believe that MSG’s assets are worth at least $32 with upside over $50. Below is a brief description of each of the segments followed by my conservative sum of the parts valuation. Even using the most conservative estimates, I reach a value of $32 a share.

Media

MSG owns and operates three cable networks, MSG, MSG+, and the Fuse network.  These networks generate revenue through subscriber fees from pay-tv operators (approx. 80% of segment revenue) as well as through advertising (approx. 20% of segment revenue). 

MSG/MSG+: The most valuable of the Company’s networks, MSG and MSG+ are regional sports networks that broadcast the New York Knicks, New York Rangers, New York Liberty, New York Islanders, New Jersey Devils, Buffalo Sabres and New York Red Bulls games.  Additionally, they carry several other sports programming, including major college basketball and football games. The first major non-Knicks/Rangers contract, with the Buffalo Sabres, ends in 2017. Each network has over 8 million subscribers, primarily in the NY, NJ, and CT areas.

FUSE:  Fuse focuses on music related programming including coverage of premier artists, events and festivals, original content and high profile concerts and has over 50mm subs.

*The media segment is the easiest to predict as much of it is based on contracts with the cable operators that are somewhat predictable. I expect 2010 EBITDA of $153-159 million. I take the midpoint of that range for my valuation.

Sports 

MSG owns and operates the:

• New York Knicks (NBA)
• New York Rangers (NHL)
• New York Liberty (WNBA)
• Hartford Wolf Pack (AHL)

• Sources of Revenue: tickets, concessions, television (both national TV contracts and local cable rights), sponsorship, and merchandise.
  • Both major teams, the Knicks and the Rangers, have been pretty terrible lately, which has led to poor economic performance.

*The sports segment assumes the teams perform slightly better and the Knicks pay lower luxury tax, but still produces negative EBITDA. It should be noted that the Knicks paid out $24.9 million in 2008 and $23.5 million for the nine months ended September 30, 2009 for costs associated with transactions relating to players on our sports teams for season-ending and career-ending injuries, but mainly for waivers and terminations of players and other team personnel, including team executives. However, these costs should come down as the team basically has a clean slate heading into this summer’s free agent frenzy. It should be noted that under my conservative assumptions, I am not valuing any sort of catalyst for the Knicks/ media segment that one or two big-time free agents could provide. I take the midpoint of my 2010 Consolidated Sports EBITDA estimated range to get to a small loss (approx. 10 million) for my valuation.

Entertainment

MSG creates, produces, and presents a variety of live productions. It earns revenue based on ticket sales on shows that it promotes, as well as license fees on non-promoted shows. 

The Company has 100% ownership of Madison Square Garden Arena, the Theater at Madison Square Garden, and the Chicago Theater (purchased in 2008 for $16 million). It also owns 50% of the 4.5 million square feet of air rights above MSG. It has long term leases on the Radio City Music Hall and Beacon Theater, and a long-term booking agreement with the Wang Theater. In total, the Company’s venues host over 800 events per year.

*The entertainment segment is the most economically sensitive, and therefore the most difficult to predict, but these assumptions are fairly conservative with 2010 expectations still far below 2007 profitability. I have decided to assign ZERO value for this segment in my sum of the parts valuation. The reason for this is that it is difficult to predict, and I feel that assigning it zero value is an extremely conservative assumption that potentially provides my valuation considerable upside with an improving economy. This makes me feel more comfortable with the valuation since I am not really betting on an economic recovery (although that would also obviously provide considerable upside). 

Valuation:

One of the primary reasons investors are dismissing MSG is that the approximately $800 million of cap ex remaining related to a major renovation at Madison Square Garden will not be a good investment for shareholders. I generally agree with that statement because it is difficult to know exactly how the capex will be spent, although there are several ways it could increase sales and attract more marquee events. Regardless, I have treated this expense in my conservative valuation as if the company just burns all $800 million in cash and receives zero economic benefit.

2009 Forbes Values:

Knicks (2^nd most valuable NBA franchise): $586 million http://www.forbes.com/lists/2009/32/basketball-values-09_New-York-Knicks_328815.html

New York Rangers: $416 million: http://www.forbes.com/lists/2009/31/hockey-values-09_New-York-Rangers_315381.html

*The Sports Forbes values only account for The New York Knicks and New York Rangers. Therefore, my valuations disregard any value from the New Yor,k Liberty or Hartford Wolf Pack

Why My Assumptions Are Conservative

All recent sports transactions have been at significant premiums to the Forbes Values and none of them have had the allure of

MSG and MSG+ are largely “Tivo-proof” since most viewers prefer to watch sports live, and operate under long-term contracts. Because of this, they command premium pricing and deserve a higher multiple. Several research reports agree with this thinking and point to a variety of recent transactions as evidence.

