Madison Square Garden (MSG) is on track to be broken up into two companies in the next 5 months, explains Richard Howe, editor of the specialized advisory service Stock Spin-Off Investing and a contributor to MoneyShow. Indeed, among all pending spin-offs, he notes that he is most excited about this situation.
For the past three years, the investment case for owning Madison Square Garden has been built on the argument that it’s trading at a discount to its sum-of-the-parts valuation.
That’s why the stock rallied so sharply when the company announced in June 2018 that it would explore spinning off its sports business. Within 10 days of the announcement, the stock had rallied 23% to $327. Since then, investors have moved on to the next shiny investment opportunity, and Madison Square Garden’s stock has languished.
We are betting that investor excitement will begin to bubble up given that 1) the spin-off is scheduled to be completed by yearend and 2) Madison Square Garden currently trades at a 30% discount to its sum-of-the-parts value.
Let’s take a step back and review Madison Square Garden’s key assets.
- New York Knicks Franchise
- We value this asset at $4.8 billion, a 19% premium to the Forbes valuation (
NBA franchise sales have historically taken place at a 38% premium to the latest Forbes valuation).
- We value this asset at $4.8 billion, a 19% premium to the Forbes valuation (
- New York Rangers Franchise
- We value this asset at $1.7 billion, a 10% premium to the Forbes valuation (NHL franchise sales have historically taken place at a 20% premium to the latest Forbes valuation).
- Madison Square Garden Arena
- We value the arena at $1.2 billion in-line its tax assessment.
- Madison Square Garden Air Rights.
- We value the air rights at $450 million ($225 per square foot).
- Cash
- Net cash on balance sheet of $1billion
- Other assets:
- The Forum in LA: $190 million (JPM estimate)
- Christmas Spectacular at Radio City: $300 million (JPM estimate)
- Tao Group: $181 million (JPM estimate)
Add up all these assets and you get a valuation of $9.8BN or $414 per share. The current share price is $290.
Why does MSG trade at such a discount?
- Conglomerate Discount.
- Dolan Discount
After the spin-off, the conglomerate discount will evaporate, but the Dolan discount will remain in place. What is the Dolan discount? Jim Dolan is the CEO and Chairman of MSG and has a poor reputation with investors.
However, we need to remember that Dolan owns over 20% of the stock (over 70% of the voting shares) and is interesting in maximizing shareholder value because it will increase his net worth.
In fact, he has made several good capital allocation decisions in the past that have benefitted shareholders.
First, he spun off Madison Square Garden from Cablevision, the media company founded by his father. This was a smart strategic decision. Then he and his family agreed to sell Cablevision to Altice, a European cable firm in 2015. This was excellent timing given the headwinds facing the US cable TV business.
Further, he and his family agreed to split up Madison Square Garden into a sports and entertainment company, Madison Square Garden (MSG) and a media company, MSG Networks (MSGN). While both companies have traded in line with the S&P 500 since the spin-offs, they are both positioned well as acquisition candidates.
Now, Madison Square Garden's sports and entertainment assets will be split into two new companies.
After the spin-off, the new sports company will consist of the New York Knicks franchise, the New York Rangers franchise, as well as some other less valuable assets.
The remaining business (the entertainment company) will own Madison Square Garden (the arena) and focus on live entertainment. It will have a very strong balance sheet (approximately $1 billion of net cash).
Once the spin-off occurs, the disconnect between the 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 — made up of The Knicks and The Rangers — is $6.5 billion.
If the Sports Company traded at a 30% discount to its fair value, it would have a market cap of $4.5 billion, below the standalone franchise value of the Knicks! We 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, we 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 $3.3 billion. If the Live Entertainment Company traded at a 30% 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 Madison Square Garden Air Rights, The Forum, the Christmas Spectacular and the Tao Group.
We also find the stock attractive because the company's underlying assets are defensive. In the current economic environment (late in the cycle), we want to own defensive businesses. NHL and NBA revenue actually grew during the Great Financial Crisis. People like sports, even in recessions.
Another interesting aspect about Madison Square Garden is its beta — which is extremely low at 0.37. This is also attractive late in the economic cycle.
We also believe that the stock's underlying value will continue to appreciate. Not only are we buying an asset that is trading at a 30% 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.
We 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.
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.
Another potential positive is that 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.
Madison Square Garden appears ready as it is developing a mobile wager app. Mobile sports gambling, if approved, has the potential to generate hundreds of millions of dollars for the company.
We think legalized sports betting on mobile devices in New York will ultimately happen, 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.
There are risks. First, the spin-off could be cancelled. While this is possible, we view it as relatively unlikely given management’s confirmation on the last quarterly call that the spin-off was on track for the second half of 2019. Further, Madison Square Garden was trading at $262 when the spin-off was announced, only 10% lower than the stock’s current price.
Another risk is that professional sports franchise transaction multiples decrease.
In the early 2000’s, NBA franchises used to be purchased for 2.5x to 5.0x revenue. Now teams are being purchased for 5.0x to 11.0x revenue. If valuations were to revert back to lower levels, MSG would underperform. While we acknowledge this risk, we believe valuation multiples are unlikely to revert lower for the foreseeable future due to:
- The favorable dynamic between the supply of global billionaires (i.e. the supply of potential franchise buyers) and the fixed number of professional sports franchises.
- Media buyers are focused on live sports as it’s one of the last places where you can find a live, engaged audience. Analysts have lauded FOX Corporation’s strategy of focusing on live sports (as well as live news). This trend will support ad deals and increased revenue generation for professional franchises.
- Quirks in the tax code allow buyers of professional sports teams the ability to write off $120 million per year for fifteen years against other earned income. This factor will continue to support lofty franchise valuations.
- The huge future revenue opportunity from legalized 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
Currently Madison Square Garden is trading at a ~30% discount to its fair value. We estimate that the 30% discount will narrow to 15% or less by the end of the year, driving 21% upside. (Disclaimer: Rich Howe owns shares of MSG. Please do your own due diligence and consult with an investment adviser before buying any stock mentioned on www.stockspinoffinvesting.com.)
