Welcome to Episode 65 of Special Situation Investing.
Today we will cover Madison Square Garden (MSGE) and its upcoming MSG Sphere Corp spin-off. We will admit upfront, we don’t plan to invest in the company. We were fascinated enough to research it and it may even work out well for other investors but we’re personally very debt averse and MSG has taken on significant debt to fund its Las Vegas based Sphere project. That said, there are plenty of investors who are bullish on the stock and for this reason we thought it worth the research and a write up.
In order to understand MSG today, we must to go back to the beginning and recap its founders entrepreneurial journey. Born in Cleveland, Ohio in 1926, Charles Dolan’s first business venture saw both he and his wife splicing together sports reels in their home which they subsequently sold to television stations across the country for syndication. Charles, later sold that business and moved his family to New York in pursuit of his next venture.
Once established in New York city, young Mr. Dolan spotted his next opportunity and that opportunity again led him into television and media. Dolan, observed that city residents had very poor television reception when using traditional set-top antenna receivers and surmised that the cities tall buildings were the root cause of the problem.
Armed with this knowledge, Charles set out to wire the city for cable and went heavily into debt seeing his vision through to completion. While his efforts to bring better reception to the city were successful, they came at great cost and Time Inc, one of his major backers, began to think their investment in cable would be an expensive flop. The investment appeared doomed because, although the reception was better, the cable network had no content to distribute on its platform.
Always ready to innovate, Mr. Dolan added a movie channel to his network. The movie channel was a new concept that hadn’t yet been attempted in television and the station, later named HBO, became a huge success. Charles, would go on to to found multiple successful companies to include Cable Vision and others and would leave his mark as one of the legends of the cable industry. The key takeaway here is that Charles Dolan was a self made billionaire entrepreneur, was well respected, and that he founded what is known today as Madison Square Garden Entertainment.
Charles Dolan’s son began to take an active role in his father’s company in the late 1990s. His leadership foray began with the NY Knicks and has since grown to encompass nearly every aspect of the company. Unlike his father’s celebrated legacy, the son, James Dolan’s, time as CEO has been marked by controversy. This isn’t the forum to criticize a CEO’s leadership ability but for those interested in an entertaining and insightful summary of James Dolan, I recommend the podcast Shattered: Hope Heartbreak and the New York Knicks, specifically Episode 2: The Dolan Family Business.
Whether or not the stories about James Dolan are true the fact that the internet is littered with unflattering vignettes from his tenure as CEO should be taken into consideration before investing in one of the Dolan controlled enterprises. In several instances, my research indicated that MSG business valuations are discounted simply because they’re run by James Dolan. With that said, MSG is a family run business with skin-in-the-game and MSG stock has outperformed the S&P 500 by 515% to 359%, including spin-offs, between February 2010 and April of 2021, according to their recent investor presentation.
With that background out of the way, let’s dive into the spin-off and business valuation. To begin, MSGE set a March 2023 target date for the spin-off of its Sphere, Tao Group and MSG Network businesses with the remaining businesses being renamed Madison Square Garden Entertainment Corp.
Let’s begin with a look at the “Remain-Co” Madison Square Garden Entertainment. Post spin-off, MSGE will own a series of venues to include Madison Square Garden, the Hulu Theater at Madison Square Garden, Radio City Music Hall, The Beacon Theater and the Chicago Theater. MSGE will also retain the entertainment and sports booking business to include online betting, the Radio City Rockettes Christmas Spectacular and licensing agreements with the NY Knicks basketball and NY Rangers hockey teams.
Using a combination of annual reports and Value Investor Club write ups the “Remain-Co” can be relatively easily valued. The valuation is fairly straightforward because the remaining business are well established and produce predictable cash flows with the only exception being the sports betting business.
Valuation for MSGE looks something like this. Madison Square Garden is worth around $1.68 billion, according to a recent NYC Planning Commission estimate that looked at rebuild cost for a similar facility in the same location. Madison Square Garden is unencumbered making it the most valuable asset within MSGE.
The remaining wholly-owned and leased theaters can be valued as follows: $30 million for Radio City Music Hall, the Beacon Theater, and the Boston Calling Music Festival and an additional 33 million for the Chicago theater. The Radio City Rockettes Christmas Show brings in around $45 million per year in EBITA and can be valued at around seven times that number or $315 million in total.
The entertainment booking and sports betting business is more challenging to value because it’s new. Sports betting is a growing, high margin business that has only recently been legalized in some US states. For the sake of conservatism and simplicity, let’s assign zero book value to this portion of the business so that any success it does experience will enhance our estimate of the “Remain-Co’s” value.
Before moving on there is the question of debt and how that relates to the “Remain-Co” valuation. Up until 2020 Madison Square Garden Entertainment had very little debt and saw total indebtedness rise from $200 million in 2020, to $900 million in 2021, and finally $2 billion in 2022. The debt is predominately tied to construction of the soon-to-be spun-out Sphere project. If events transpire as planned, we would expect that the debt associated with the Sphere project would also go with the spin-out and that MSGE would be left relatively debt-free. MSGE took out a proportionally small amount of debt early in the pandemic and secured it against the Rockettes and a few theaters but again the majority of the debt is connected with construction of the Sphere.
