MSG Networks - A Nice Little Franchise

| About: MSG Networks (MSGN)

Summary

True operating earnings are masked by transition costs.

Comparable private market transaction implies significantly higher share price.

Cord shaving fears are likely to be overblown.

Introduction

Early October 2015 Madison Square Garden (NYSE:MSG) has been separated via spin-off from MSG Networks (NYSE:MSGN). MSGN is a regional sports network (RSN) with 2 channels: MSG and MSG+. MSGN has an estimated 8.2mln subscribers in the New York area. Their main asset is a 20 year license to broadcast home games of the New York Knicks and Rangers. They also have licenses for NY Liberty, NY Islanders, New Jersey Devils, Buffalo Sabres, Major League Soccer's Red Bulls and the Westchester Knicks.

MSGN sells their programming to distributors: e.g. Cablevision (NYSE:CVC), Time Warner Cable (NYSE:TWC), FiOS (NYSE:VZ) for a fee per subscriber (affiliate fee). A small percentage (10-15%) comes from advertising.

MSGN is controlled by the Dolan family. The Dolans also control AMC Networks, Madison Square Garden and are currently in the process of selling Cablevision to Altice.

Share Price

$17

Shares out (A+B)

74.73mln

Debt

$1,537mln

Cash

$213mln

Tax liability expected to be paid in 2016

$152mln

Click to enlarge

Valuation

The business is very profitable and growing. With AOCF margins (EBITDA + share based compensation, the preferred operating metric) increasing from around 40% in 2011 to 50% in Q1 2016 and revenues growing 11% p.a. over the last 3 years (excluding Fuse). Capex is minimal at around 1% of revenues which leads to FCF conversion ratios of over 50%.

Unfortunately investor relations are a bit light on information. There are no investor presentations and no call transcripts. Besides segment information for the combined company pre-spin there is only a spin-off document for MSG and a 10-Q for MSGN for the quarter ending September 2015.

MSG is the owner of the Knicks and the Rangers and they have renegotiated the license agreement with MSGN as part of the spin-off transaction. The license runs for 20 years with an initial increase of $49mln to $130mln in 2016 and annual fee increases thereafter. Had the license been $130mln during 2015 Segment AOCF would have been $295mln instead of $344mln and the AOCF margin would have dropped from 54% to 47%.

1st Quarter 2016 (ends Sep-2015) is the first quarter to be reported after separation although the spin-off had only been consummated early October 2015. AOCF for the 1st quarter 2016 has come in at $51mln or $205mln annualized despite 4% in annual revenue growth. According to their 10-Q AOCF has been hit by $27mln of transitional costs that they don't expect to incur going forward. Adjusting for it gives an annualized AOCF of $313mln.

Comparable Private Market Transaction

Rupert Murdoch has been acquiring a 49% stake in a very similar company in 2012, the YES Network. The YES Network is the RSN (regional sports network) of the New York Yankees. In 2014 he has increased his stake to 80%. Murdoch has paid an estimated EV/Revenue multiple of 7.15 and an estimated EV/EBITDA multiple of ~15.

Applying the same multiple to MSGN's adjusted 2015 results would yield $40 per share or 135% upside to the current share price.

Licenses

RSNs pay a license fee to sport teams to carry their home games in local markets. The licenses are usually of a long term nature. If these licenses are up for renewal they likely command higher fees which would pressure earnings. In case of MSGN the only license up for renewal that could impact earnings in the short term is with the Buffalo Sabres. Assuming an annual increase of 7% p.a. over the last 10 years from a base of 15mln would imply a 30mln fee going forward. This would negatively impact AOCF by around 5%.

The majority of licenses are with MSG which is also controlled by the Dolan family. The total fee payable to MSG is 130mln for the year 2016. The fee increases by an estimated 7% p.a. until 2020 and 3% p.a. thereafter until 2035. For comparison YES's long term license with the Yankees increases 5% p.a. for 30 years. In order to compensate for the increase in license fees by 2020 MSGN's revenues would have to increase by 2% p.a.

Team

MSG owned

License fee in mln p.a.

End date

Last renewal date

NY Knicks

Yes

100

2035

2015

NY Rangers

Yes

30

2035

2015

Westchester Knicks

Yes

NY Liberty

Yes

NY Islanders

No

27

2030/31

2000

NJ Devils

No

24

2024/25

Buffalo Sabres

No

10-15

2016/17

2006

Red Bulls

No

1.2 (estimated)

after 2017

2014

Click to enlarge

Cord cutting/shaving

MSGN charges an estimated $3.29 per channel in affiliate fees. Since 2012, fees have increased by approximately 11% p.a. This compares to YES Network, which charges an estimated $3.36 with 4% p.a. in fee increases over the same period. Including Sports Net New York affiliate fees are approximately $12.45 per month for all three RSNs. This is a lot compared to the average cable bill of around $100 per month and might be a good way for consumers that are not interested in sports programming to cut costs.

On the other hand RSNs can reach large audiences for prime time events pulling ratings above 4 and even higher for special games like Derek Jeter's final game at Yankee Stadium which pulled above 10.

For comparison NBC Sunday Night Football, the most watched program in the 18-49 age group, achieved an average rating of 7.3 in 2014/15 including Super Bowl.

It is unclear how many consumers might choose to drop RSNs when offered unbundling options. A survey found that only 35% of cable customers would pay for ESPN if they were asked to individually select their channels.

Threatened by declining subscriber numbers and increasing licensing fees all RSNs are in the same boat. When Verizon's FiOS tried to unbundle sports content last year ESPN, Fox and NBC Universal threatened to sue for breach of contract. Lately Verizon seems to comply and sports content will be reintegrated into their skinny bundle offering.

Legal contracts thus make it tough for cable providers to unbundle certain content. Not to forget that some cable providers are also owners of sports content. For example Comcast (NASDAQ:CMCSA) owns NBC Sports and Sports Net, Time Warner Cable owns TWC Sports Channel and DirecTV Sports owns Root Sports Southwest. Presumably these cable providers have no incentives to unbundle sports content. Also the content owners are doing a good job of limiting online access to sports content. For example a cable subscription is needed in order to access ESPN online.

Opportunity for growth

MSGN's revenue has increased 4% in Q1 2016 vs the prior year despite a low single digit reduction in subscribers. If revenues could increase at the same rate until 2020 EBITDA would increase by 55mln despite escalating license fees. An EBITDA multiple of 15 would value MSGN at $50 per share. Assuming that over 5 years around $1bln in free cash-flow could be used to pay down debt, the per share value would further increase to around $64.

Advertising revenues

Besides raising affiliate fees faster than subscribers can resign increasing advertising fees could be another source of revenue growth. Currently only a small percentage of revenues are made from advertising fees, approximately 10-15%. ESPN on the other hand derives ~40% of their revenues from advertising fees. That advertisers increasingly focus their ad dollars on live sport events (35% increase for the "big four" broadcasters over the last 5 years) should provide some tailwind for MSGN to improve their revenue mix.

Catalysts

  • Investor call on 5th February
  • Elimination of transition costs in the next few quarters
  • Continuing revenue growth despite subscriber losses

Disclosure: I am/we are long MSGN.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article does not constitute investment advise. I might add or reduce the position at any time without giving any notice. Please do your own research.