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Summary

  • WWE's streaming service will cannibilize its current revenue streams.
  • Streaming content has substantial hidden risks.
  • WWE has a potent case of key man risk.

WWE. A Fundamental Short Opportunity

The WWE (NYSE:WWE), or World Wrestling Entertainment, has been able to generate substantial star power for its iconic "SuperStars" (wrestlers), and commands a near monopoly on televised "professional" (in quotations, because as opposed to amateur wresting, "professional" wrestling is choreographed, scripted, and essentially rigged; see this video) wrestling in the United States. At some point in the 1990s, Vincent McMahon, the controlling shareholder of WWE, started using the term "sports entertainment" [a more apt way] to describe his product.

WWE's stock has rallied handsomely since 2013, from about $8 per share and reached highs of around $30. The stock's most recent rally was attributed to a tweet that came from the firm's IR department proclaiming the most widely viewed WrestleMania (its premier pay per view event) ever, with over 1 million viewers.

A case for a valuation short can be made relatively easily, as the established company is trading at a multiple of 600 times trailing EPS ($0.04). Seemingly a goofy multiple for a traditional media company; it would appear the valuation has something to do with the market's hysteria over anything streaming. However, I will focus on a poor product decision by management that I believe will materially deteriorate future earnings.

What the Business Is All About

WWE essentially contracts talent, who are a combination of body builders, stuntmen, and actors, and has them play out various storylines within the context of the professional wrestling backdrop.

Revenue Breakdown

Category

% of Net Revenues

Live Events (Ticket Revenue)

22

Venue Merchandise (At Live Events)

4

Pay-Per-View Programming

16

TV Rights Fees

32

Consumer Products, Licensing and DVDs (Video Games, Magazines, Etc)

15

WWE generates revenue across several venues. WWE Monday Night RAW, its 3 hour premier weekly event, is consistently one of the most viewed shows on cable, with about 4.8 million viewers. WWE Friday Night Smackdown, attracts about half as many viewers. Television rights fees provide WWE with about a third of its net revenues.

Once a month, the WWE hosts a premier Pay-Per-View event, and their annual flagship event is WrestleMania. As you can see below, it's an expensive proposition to be a WWE fan. The total cost of watching the events annually is $559.44.

Name of Pay-Per-View Event

Date

Venue

Pay-Per-View Cost ($)

Royal Rumble

1/26/2014

Consol Energy Center

44.95

Elimination Chamber

2/23/2014

Target Center

44.95

WrestleMania XXX

4/6/2014

Mercedes-Benz Superdome

64.99

Extreme Rules

5/4/2014

IZOD Center

44.95

Payback

6/1/2014

Allstate Arena

44.95

Money in the Bank

6/29/2014

TD Garden

44.95

Battleground

7/20/2014

Tampa Bay Times Forum

44.95

SummerSlam

8/17/2014

Staples Center

44.95

Night of Champions

9/21/2014

Bridgestone Arena

44.95

Hell in a Cell

10/26/2014

American Airlines Center

44.95

Survivor Series

11/23/2014

Scottrade Center

44.95

TLC: Tables, Ladders & Chairs

12/14/2014

Quicken Loans Arena

44.95

The WWE Network

WWE has come out with a Netflix like product, WWE Network, to stream content to its users. Subscribers can access a library of historical productions, or screen live events, including Pay Per-View programming. With a $9.99 per month fee and a 6 month commitment, subscribers can bypass all Pay Per-View fees, and generate a savings of approximately $440 annually; assuming the said fan would have purchased all the events. Although PPV revenue must be shared with the distributor, it's not clear what the net margins are on either side, as the costs to set up the WWE Network will also be substantial.

Within the first year of the launch, the WWE Network has thus far failed to achieve management's goal of 1 million subscribers, which could translate into about $120M in gross revenue annually (1M users x $10 per month). This was evident from the most recent earnings call, when the CFO George Barrios was responding to soft pitch by an analyst.

My argument is that the WWE Network can (and most likely has already begun to) and will cannibalize the WWE's existing income streams, not necessarily bring in new customers. In addition, the streaming business is fraught with hidden risks that have begun to emerge for players in the space such as Netflix (NASDAQ:NFLX). Net Neutrality is an issue that will be in the spotlight for the coming months. I think it's very feasible in the future to see the ISP providers charge streamers for excess bandwidth users if the laws are reversed. Within the company's most recent annual filing, here is their long winded way of saying their strategy is a do or die one.