With that breakdown behind us, we’re left with a remaining company named Madison Square Garden Entertainment that consists of Madison Square Garden itself, the lesser theaters, the Rockettes, the booking and betting business and very little debt. Totaling up the valuations discussed so far gives us a book value of about $1.7 billion. This isn’t too bad considering the pre spin-off market cap $2 billion for all of the companies assets.
By valuing the “Remain-Co” you can see that the spin-out is largely a bet on Sphere and that the remaining company represents the stable core of the family’s business. The “Remain-Co” should continue to provide free cash flow in a post-Covid world where entertainment venues again operate at capacity.
Transitioning now to the spin-off, we must value the Sphere project, the Tao Group and MSG networks which are all set to be spun-out into MSG Sphere Corp. The Sphere project is the make or break segment of the spin-off so we will cover it first.
Touted as an immersive entertainment experience the Sphere is a 330 foot tall spherical structure constructed adjacent to the Venetian resort in Las Vegas Nevada. The sphere will surround guests with the largest LED television ever constructed topping out at three times the height of an American football field and will accommodate up to 20,000 guests. The Sphere promises to deliver an unparalleled entertainment experience but is also two years overdue and $1 billion over budget.
Originally slated for completion in 2021 at a cost of $1.1 billion, the project is still incomplete in 2023 with an updated price tag of $2.2 billion. Clearly the company could not have predicted the scale of economic disruption that began in 2020 and led to supply chain disruptions, labor shortages, and skyrocketing costs but the effects, whether anticipated or not, have taken their toll.
With the grand opening set to coincide with the Formula One championships in Las Vegas this fall and U2 set to headline the event, Sphere, is still plagued with difficulties. Just recently MSGE CEO, James Dolan fired the Sphere’s project management team out of concern for cost overruns and delays and plans to oversee the projects completion himself. Experienced though he may be as a CEO, one can only imagine the complexity that goes with managing a custom building project on the scale of the Sphere. It’s easy to imagine that this recent leadership shakeup portends further delays and overruns.
Best estimates for the Sphere’s cash flow put it somewhere near $200 million per year based on tickets sales, advertising, naming rights, etc., but any estimated revenue strike us as purely speculative at this juncture. MSG will have the ability to franchise the Sphere concept if it’s a success and has already proposed a similar project be constructed in London. Each new Sphere would generate a revenue share for Madison Square Garden but again the whole enterprise strikes us as an option that will either pay off big, or expire worthless.
The next largest part of the spin-off is TAO group which includes high-end clubs and night life venues in destination cities around the globe. MSG’s 63% ownership in TAO Group can be valued at about $181 million according to most estimates and is a stable cash generator for the company.
The final business set to be spun-out is MSG Networks, the companies legacy cable network business. Given the ever increasing “cord cutting” trend away from cable this business is in secular decline. It currently generates around $150 million in EBITA and could be valued at 5x that number or $750 million. The cash flow generation from the network and from the TAO group will help MSG Sphere get up and running and perhaps MSG will manage to reinvigorate the legacy network business model but at this point managements ability to transform the business is anything but guaranteed.
Valuation for the MSG Sphere spin-off could be $2.2 billion for Sphere, $181 million for TAO Group, $750 Million for MSG Networks and $432 million in cash against a backdrop of around $2 billion in debt. Combined, this adds up to about $3.1 billion in assets and $2.2 billion in debt for a spin-off with an unproven record of revenue production.
To sum up, investors could frame this spin-off from either of two distinct perspectives. The optimistic view would reflect a founder and family-led media company with a history of innovative entertainment offerings who have once again spawned a value-creating business from inside of an already successful media empire. The pessimistic view would describe a founder-led company run by inherited wealth engaged in an expensive bridge to nowhere project poised to become an albatross to the families established legacy.
Because we could be convinced by either perspective and because we don’t have to formulate an opinion on every investment opportunity, we’re throwing this spin-off into the “too hard pile.” The complexity and uncertainty surrounding the Sphere project coupled with the debt incurred to bring the project to life put the investment squarely outside of our circle of competence. Some of our listeners might have expertise in the media industry or otherwise have more insight into the project than we do. Listeners who fit that description may choose the bull path regarding Madison Square Garden and we wish them all the luck in the world but for us, again, this is a pass.
With that we’ve reached the end of Episode 65 and we hope that we’ve once again jump-started your own investment research.
As always you can find the show transcript via the link to our Substack page included in the show notes. We greatly appreciate your support on the Fountain podcasting app and encourage each of you to listen to all of your podcasts there where you can exchange value for value via the bitcoin lightning network.
Thanks again and we’ll see you again next week.
Madison Square Garden spin-off of MSG Sphere Corp (MSGE)