- The April 7, 2014 15% share price sell off was an overreaction as the growth story is still intact.
- According to the CFO, the re-pricing of its upcoming U.S. broadcasting rights negotiation should wrap up by early May and drive meaningful OIBDA growth in 2015 and beyond.
- The WWE Network is a compelling value proposition at $10 per month.
This is a short and sweet rebuttal to the short thesis, which essentially argues World Wrestling Entertainment (NYSE:WWE) is richly valued through the lens of rear view mirror financials and management's relatively poor track record of generating robust and consistent cash flows. The objective of this write up is to paint the bullish picture through the lens of an admittedly WWE optimist.
How growth stocks work: (Optional Reading)
Before I launch into the bull case for World Wrestling Entertainment, I would like to discuss, my perception of how growth stocks work. I have been lucky enough to have a few professional buy side analysts and portfolio managers as mentors. These mentors have selflessly shared way too much of their time and knowledge, and through a series of lively and rigorous email exchanges, over the course of over nine years, we've discussed many different stocks. Along the way, I have some idea of how stocks work. So in the interest of paying it forward, I would like to share what I have and continue to learn.
I would argue that investing is 80% art and 20% science. Today's super computers can trade billions of dollars worth of stocks at the speed of light, using algorithms written by some of the world's best math minds. So, given the advances in computing power, I think it's fair to say, computing financial ratios like P/Es, revenue, and cash flow through the lens of historical financial results is important, but everyone knows this and has access to this information. Therefore, this information often is and should be fully discounted into current stocks prices.
So, the key to making money in growth stocks is really about understanding how consensus estimates are derived, usually through building a simple financial model, for the current year as well as peak earnings power. Moreover, I would argue that less is more and financial models really only need to be complicated enough to capture the major moving pieces.
Now let's move into the fun part, the art piece, where synthesizing all the publicly available information you can get your hands on like 10-Ks, 10-Qs, earnings transcripts, investor presentations, and perhaps even a sell side report or two (only if they contain original proprietary research like market scans full of excellent qualitative analyses). If you invest the time and are reasonably good at synthesizing information then this where the magic happens! After you have digested and synthesized all of these inputs then you should have enough dots to connect to determine your estimate of what's the peak "E" in earnings power. Armed with this analysis, you can then compare the picture, from the dots you connected, of your future "E" estimates versus consensus estimates. For example, if current estimates are earnings of $1 per share in FY14 and your analysis points towards, $2 per share, then you should buy the stock every day, all day, despite its valuation. It's a hard concept to grasp, as it goes against some of the textbooks and conventional wisdom. However, when it comes to growth stocks, it's really about discovering stocks with large earnings and revenue upside potential.
So although I appreciate the exhaustive ratio calculations and valuation comparison to the S&P 500, in this unique case, I place little value on this type of analysis, as in the case of WWE, earnings upside for 2015 is how this stock should be valued.
The bull case
"If past history was all there was to the game, the richest people would be librarians."- Warren Buffett
What happened on April 7, 2014?
Shares of World Wrestling Entertainment got hit hard on April 7th, declining 14.7% on volume approaching 9 million shares. This had little to do with the negative piece in Barron's published over the weekend, it stemmed from the release of the WWE Network's current subscriber numbers of 667K. Despite, at face value, what appears to be an auspicious start after only 42 days, clearly, the market was anticipating a higher numbers. However, as an investor on the sidelines, I was overjoyed to take advantage of what I believe is an air pocket and overreaction, and I'm thankful that a depressed Mr. Market was willing to sell me shares at $22.23. To explain why I'm excited to be long, let me walk you through my high level bullish thesis.
Share of World Wrestling Entertainment are compelling for the following two reasons:
1) The successful launch of the WWE Network
Prior to the launch of the WWE Network, the WWE had twelve pay per view events per year, including the super bowl caliber event WrestleMania, with WrestleMania 30 recently having just taken place in New Orleans. Not too long ago, these pay-per view events were broadcast by the major cable networks and offered to customers at $45 - $65 per event. The problem with this model was that besides the "super bowl event - WrestleMania", only a limited segment of WWE's fan base participated at this high price point.
