Key Points
- Madison Square Garden Entertainment is a diversified live entertainment and restaurant play centered in New York, Las Vegas, and Chicago.
- The company recently merged with Madison Square Garden Networks, which is one of the most desirable regional sports networks in the world and brings a lot of free cashflow to the table.
- This pair-up potentially positions the new entity for lucrative sport betting partnerships in the likely event that online sports betting becomes legal in New York State this year.
- The company is trading at a significant discount to book value, and the shares have suffered significantly as Delta variant fears have risen. We see evidence that Delta has peaked.
- The combination of extremely high quality and mature live entertainment assets and innovative growth initiatives that have the potential to disrupt live the future and economics of live entertainment make this an attractive long-term investment to capitalize on re-opening, even if it is delayed.
“But even lying on the ground, it is a marvel.”
-Pliny the Elder, referring to the Colossus of Rhodes
The Colossus of Rhodes was constructed after a harrowing year-long siege to celebrate its peoples’ heroic resistance. The expensive siege weapons left on the field of battle by the enemy were used to finance part of the costs of one of the ancient world’s greatest wonders. Sometimes amazing things come out of adversity.
Despite feeling back in the grips of an unpredictable and dangerous pandemic, bright days will come again as they always have after our darkest times. Although it is undoubtedly a shame that returns to gatherings at places like the flagship asset of our subject this week are postponed, Madison Square Garden, the joyful returns to these treasured locations will nonetheless still occur. When they do, many consumers will spare no expense.
We all feel the frustration building as COVID-19 continues to dominate our daily lives and interrupts our plans. Demand already pent-up is getting pressurized like a shaken soda can. The International Auto Show at the Javits Center in New York was just canceled. So was Jazz Fest in New Orleans. The cities of Las Vegas, Miami, Orlando, Austin, and New Orleans have healthcare systems that are in the throes of a vicious COVID wave and are also favorite regional conference destinations. The virulent Delta variant has undoubtedly postponed the massive comeback in live events, gatherings, and experiential real estate.
Nowhere is this reality more frustrating or more consequential than the business of live events. Many events are being canceled; some are not. The Delta variant has forced people to rethink the playbook. There appears to be a growing trend toward requiring proof of vaccines, but this policy likely has its limits as well. The future is very uncertain, and fear is reaching a high level around COVID-19 now. However, if the recent past is any indicator of the future, it seems that market panic has either climaxed concerning the recent variant or is close to doing so.
We Think Delta Variant Is At Or Near Its Climax
Why do we say this? We observe the COVID-19 trends very closely, and we have noticed some of the most affected states seem to be rolling over. We do understand that the Delta variant is mysterious, and this could only be temporary relief. Still, based on the timeline of Delta’s rise and fall in other countries, including those with similar vaccination rates, the timeframe of about 39-45 days seems to make sense.
Also, one of our favorite forecasters regarding COVID-19, IHME, now predicts that there will not be a subsequent fall wave. If this is the case, then re-opening related names like MSGE, who have suffered adverse price actions because of the Delta variant fears, should begin to reverse that negative momentum. We see a classic “Wall of Worry” scenario where markets can outperform bad expectations that may or may not be primarily baked in. Time will tell.
In any event, our recommendation on MSGE should be considered within the following context; firstly, it is a small-cap stock with many risks and should not comprise a significant portion of your total holdings. Secondly, we recommend this stock partially because of its growth initiatives. The benefits of these will take years to play out, so it is a buy-and-hold type situation. It is also subject to many risks, so don’t concentrate yourself unduly. While we think the current valuation is cheap and entry here looks attractive, the return of meaningful live event revenue is uncertain and subject to many variables.
The bottom line is this; the company has lost a considerable amount of money since the spin-off due to the catastrophic impact the virus had on its core business. However, the company has pivoted and reduced expenses, and though we can’t say for sure exactly when, we can say undoubtedly that better times are ahead and that the unique and valuable assets this company owns will be able to earn once more, perhaps better than they ever did in the past. In addition to this, the management team is going all-in on an exciting growth project that could reap significant benefits. The recent trend in estimates has been more positive in peers despite it lagging significantly in valuation.
The Epitome Of A Marquee Brand
Madison Square Garden is synonymous with entertainment in New York, and before the COVID-19 crisis, it was the top-grossing venue in the United States. Obviously, COVID-19 has been devastating for revenues, and we would consider this name to be in many ways a flagship Epicenter stock and one that will particularly benefit if the Delta variant subsides and this recent wave proves to be the last significant one of the year. The arena revenue has historically been around 40% of total live revenue and 46% of total ticket grosses before the pandemic. That portion may end up being higher in a world where live events return after more time than many operators were prepared for.
Part of this is an intuitive call as well. The company not only has a scarlet letter and a management team that draws the ire of New York Sports fans like William Tecumseh Sherman did from the women of the South, and many investors don’t have the highest regard for the team. Nonetheless, the assets are incredible and one of a kind, and there’s not really a lot of people making the argument that this company won’t be able to make money with them when normalcy returns.
When we see peers like Cinemark and IMAX have P/B ratios many factors higher than MSGE, we suspect a convergence in favor of the latter is the more probable outcome. Let’s put it this way, would you rather own Madison Square Garden and be working on a state-of-the-art live theatre in Vegas or own a bunch of movie theaters?
Born In A Crossfire Hurricane
On April 17th, 2020, Madison Square Garden Entertainment (MSGE) was spun off during the height of the pandemic. The lockdown was in full swing, and live entertainment revenue ground to a literal complete halt. The company used to own the top two grossing venues in the above 10,000 category, the Garden and the Forum in Los Angeles. The Forum was sold at a significant profit.
