Recent purchase – The Madison Square Garden Company(MSG)

Guys, I own a piece of the Knicks now!

I’ve always been a basketball fan and the recent purchases of NBA franchises at increasingly higher prices has led me to take a closer look this stock. There aren’t a ton of ways to invest in sports teams with only a few publicly traded companies offering investors an opportunity to do that and MSG is one of those.

My recent portfolio update showed me lagging behind on my mid-cap allocation and MSG fits that criteria with a market cap just above 5B. The stock has had a solid year and is up 24% YTD. I never looked at the stock before but the not so recent spin off of MSG Networks, the under performing cable assets the company used to own has made it an intriguing proposition.

MSG owns the Knicks but also owns a variety of other assets most notably the Rangers, the most valuable NHL team and the MSG arena.

Valuing an trophy asset such as a basketball team is very tricky. Forbes does an annual list of NBA valuations which has the Knicks listed at 3.3B for 2017 so that’s a good starting point but how does that valuation compare to the actual amount people are willing to pay to own such a unique luxury asset. The recent purchase of the Rockets at 2.2B gives me a good start pointing but it’s also worth looking at a few other recent NBA teams that have changed hands as well. 

NBA TEAM VALUATIONS

The data shows me a few things. The first is that the business of basketball is pretty damn good with strong growth rates since 2008 and even better growth rates in the last few years due to the new TV deals.The table above shows some data I pulled from the last four NBA sales starting with the bucks in 2014.

The second is that potential buyers throw standard valuation metrics out the window when it comes to the ownership of a basketball team. The best way to visualize that is to look at the $2 billion purchase price of the clippers by Steve Ballmer in 2014. At the time of his purchase, he paid 15.6x revenue and nearly 3.5x the Forbes value. Strong revenue growth since that time has brought the valuation to a more reasonable 10.8x revenue based on 2017 revenue and the $2B purchase price. Based on the data above, there is also a clear divide between small market, small revenue teams and large market and/or high revenue teams as the valuation of the Rockets and the Clippers is much higher than that of the Bucks and Hawks.

The third is that the Knicks are by far the best of the breed when it comes to comparing these recently sold teams and all NBA teams in general. Their revenue is the highest in the league and 50% higher than the Rockets, the largest revenue team of the recently sold group. Their growth rate is higher than the Rockets despite the much larger starting base and isn’t too far behind the smaller teams on the list. As a comparison, the Lakers who are #2 in revenue have seen a 4.3% growth rate since 2014. The highest growth rate in the league stands at right around 24% in that time frame and unsurprisingly comes from the Golden State Warriors.

The interesting thing here is that the Knicks have maintained this stellar growth rate despite pretty terrible results and poor management. Imagine what would happen if the team actually started to play well again which may not be that far away if Kristaps Porzingis can keep improving. Playoffs are a big revenue and income boost to teams and that’s something that has eluded the Knicks for some time now. It’s unlikely that the Knicks will be good any time soon especially now that they just traded Carmelo for some mediocre assets. They have a few bad contracts(Noah) that are not going to be until the 20/21 season but at least they have their draft picks now which can lead to some improvement if management can get their act together.

This is a team that needs to rebuild around Kristaps and it seems like that’s the plan right now. This is already the most likable Knicks team in a while mainly because of Kristaps so hopefully he sticks around and stays healthy. SO MARKETABLE!

Now, what does that all mean for the stock? I think it means it’s a great value. If I look at the table above and see that the Rockets, a middle market team with 50% less revenue are selling for 2.2B, a good 33% above their Forbes valuation then what’s a reasonable price for the Knicks, the most financially successful team in the league in the biggest market?

If I simply apply the 9x revenue figure to the Knicks, I get a valuation of 3.38B which is right on top of the Forbes valuation but the Knicks definitely don’t warrant the same multiple as the Rockets. They might not be performing as well right now but they’re the freaking Knicks. There’s a certain something about seeing home games at MSG, right in the middle of NYC and that’s why the Knicks home games continue to fetch some of the highest prices in the league.

They’re playing terrible and their tickets for home games are selling for more than 2.25x the going rate for the Rockets. They’re selling for more than 2.7x than tickets for Clippers games in LA, a team that sold for 15.6x revenue. If someone is willing to pay 9x for the Rockets, what are they willing to pay for the Knicks?

I think the answer lies somewhere in the middle of those two numbers. The Clippers deal seems like an overpay to me despite the strong growth since that time which has made it more reasonable especially in the light of the recent purchase price for the Rockets.

There’s always going to be a premium for a major market team especially one as prestigious as the Knicks. Let’s be conservative and assume the 10.8x valuation for the Clippers based on their 2017 revenue. Using that, I get a 4.06B price for the Knicks or about a 23% premium to the Forbes valuation. It’s clear that based on recent sales, the Forbes valuation is generally seen as a starting point and not a true value and any purchase price would be quite a bit higher. The premium to the Forbes might not be as high as what we saw with the Clippers as that Ballmer valuation spike is now embedded within the Forbes valuation but it’ll still certainly be more than 1x which makes a 4B+ valuation for the Knicks quite reasonable in my mind.

In fact, a $4 billion price point for the Knicks might be light given the surging values of NBA teams in recent years.

Another thing to keep in mind is that MSG also owns Madison Square Garden, the arena in which the Knicks play and that’s unique as a lot of arenas are either co-owned or simply leased by the team. A recent tax assessment values that arena which is located in the heart of NYC at 1.2B and that’s likely light based on location and the ownership of the air rights around it.

That means that MSG is a stock that’s sitting at a market cap of 5.03B with a strong balance sheet which includes 1.16B in net cash and an asset that’s likely worth about 4B(possibly more if you include MSG). That’s the whole market cap right there which means an investor is essentially getting everything else for free.