For example, in November of 2009, Liberty Media merged its stake in DirecTV along with its RSNs, and as part of a fairness opinion associated with the transaction, the middle end of the valuation for the RSNs valued them at approximately 11x EBITDA (the multiple I used for 2010E). There is no reason why MSG and MSG+ aren’t worth similar multiples. “RSN’s” typically traded around 15-20 EBTIDA multiples before the financial crisis, and recent transactions have been in the 10-15 multiple range. Because of this, I feel like the 11 EBITDA multiple is very reasonable for such a high end RSN that consistently produces over 100M in EBITDA and could potentially benefit from this summer’s big NBA free agency splash.           

The entertainment business is perhaps the trickiest to value because it has been pretty volatile, and is more sensitive to the health of the economy. In 2006 and 2007, this segment produced over $40 million of EBITDA and EBITDA margins of 16.6% and 14.9%, respectively. In 2008, MSG expanded at the worst possible time, and the other businesses in this segment also came under pressure. As a result, EBITDA declined to marginally positive levels, but MSG has made significant adjustments across this segment after the financial crisis. Despite the potential value here, I have decided to assign zero value to this segment since it is very sensitive to the economy and basically broke even last year. I feel that this is yet another VERY conservative assumption.

The sale and recent valuation of Maple Leaf Sports & Entertainment, the Company which owns the Air Canada Centre, the Raptors (NBA), Maple Leafs (NHL), and the regional sports networks which broadcast the team’s games is a good comp because it included an arena, an NBA team, an NHL team, and the regional sports networks, but this still represented a minority interest in far less valuable assets near the height of the economic crisis, all of which point to significantly more value for MSG’s similar assets, with potential additional value from MSG’s entertainment assets, Fuse network, MSG air rights, etc. In December of 2008, a 7.5% minority interest was sold in Maple Leaf Sports for $90 million, valuing the whole Company at $1.2 billion. This suggests much greater value for MSG’s assets. Remember that MSG’s market cap is currently only 1.6B.

The Variant View:

1)   Questionable Management

• Although an insider control discount of is appropriate, I do not see why there should be any further cut. There has been plenty of speculation that this spin off was part of their estate planning, and that in the end, James Dolan would like to take MSG private.

• In terms of their sports management decisions, they really can’t do any worse, but I think we could really be buying at a low. They recently signed Amare, and have a chance for Carmelo next year 

2)   MSG is spending too much (approx. 800 million) to renovate The Garden, which is unlikely to be a good investment for shareholders

• I think it is too early to make such a conclusion, but I have decided to treat this cash as if they immediately burned it (even though it will be over three years)… and provided zero economic benefit. I still reach an attractive valuation with several other conservative estimates. In addition, renovations could potentially lead to more marquee events for their entertainment segment, as well as additional revenue streams for their sports teams (new premium seating).

3)   Potential NBA lockout (this actually applies to the NHL as well)

• I believe an NHL work stoppage is very unlikely since the players have a powerful recent memory of the lost 2003-2004 season, and both the players and owners realize the league can’t survive another hit like in 2003-2004.
• The NBA lockout is much more likely than an NHL one because the players association has taken a tough stance to the NBA’s initial proposal to lower player compensation significantly. While this is certainly a risk, I think it is unlikely that there will be a work stoppage, and a resolution is more likely to positively impact team economics relative to the current collective bargaining agreements. In addition, it would not be the end of the world for the sports segment. MSG would still have the Rangers games, and could then use the arena to host a variety of other sporting events as well as compliment their entertainment business. The values of sports franchises do not decline because of the short-term lockout, and they have historically been cash flow negative, so this is not a nightmare scenario.

Concluding points: The three points addressed in the variant view are legitimate, but I don’t think it justifies the dirt cheap valuation. If you’re uncomfortable with the management situation, or looking for a company selling at a huge discount to present free cash flow, this is probably not for you. However, Madison Square Garden is a classic deep value special situation, with informational inefficiencies surrounding a spin off, sports franchises that are poised for a rebound (summer free agency), and a collection of irreplaceable trophy assets selling at a serious discount to private market value. As the company gets more institutional coverage, I expect this spinoff to outperform the market as it trades back up to realistic multiples. In addition, I would not be surprised if the company was taken private at a substantial premium, which is exactly what has happened to every other recent U.S. based public sports team.

Regards,

Connor Haley

Disclosure: At the time of writing, Connor Haley owned shares of Madison Square Garden (MSG).