The company has at its share of controversies, but MSG outperformed the S&P 500 over its 11 year lifetime. While MSGE probably couldn’t have been spun off at a more challenging time, it has nonetheless made it through the period of its troubled youth. Earlier this summer, when the firm announced the merger with MSGN, a lot of people criticized the deal, including a lot of MSGN shareholders who felt they got the short side of the stick.
To quote one of the activist letters criticizing the transaction, “As the transaction is currently structured, MSGE and its’ shareholders are positioned as the primary beneficiary of MSGN’s future free-cashflow generating abilities.” We’d agree to an extent, which is one of the additional reasons the shares seem absurdly cheap. We believe that as soon as the core assets begin to operate at full capacity, a torrent of pent-up demand will help this multiple expand. The company has impressive growth initiatives underway and has proven to have an appetite for targets of opportunity in the M&A space.
If you are a New York sports fan please, try to reserve your judgment and bias that James Dolan is the CEO of this company. However, even with what some on Wall Street refer to as the “Dolan Discount,” this stock seems ridiculously cheap, particularly given that it successfully closed a merger that adds significantly to its recurring revenue and financial stability.
There have been several controversies and spin-offs surrounding this name. The company recently closed a merger with MSGN, and while there are still minimal risks from some lawsuits around the transaction, it looks like it is a done deal. Immediately, this will significantly increase the assets of the entity.
One of the criticisms of this transaction was that it made MSGE less of a pure re-opening play. The earning assets of this stock also include the Tao Hospitality group that owns premier restaurant and nightlife brands. That subsidiary also just completed an accretive merger that boosted its presence in Vegas and markets across the world, including Asia.
In a ‘ground-hog day,’ post-Delta variant reality where cancellations of the comeback events are again happening en masse and uncertainty permeates the live events industry, the decision to diversify revenue looks less like a valid critique and more like a prudent move from a risk management perspective. The recent merger should improve the company’s credit profile, and the estimated savings are around $200 million, the better part of what MSGE lost in its first year. The company’s borrowing costs were already in the middle of the pack compared to peers and should only improve.
It is not a question of whether Madison Square Garden or New York City or Las Vegas will come back; it is a question of when. MSGE has shifted its orientation toward its’ growth projects and is patiently waiting for when capacity restrictions are lifted when it can begin earning with its core assets which happen to be some of the more valuable and unique real estate assets around.
Another rumored reason for the tie-up between MSGN and MSGE was potentially taking advantage of legalized online sports betting with lucrative partnerships. This could pump some additional life into the name in addition to the coming throngs of the long ‘eventless.’
Take The Stones People Throw At You And Build A Monument
The company’s main and most ambitious growth initiative is truly an extraordinary and controversial project. For one thing, it is literally of monumental status, and when completed, it will be the largest spherical structure on the planet. It will also be covered in the most giant programmable screen in the world. It certainly has the potential to be amongst the most disruptive projects in live entertainment. However, the implementation is full of risks. However, if successful, the company will likely redefine live entertainment in a lucrative fashion for its shareholders.
There are also tentative plans for opening one in the Stratford neighborhood of London, although there are some hoops to jump through before approval is finalized. The management team says they are primarily focused on getting Vegas right for what it’s worth. However, if their project is successful in Vegas, you can bet it will be at least three or four times more successful in Macau.
There are also compelling reasons to think that MSGE may significantly alter the venue business model in its favor with its expensive and awe-inspiring project. The traditional venue model has minimal utilization like you might get about one event a day over a year in the absolute best-case scenario. It is easy to see this project being high-growth given the pent-up demand for live events if you envision an optimistic future. Construction progress has been considerable.
However, with the new features planned in the sphere, MSGE will not only be partnering with artists but also generating original content to be displayed. This would fundamentally alter the economics in the company’s favor. There will be able to be multiple screenings a day which significantly increases the potential revenue.
We also are encouraged that they have the right partner in LVS and the Venetian to drive traffic to this new investment which should open in 2023. The management has also discussed the future expansion of this project using a capital-light franchise model where intellectual property may be more important than construction loans.
Risk And Where We Could Be Wrong
This stock is prone to a lot of risks and is a high-beta re-opening play. Recent transactions have diversified the company’s business, and its assets will go up. However, the first report containing the consolidated financial statements is coming up, and there’s always a risk that investors see something they don’t like in the post-merger entity.
There have been many controversies around management too. Still, all in all, we think James Dolan has a pretty consistent record in terms of capital allocation that plays on the strengths of his core assets and has been successful in the past.
Nonetheless, many risks could result in this stock continuing to lose value even though it is incredibly cheap by measures like price to book. The unique real estate assets and cash on the books alone make this seem like it is cheaply valued, and there may be many reasons for this, but it is possible that you could be trying to catch a falling knife. Valuation is never a guarantee of investment success, but it is an essential tool.
So, please manage your exposure to this name accordingly, and please only buy if you have a medium or long-term horizon as we are picking this stock partially because of their exciting growth initiatives in addition to their core businesses, which we anticipate to recover very strong. One of the earlier iterations of Madison Square Garden made it through the 1918 Spanish Flu, and we firmly believe this exceptional brand has a lot more to offer in a bright future where live events are again commonplace and not dangerous.
The primary risk associated with this stock remains that the healthcare situation continues to postpone the recovery in live events beyond this company’s cash and goodwill. We’d say this company’s peers are at far greater risk of that fate than MSGE. We believe the recent merge strengthens the prospects of MSGE shareholders.
However, the situation with COVID-19 is mysterious and unpredictable, and the price remains very much at the mercy of healthcare developments. While it does appear Delta cases are slowing down, it is always possible that this reverses or another variant emerges. Though the stock is a small-cap, it was part of a larger cap stock in the past and enjoys analyst coverage and ample institutional ownership.