From WWE's 10-K:

The Company has spent, and will likely continue to spend, substantial amounts to produce content and infrastructure for distribution of content on our new WWE Network which is scheduled to launch domestically on February 24, 2014. While we have significant experience monetizing content across many platforms, we do not have the same level of expertise in the distribution platforms that will carry our digital over the top WWE Network on a subscription basis and we could experience significant setbacks in such monetization efforts. If, for any of a number of reasons, we are unable to monetize this distribution platform successfully, these additional costs, and the possible loss of very significant revenue from other distribution platforms potentially being displaced, could have a material adverse effect on our operating results. Loss of Pay-Per-View Revenue and Profit. As part of the subscription to WWE Network, we are including programming that we have historically offered through pay-per-view channels. On a pay-per-view basis, such programming resulted in worldwide revenues of $82.5 million and OIBDA of $34.1 million for the year ended December 31, 2013. A majority of these revenues and OIBDA are for domestic pay-per-view distribution. Although we intend to continue distributing this programming through pay-per-view channels domestically after the launch of WWE Network, distributors may decide to no longer carry such programming and we cannot require them to do so. If, for any number of reasons, our audience does not subscribe to WWE Network in sufficient numbers to offset or exceed any loss of pay-per-view revenue, the resulting loss of revenue and profit could have a material adverse effect on our business and operating results.

The adoption of any laws or regulations that adversely affect the growth, popularity or use of the Internet, including laws limiting Internet neutrality, could limit the demand for our subscription service and increase our cost of doing business. In late 2010, the Federal Communications Commission adopted so-called net neutrality rules intended, in part, to prevent network operators from discriminating against legal traffic that transverse their networks. These rules were recently overturned, and the impact of such ruling currently cannot be fully understood either legally or commercially. To the extent that network operators use this ruling to engage in discriminatory practices, our business could be adversely impacted. As we expand internationally, government regulation concerning the Internet, and in particular, network neutrality, may be nascent or non-existent. Within such a regulatory environment, coupled with potentially significant political and economic power of local network operators, we could experience discriminatory or anti-competitive practices that could impede our growth, cause us to incur additional expense or otherwise negatively affect our business. Similarly, to the extent that network operators implement usage based pricing, including meaningful bandwidth caps, or otherwise try to monetize access to their networks by data providers, due to the heavy bandwidth use of audio/visual content, we could incur greater operating expenses and our subscriber acquisition and retention could be negatively impacted. If network operators create tiers of Internet access service and either charge us or our service providers for, or prohibit us from being available through, these tiers, our business could be negatively impacted.

Although WWE have a base of diehard fans, it is a niche product, and cannot in my opinion reach the scale of a Netflix, Hulu or Amazon Prime (NASDAQ:AMZN) because they lack diversity of content.

However, the damage has already been done. Pay-Per-View fees (12% of gross revenues) are likely to evaporate with the advent of the WWE Network. DirecTV (NASDAQ:DTV) and Dish Networks (NASDAQ:DISH) both threatened to exclude further WWE content from their PPV offering when the WWE announced the terms of WWE Network. I believe once the PPV revenue is gone it cannot come back. With this advent, and the lower overall cost of being a subscriber to WWE's premium content, we will see a deterioration of approximately 15% of the company's top line.

For the die-hard fan who would watch WrestleMania one way or another, it's a loss for WWE as they are only receiving, in net revenues, a fraction of the pricing power they would have commanded. In addition, WWE Network will likely cannibalize their TV revenues as well, since subscribers can simply view content whenever they please, without commercials. This is especially potent, now that WWE is renegotiating its agreement with NBC Universal for its televised programming.

One other important risk worth mentioning is the key-man risk associated with WWE's stock. Vincent Kennedy McMahon is not only the CEO & Chairman, he is the creative talent behind the WWE's all important storyline, and a character actor in the content they product. One of Warren Buffett's favorite lines is that one should invest only in companies whose business model is so rock solid they "can be run by an idiot", because "at some point one will." In its current incarnation, Mr. McMahon is irreplaceable to the WWE. He has been the driving force behind their success. Currently 68 years old, Mr. McMahon built up the WWE from a small shop by acquiring rivals and building a national following for his product. In a similar light to Mr. Buffett at Berkshire, it's difficult to imagine a replacement for Mr. McMahon at WWE, and his death or demise is a massive risk to this business.

To summarize, the WWE Network will not likely grow its user base, rather cannibalize their existing revenues. The launch of the product was [at least partially] motivated to capture some of the explosive upside from the streaming names (think Netflix, Amazon), and to that degree management has been successful in propping up the stock price. However, the product appeals to only a niche audience, and is not of interest to the broad market place. As such, the revenue lost will not easily be replaceable, and the product launch will fail to generate shareholder value.

Source: World Wrestling Entertainment: A Fundamental Short Opportunity