Moreover, the cable companies had more favorable revenue sharing arrangement terms. Besides some advertising expenses, cable companies didn't have to share in the cost of content creation and they charged WWE upwards of 50% of the gross revenue for airing the event on its networks as well as handling billing and payment processing. As the WWE didn't own its own cable network it was held hostage to this unfavorable revenue sharing arrangement. This was the sad state of affairs until the rapid technological advancement and disruptive innovation forged by trail blazer, Netflix (NASDAQ:NFLX), intervened, creating a behavioral sea change shift, thus offering the opportunity for owners of valuable content, like World Wrestling Entertainment, to distribute its content in the "over the top model" form. In my own home, we have a Roku 2 and Netflix, and I must say, it's pretty awesome, and yes the WWE Network is available.
With this new model, the value creation is compelling at only $10 per month, with a six month minimum commitment. As a subscriber of the WWE Network, your monthly fee provides you with access to all twelve pay-per view events, as well as over 120,000 hours of content from WWE's thirty plus years of wrestling archives. Due to the fact that the WWE Network is only forty two days old, it's hard to know the future trajectory of its subscriber growth and upside potential. CFO, George Barrios, estimates that including the prospect of cannibalization, break even in this new format is 1 million subscribers, with OIBDA upside of $50 - $150 million if WWE achieves 2 - 4 million subscribers.
For some perspective, let's look at WWE's addressable market, according CEO Vince McMahon, WWE averaged 14 million viewers for its weekly wrestling program aired on NBC Universal's cable networks. Also, WWE, a global brand, has 246 million social media followers. These are massive numbers, so I would argue that if they do convert and capture a small fraction of its fan base, that WWE's OIBDA upside is dramatic and achievable.
2) Upcoming television broadcast renewal negotiation in the U.S. and International growth/popularity
WWE has a powerful television broadcast renewal cycle that kicked off at the start of fiscal year 2014 with deals already signed in the United Kingdom and Thailand. On its Q4 2013 earnings call, management seemed pleased with the new pricing terms of its U.K. deal commencing in 2015. However, the most important upcoming negotiations are taking place in the United States, as NBC Universal's exclusivity period expired at the end of January and WWE has gone out to seek bids for its "Raw" and "Smackdown" weekly cable broadcasting rights currently aired over NBC Universal's cable networks. In fact, WWE has held talk with AMC Networks, Viacom (NASDAQ:VIA), and Time Warner (NYSE:TWC). WWE's CFO has publicly told the press that the deal should be finalized by late April or early May. Armed with excellent quantitative data from Nielsen ratings, including favorable demographics compared to Nascar, WWE has the realistic opportunity to significantly re-price its U.S. broadcasting rights, in line with its strong viewership, which would significantly increase revenue and cash flow generation taking effect starting in January 2015. Outside of the U.S., World Wrestling Entertainment is in negotiation in India for its broadcasting rights. India represents WWE's third most important broadcast country.
Outside of the WWE Network and its television broadcast rights, WWE's strong brand and compelling wrestlers themselves are iconic characters in the eyes of its fans, enabling WWE to successfully generate revenue from the licensing of toys, merchandise, and video games.
Guidance for 2015: This is a quote from CFO George Barrios regarding 2015 guidance:
Now looking ahead, based on our analysis of the value of launch SmackDown compared to other benchmark programs and extensive research regarding consumer interest in our WWE Network, we continue to believe that we can double or triple our 2012 OIBDA results by 2015. Our program shared key determines of value that are attributed to live sports, significant first run hours and the associated gross rating points, a passionate and loyal fan base and 90% live plus same day viewership, which makes WWE content like sports TVR approved.
My view is that the future is bright for World Wrestling Entertainment, given the large addressable global market and the very compelling value proposition for WWE Network subscribers. Moreover, the upcoming catalyst of a re-pricing of its U.S. broadcasting rights contract, scheduled to conclude by early May should help stabilize WWE's share price. Remember, content is king, and given the strong weekly viewership of its "Raw" and "Smackdown" programs as well as 25% of revenues originating from outside of the U.S., not to mention the very real prospect of OIBDA doubling or tripling from 2012 levels, makes WWE an attractive growth stock in the $22 - $24 price range. Lastly, there is also some optionality value that WWE could be acquired at some point in the future, I'm just not sure how much value this has and how to calculate this probability.
Additional disclosure: I bought a modest long position in WWE at $22.23 and plan to hold it for at least thirty days. I was quite pleased that Mr. Market was willing to sell me shares at that price.