Madison Square Garden is an iconic New York City landmark and a coveted performance venue for professional athletes and performers alike. That's what makes The Madison Square Garden Company (MSGN) so distinctive. Not only does it own world-renowned sites like its namesake as well as Radio City Music Hall, the Beacon Theatre, the Forum in L.A., and The Chicago Theatre, it's also home to legendary sports franchises the New York Knicks and the New York Rangers. Recently, though, the company approved plans to break apart its portfolio. What does this mean for investors?
Image source: Getty Images.
The breakup
On Dec. 3, Madison Square Garden's board approved its proposal to spin off its entertainment businesses into a separately traded public company during the first calendar quarter of 2020. Executive Chairman and CEO James L. Dolan believes the spinoff makes sense because it "...would create two distinct companies for MSG shareholders, each with a defined business focus and clear investment characteristics. One company would be a leader in live entertainment that would take advantage of significant opportunities to grow rapidly within the changing entertainment landscape. The other entity would be a sports company with marquee assets that would enjoy steady growth and strong free cash flow."
This breakup, though, is not a surprise. Almost one and a half years before the announcement, in June 2018, the company announced that its board was looking into splitting these businesses -- and investors responded, with the stock climbing 14% over the following two days.
The sports franchises
The current MSG Company will retain the sports teams. These include The New York Knicks professional NBA franchise and its farm team, the Westchester Knicks, and The New York Rangers professional NHL franchise and its development team, the Hartford Wolf Pack. Some other gaming assets and a training facility will also be included. However, bookings for their games or other sporting events will move to the entertainment company.
As of the end of fiscal year 2019, roughly half of the company's total revenue came from this segment. Compared to the year prior, revenue grew 4%, but expenses outpaced that growth and operating margins fell by 1.5%. However, costs related to its sports franchises vary from year to year, primarily due to player and team personnel contracts. Revenue is influenced by win/loss records: When teams win, they attract more ticket, merchandise, and concession sales, and if they make the playoffs, have more games for which to grow those sales. When they lose, sales contract, like they did last fiscal year, when fewer suites (often referred to as luxury boxes) were sold, hurting revenue as both teams performed poorly. Since sales and expenses depend on contracts and wins, year-to-year earnings can be very lumpy.
Valuation of the sports company should reflect the worth of the individual teams. Both the Knicks and the Rangers are No. 1 on Forbes' latest team valuation rankings for their respective sports, at $4 billion and $1.55 billion, respectively. Over the past five years, two NBA teams have sold: the Brooklyn Nets, for a 12% premium to its Forbes valuation, and the Houston Rockets, for a 33% premium. Similarly, two NHL teams got new owners: the New York Islanders for a 26% premium, while the Carolina Hurricanes were sold for a 7% discount. If we take an average of the NBA and NHL premiums/discount, that would mean the Knicks and Rangers could sell for a combined value of $6.63 billion ($4.92 billion for the Knicks and $1.71 billion for the Rangers). But this "public sale" is different than a private one, because in a private sale, full control over the team is granted to the owner, whereas in the public market, a single shareholder has very little control, so that premium is unlikely to hold after the spinoff.
The entertainment business
The new entertainment company will feature its flagship property, Madison Square Garden, as well as the previously mentioned venues. It will also own the Radio City Rockettes and the Christmas Spectacular, a majority interest in the TAO hospitality group, and minority ownership in Boston Calling Events. Additionally, it will own roughly $1 billion in cash on hand.
During fiscal year 2019, entertainment revenue at the company grew 5%, but operating income declined 1% as expenses increased. Like revenue from the sports franchise, sales are influenced by event-related factors: types of events and demand for tickets.
The entertainment company's valuation is at least $2.2 billion. This includes the value of the cash plus the value of the Madison Square Garden property. The most recent taxed-assessed value of the property was $1.2 billion after its renovation, and currently Wall Street analysts have valued it between $1.3 billion and $2 billion. The other properties, investments, and festivals/events could add another $659 million to $1.5 billion, according to Wall Street estimates.
Why the big discount?
Using the private market value of MSG's portfolio, analysts have computed a per-share price of about $378. Currently, MSG is trading at $299. That's a discount of 21%.
You may be wondering why there is such a big difference between the company's private market value and its current price per share. Part of the reason is that it is a conglomerate: Often a company with disparate businesses does not trade at the full worth that all its assets would have if those assets were owned separately. But in MSG's case, there may be an even bigger reason for the discount: its ownership structure. The Dolan family owns more than 20% of shares, but more important, 70% of the voting rights. Investors are wary of CEO James Dolan's perceived difficult reputation, and of his reputation for management of sports franchises in particular. As an individual shareholder, knowing that there's little to no say in how the company is operating or deploying its resources is disconcerting. So, it seems the stock may always trade at a discount.
What's it worth?
The stock has only risen about 2% since the deal was approved on Dec. 3, and since the initial announcement on Nov. 7, it's up about 7%. So, if there is such a substantial discount to the value of its franchises and properties, why aren't investors champing at the bit?
There are several risks, beyond the Dolan and conglomerate discounts, that have investors worried. One is the concern that the sports franchise values might contract in the future -- whether it's overpaying for athletes or continued poor performance that could hurt ticket sales. The entertainment business can likewise be affected by a poor lineup of artists, competing with cheaper or more desirable venues, or from a collapse of real estate values. Any of these factors could influence the company's future earnings. Here's the counterargument: The New York Knicks' percentage of winning seasons since 2000 is a woeful 20% -- they've only had four winning seasons out of the last 20. So, if the franchise's worth were to decline, it seems safe to assume that it would have already done so. There may actually be upside potential should the team start winning. (The Rangers have fared better, making the playoffs in 11 of those years.)
But often sports franchises don't trade on their assumed value. Rather, they trade based on a market multiple. I reviewed the P/E ratios of other sports franchises that traded publicly as proxies for what could be a reasonable multiple for MSG. Valuations ranged from 15 times for the Cleveland Indians when they went public to 7.9 times currently for the AFC Ajax Amsterdam soccer team.
On the entertainment side, investors are worried about the costs and other risks associated with MSG's new Sphere concept -- a new venue in Las Vegas that will be architecturally revolutionary and completely interactive. That concern may lower the valuation for the new company, at least in the short term. Putting a market multiple on this business isn't easy either, because there isn't a true comparison company with similar assets. Live Nation Entertainment, for example, which has a similar booking and event business but doesn't own the properties, is trading at a price-to-book of 11.32 times.
At an approximate 21% discount to its private market value, the stock appears to be undervalued. Some investors may look at that discount and consider buying the stock before the spinoff. There are several factors to think about: The conglomerate discount should disappear after the spinoff, which should unlock the value of the individual assets. Additionally, the ability to own "scarce" professional sports franchises should raise the value of the sports unit closer to the private market value. But the ownership structure and CEO concerns that worried investors in the past remain. So investors will have to determine how much of a discount should be put on the ownership structure going forward. That will determine how much investors are willing to pay for the assets post spinoff.
