True Value Of Jeremy Lin To Madison Square Garden Is Overrated

| About: The Madison (MSG)

Jeremy Lin has been on a tear recently, as have shares of the Madison Square Garden Company (NASDAQ: MSG).

For those that do not know, Jeremy Lin is the breakout star of the New York Knicks basketball team. After moving around basketball teams and doing nothing much other than sitting on the bench for the last few years, the Knicks decided to give Jeremy one last chance. Lin played his first game with the Knicks on February 4 and earned himself 25 points. He has done exceedingly well in the games that followed. In fact, he has had the best start of any NBA player ever.

MSG Share PriceSince Jeremy Lin's started with the Knicks, the share price of MSG-- the parent company of the New York Knicks-- has appreciated by nearly 10%. Not surprisingly some are saying there is a correlation (even causation) between Lin's performance and the share price of MSG.

If this is true, then perhaps the tale of Jeremy Lin can serve as a reminder that good companies (or players) do not necessarily make good stocks.

MSG was spun-off from Cablevision Systems Corporation (NYSE: CVC) in February of 2010. Since the spin off, MSG has been trading at an average P/E of 28x TTM earnings and since August 2010 (the release of the 10Q for the period ended June 30, 2010) MSG has been trading at 24x TTM earnings.

The following chart shows MSG's TTM P/E since the spin off.

MSG Price Earnings TTM

With the recent run up in MSG's share price, it now trades at nearly 32x TTM earnings.

Assuming the Jeremy Lin effect does not increase valuation but only increases earnings, earnings would have to be just under $1.35 per share on an annual basis to justify the current share price of $32.32. This represents an increase to the trailing twelve month earnings of nearly 40%.

One gets the sense that a 40% increase in earnings resulting from one player seems unlikely. Upon further examination, this sense is reaffirmed.

MSG operates 3 divisions, MSG Media, MSG Sports and MSG Entertainment. The MSG Entertainment business revolves around live entertainment (e.g. the Rockettes) and therefore should not be materially affected by Jeremy Lin. MSG Media manages a variety of sports related networks, including some (e.g. those relating to hockey's NY Islanders and NJ Devils) that are not related to teams owned by MSG. Finally, MSG Sports owns and operates sports franchises, namely the Knicks (part of the NBA) and the Rangers (the NHL) but also the Liberty (the WNBA) and some minor league teams. Therefore, if Jeremy Lin were to have a material effect on MSG's earnings, it would appear in one of the latter corporate divisions.

For simplicity I will assume that when it comes to MSG Sports and MSG Media, the Knicks and Rangers are the only teams that drive EPS. Without this assumption the final conclusion would only be stronger.

The hockey season runs from around the start of October to mid April, with the playoffs concluding in June. The basketball season (normally) starts at the end of October and ends in mid April, with the playoffs concluding at the end of May. Therefore, unsurprisingly the three month period ending in September is the worst for the MSG Sports division, while the three month period ending March 31 (e.g. when the Knicks and Rangers are playing for the full three months) has historically been the best. Somewhat surprisingly, the income driven by MSG Media's is relatively flat throughout the year-- perhaps due to league revenue sharing and long term contracts.

Therefore, although Jeremy Lin may drive more viewers to MSG Media, his effect on the consolidated bottom line will likely be most, if not totally, seen in the MSG Sports division. In other words, through ticket sales (unlikely due to the already capacity crowds for Knicks games and near capacity crowds for the record Rangers games) or merchandise.

Assuming a 50:50 split between the revenue generating ability of basketball and hockey (how I reach this conclusion is a bit of a long winded explanation based on the NBA lock out and relative lengths of the NHL and NBA seasons), Lin must increase the revenue of MSG Sports that is associated with basketball (e.g. 50% of MSG Sports revenue for the 3 fiscal quarters during which basketball is played) by a factor of 3.5. (That is the result obtained by (i) multiplying approximately $1.1B - MSG's revenue for the last 12 months by (ii) 0.4 - the required increase to earnings, (iii) adding to the product $181M -- a proxy for annual basketball revenue being the 50% of the revenue of MSG from October 2010 to June 2011 and (iv) dividing the entire amount by the $181M).

Having one player increase revenue by 3.5x seems like a nearly impossible feat. Therefore, if the recent appreciation in MSG's share price is really driven by the success of Jeremy Lin, we should expect the share price to decline as investors look past the hype and at the fundamentals.

I hope that this analysis has shown that although Jeremy Lin has had a big impact on the Knicks, his impact on Madison square Garden Company has been overrated.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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