A spin-off is in the works for this entertainment company, and analysts are forecasting the company will grow at an annual rate of 16.9% over the next five years.
The Madison Square Garden Company (MSG)
From The Stock Spin-off Investing Newsletter
The Madison Square Garden Company (MSG) is on track to be broken up into two companies in the next 5 months. Despite the imminent catalyst, the stock trades at 31% discount to fair value. We believe that the discount deserves to be cut in half (at least) which would drive ~20% appreciation by year end. More importantly, MSG is defensive (NHL and NBA revenue grew during the Great Financial Crisis) and is exceptionally well-positioned in the media world due to its focus on live entertainment and sports. As a result, underlying asset value should continue to appreciate driving significant upside over the long term.
Investment Case
#1 Value is About to be Unlocked. Management confirmed in May 2019 that the spin-off is on track to occur in the second half of 2019. Currently MSG is trading at a ~31% discount to its fair value. I estimate that the 31% discount will narrow to 15% or less by the end of the year driven by the spin-off. If that were to occur the stock would appreciate by 22%.
Why will the discount narrow? First, in the immediate aftermath of the spin-off announcement, MSG stock appreciated to $327 due to a spike in investor excitement for the transaction. However, it’s been about a year since the transaction was announced and investors have moved on to the next shiny object. Enthusiasm for the spin-off will begin to rise again when 1) the form 10 is filed with the SEC and 2) a target spin-off date is announced. These two catalysts could happen any day. Once the spin-off occurs, the disconnect between price and value will be hard to ignore. For instance, let’s assume that the 30% discount remains intact even after the spin-off occurs. My estimate of the Sports Company’s fair value is $6.5BN.
If the Sports Company traded at a 31% discount to its fair value, it would have a market cap of $4.5BN, below the standalone franchise value of the Knicks! I don’t think that valuation is sustainable. The disconnect will be hard to ignore. Further, management has said that the sports business will be a “return of capital story”. Thus, I think significant share buybacks are likely, especially if the spin-off trades at a discount to fair value.
My estimate of the Live Entertainment Company’s fair value is $3.3BN. If the Live Entertainment Company traded at a 31% discount to its fair value, it would have a market cap of $2.2BN, in-line with the valuation of the Madison Square Garden arena and net cash. That valuation would give the company no credit for MSG Air Rights, The Forum, the Christmas Spectacular and the Tao Group. This discounted valuation would also be hard to ignore.
#2 Underlying Assets are Defensive. In the current economic environment (late in the cycle), I want to own defensive businesses. NHL and NBA revenue grew throughout the Great Financial Crisis. Note the revenue declines in 2011/2012 (NBA) and 2012/2013 (NHL) were due to lock-outs. Importantly, revenue quickly recovered following the lockout. Another interesting aspect about MSG is its beta. According to Yahoo Finance, MSG’s beta is extremely low at 0.37 which is also attractive late in the economic cycle.
#3 Underlying Value Will Continue to Appreciate. Not only are we buying an asset that is trading at a 31% discount to fair value, but the underlying asset should continue to appreciate for the foreseeable future due to an attractive dynamic between the supply of professional sports franchises and the supply of potential buyers. Since the 2004, the number of NBA franchises has held steady at 30. Over the same period, the NHL has added one franchise (there are currently 31). Meanwhile, the number of billionaires (potential buyers) in the world has increased by ~400% over the same period. I don’t see this trend changing; wealth continues to be ever more concentrated at the top. The number of billionaires will continue to increase, and those billionaires will continue to covet trophy assets such as fine art and professional sports franchises, driving prices higher.
#4 Owner/Operator Will Unlock Value. While Jim Dolan, the CEO of MSG, has a poor reputation, he has made some good business decisions. First, he spun off Madison Square Garden from Cablevision, the original company founded by his father. Then he and his family agreed to sell Cablevision Altice, a European cable firm in 2015. This was excellent timing given the headwinds facing the cable TV business. Further, he and his family agreed to split up Madison Square Garden into a sports and entertainment company (MSG) and a media company (MSGN). While MSG and MSGN have performed in line with the S&P 500, they are both positioned well as potential acquisition candidates.
While we do not know how many shares will be reserved for executive compensation in the spin-off, we know that the Dolan family owns ~21% of shares outstanding (and controls over 70% of the voting shares), and as history has shown, James Dolan is willing to take steps to increase shareholder value.
#5 Sports Betting Could Generate Significant Revenue. In May 2018, the Supreme Court ruled that states have the right to decide if sports betting is legal in their jurisdiction, not the federal government. After this ruling, many states quickly legalized sports gambling. In July, New York voted to allow sports gambling at casinos but will not yet allow mobile sports betting or betting at arenas like Madison Square Garden. While mobile gambling faces opposition from Governor Andrew Cuomo, the state’s legislature is in favor of it and will work to pass a mobile gambling law next year.
MSG appears ready as it is developing a mobile wagering app. Mobile sports gambling, if approved, has the potential to generate hundreds of millions of dollars for the company. I think legalized sports betting on mobile devices in New York ultimately happens as it would generate significant tax revenue for New York. For what it’s worth, Mark Cuban said that professional franchise values should double due to the legalization of sports gambling.
The final point to consider is that the Knicks have been terrible for a very long time. If they improve, their revenue generation will increase substantially due to increased playoff games and higher fan engagement. Consider the Golden State Warriors. The Warriors used to miss the playoffs consistently, but in recent years, the team has become a perennial championship contender. From 2013/2014 to 2017/2018, Warrior franchise revenue increased by 139%. Over the same period the Knicks revenue increased by 59%. The Warriors are an extreme example, but consider the Raptors. Over the same period (during which the Raptors improved substantially), the franchise increased revenue by 82%. An improvement in the Knicks would at least partially offset any potential multiple contraction.
Richard Howe, CFA, The Stock Spin-off Investing Newsletter, www.stockspinoffinvesting.com, 617-750-7454, August 5, 2019