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World Wrestling Entertainment (NYSE:WWE) dropped 7% Monday due to earnings guidance well below expectations (see earnings projections here). It said earnings will be between $.08 and $.10 a share on Feb. 10, much less than analysts' expectations of $.16 a share. Originally, the stock had dropped over 14%, but then quickly recovered half its losses.

WWE has been losing market share since 2008. Losing popularity in this kind of a brand has a snowball effect to earnings. Less people watch the show, then less people talk about it, then less people buy the T-shirts, etc.

Is "fake" fighting losing its popularity? It has become a show targeted for boys aged between 8 and 18. WWE used to be largely for adults, and had adult themes to it. Now, it's more "PG". To be an adult and watch it and buy its products would be somewhat of an embarrassment. Adults also are the ones that buy the pay-per-view and if they've lost interest, they're not going to buy it as often just for their kids. Pay-per-views are WWE's biggest revenue generator. Most of the fans also tend to be people in Middle America in the lower income brackets. These areas also typically tend to have big fans of mixed martial arts competitions.

The growing popularity of mixed martial arts competitions is taking away from the staged wrestling fan base. How can someone take it seriously when they are also fans of real fighting matches? After watching the "real thing", I would think it would be tough to get back into and enjoy the staged show as much because the illusion would stand out a lot more.

Zuffa LLC, the parent company for Ultimate Fighting Championship, broke records for revenue in 2010, generating $411 million in gross pay-per-view revenue for 16 events. The top drawing card is heavyweight fighter Brock Lesnar, who, ironically, left WWE to fight in UFC and became the heavyweight champion.

Then there's also Strikeforce that is gaining popularity quickly, as well as other smaller organizations that have mixed martial arts competitions.

WWE is showing a steep decline of 3 million pay-per-view buys in 2008, to 2,593,000 in 2009, to about 2 million in 2010.

Although declining on the home front, WWE has maintained strong viewership worldwide, and 50% of its pay-per-view buys come from overseas in countries like the United Kingdom, Italy, Australia, Mexico and Japan.

However, UFC is fighting hard (no pun intended) to gain popularity overseas in those countries, and is succeeding. For example, it has lots of events in the UK with British fighters. Many of the best Japanese fighters are moving to fight solely in the UFC. Fight fans know that the best fighters generally go to the UFC. If WWE gives up market share to mixed martial arts and declines in foreign markets, it will see further earnings declines.

At some point, WWE will have to cut its dividend, and that's why I think it's a good short opportunity now. Once the dividend gets cut, the stock will tank further.

WWE has been paying this high dividend of 36 cents a quarter for awhile now even though it doesn't have the free cash flow to pay it, and this has been eroding their cash base. With a trailing EPS average of .1875 a quarter, and a dividend of .36 a quarter, they are spending .1725 per share out of their cash. This amounts to $12.75 million a quarter. It helps that the McMahon family is giving up 33% (0.12 of 0.36) of quarterly dividends on shares that they own to ensure all other shareholders continue to be paid. However, .24 is still far above their quarterly EPS.

This quarter, with earnings of only about $.09 a share, it is well under their dividend payments. If WWE doesn't cut their dividends this quarter, they are severely bleeding cash. It is inevitable that they will have to cut their dividends at some point, or go insolvent. Other than that, their saving grace would be to recreate their brand and attract a whole new slew of fans. That seems unlikely to me.

WWE does have $179M in cash and only $3M in debt. It can hold out for many more years paying the same dividend if it wanted to, but its fundamentals would still suffer. At EPS of .36 a year, and at its current $12 share price, that gives it a P/E of 33. That's the kind of P/E for a growth company, not one that's deteriorating.

My prediction is the stock will go back to $9 a share a year from now like it was during the peak of the financial crisis.

Source: World Wrestling Entertainment's Disappointing Earnings Guidance Is Bad News for Its Dividend