MSG sports also owns the New York Rangers, an NHL team that’s likely worth well in excess of 1B. Forbes valued them at 1.25B in 2016 against a revenue of 219M. NHL teams haven’t grown as quickly as NBA teams but there is potential for new growth in 2021 as the TV deals go up for renewal. You also get the WNBA team New York Liberty as well as an AHL team.

MSG also recently purchased Counter Logic Gaming, an e-sports team which participates in League of Legends, Halo, CS:Go and Super Smash Brothers. I was actually hoping they’d also be one of the teams in the new Overwatch League but it looks like they’re waiting to see what happens there. Beyond the Rangers, none of these other teams offer a ton of value but I do like having exposure to e-sports as I foresee growing viewership in that arena of sports.

MSG Sports makes up about 60% of the revenue with the Knicks and Rangers contributing the majority. Y/Y growth in revenue was 16% in the last 12 months.

MSG also operates a second entertainment based division which holds and manages live events at the MSG arena. They also manage the Rockettes as well as own a few theaters in NYC as well as in Chicago, Boston and Inglewood. MSG Entertainment also recently purchased a controlling interest in TAO, a hospitality and dining group with restaurants and clubs in NYC as well as Las Vegas. They’ve also have a controlling interest in Boston Calling Events. The company has done a good job of expanding this portfolio of hospitality and live events and has seen 22% growth in revenue this year.

That means that beyond the Knicks which, based on recent NBA sales, have a potential valuation that covers the entire market cap(when adjusted for net cash), you get the Rangers, the MSG Arena, exposure to e-sports and a growing entertainment portfolio.

You’ll notice I haven’t talked about standard metrics like FCF and earnings here because those things are less relevant when you’re talking about trophy assets such as an NBA or an NHL team. This is a unique investment that simply cannot be looked at in the same way as any other investment. I’m looking at this as a sum of its parts from a valuation perspective. I fully understand that this isn’t a stock you can value by standard metrics and am making a purchase on that basis.

There is a clear premium that people are willing to pay for these franchises that may only go on sale once in a lifetime. Valuations don’t matter when it comes to these luxury assets. That’s the reason someone like Steve Ballmer was willing to pay $2B for a team that was and continues to lose money.

With MSG you get two premier teams in two popular leagues that are growing revenue at a good clip, are profitable and are located in the biggest market in the US. Plus you get a ton of other solid entertainment assets as well. I feel like that’s pretty safe bet at today’s prices.

There are some negatives here.

The chairman of MSG and owner of the Knicks, James Dolan isn’t exactly the most shareholder friendly owner and has probably kept the value of the company down with some of his decisions. Knicks fans are not in love with James Dolan and neither am I but I do think that the CEO, David O’Connor has done a good job with the capital allocation strategy since joining the company in 2015. They’re not blowing the door off with earnings but are cash flow positive, have done a good job of expanding and growing both the sports and entertainment groups without taking on a ton of debt and have purchased back stock at an attractive valuation.

There is also some uncertainty around MSG Arena and the proposed Penn Station renovation which may force MSG to move their arena to another location. It’s a pretty big unknown but that likely won’t play out for another five years. I think worst case scenario is that the city helps MSG build another arena somewhere else in the city which may be a net negative for the company but will still retain most of the value of the original asset.

There is also the potential of this being the peak of NBA team values as the new TV deal is pretty great. There’s potential it may be less next time if TV ratings keep falling although it’s possible that streaming agreements offer an even better avenue for revenue for individual teams in the future. If Amazon is willing to pay $50 for a few football games then how much would they pay for a full season of Knicks games? The team makes a good portion of their revenue from local TV agreements and that may change in the future but I don’t believe the gain in popularity of streaming will be a big negative for MSG.

I believe MSG is a one of a kind investment with a pretty strong margin of safety. There’s really nothing like it you can buy in the stock market today and it’s a very intriguing stock at the current price of $213.

The main problem here is that the stock may take a long time to find it’s footing and grow towards what I believe is a fair valuation. There is the potential that the Dolan’s sell the Knicks or the Rangers but that’s unlikely. There’s also the potential that they take the company private now that they’ve spun off the poor performing TV assets which may generate value in the short term. The Knicks current valuation is based on an under performing team and the current valuation of NBA teams so it may simply grow naturally as the revenue in that part of the business improves and NBA valuations grow. On top of that you get the Rangers and the entertainment business which has potential to grow as well especially if their current pace of expansion of the entertainment business continues.

In any case, while it may take a few years to get there, I can easily see this company with an $8B valuation just on the backs of their current holdings. Their recent acquisitions will only help get them there faster. That’d be a nearly 60% rise from today’s prices and I wouldn’t be surprised if it went higher.

I generally tend to avoid consumer discretionary/entertainment type stocks since they can be very cyclical but I believe sports are relatively recession proof especially when you’re in NYC and have TV deals that are guaranteed for a certain amount of years. The recent expansion of the entertainment revenue does add a bit more risk during an economic downturn.

However, I believe this is a very compelling case at this price point when one adds up the value of the assets. This is a stock that’s definitely trading below fair value right now. It’s just a matter of figuring out how much and I think my 60% stock appreciation scenario is relatively conservative right now. It’s not a stock that I would put a huge portion of my portfolio into because the valuation metrics are a bit less credible than a standard stock due to the lack of information around NBA teams and the low turnover of them making valuation difficult.

I picked up a few shares a few days ago and will likely pick up a few more if the price sticks around this level and my mid-cap allocation is below target.

Disclosure : Long MSG