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The Boyar Value Group was established in 1975. Through their research division, they publish Asset Analysis Focus and Boyar's Micro Cap Focus which provides some of the world's largest hedge funds, family offices, mutual funds and sovereign wealth funds with in-depth research reports utilizing a private equity approach to public markets. In addition, since 1983 Boyar Asset Management has been managing money for institutions, individuals, and family offices. We discussed their recent letter to MSG Chairman/CEO James Dolan, the similarities and differences in the new issue market today compared to the dot-com boom and how they are taking advantage of the shorter investment holding period.
Seeking Alpha: Walk us through your investment decision making process. What area of the market do you focus on and what strategies do you employ?
The Boyar Value Group: As opportunistic investors, we keep our eyes open for chances to buy the proverbial dollar for 50 cents. We focus primarily on U.S. equities, and we are agnostic both to sector and to market capitalization. When we purchase stock or make any other investment decision, we do so based on the findings of our in-house research. Since 1975, we have made that same research available on a subscription basis to some of the world’s best-known money managers. By supplying independent research to a sophisticated audience, our team is able to interact with some of the world’s leading investors, listening to their insights on companies they believe to be undervalued and benefiting from their candid feedback on our investment ideas. Providing research to such a knowledgeable group (while defending our investment theses on the companies we profile) has made us significantly better investors—not least because the process of formally putting that thesis down on paper is a great aid to the investment process as it forces you to organize your thoughts and put together a comprehensive investment thesis.
We seek to uncover undervalued businesses using a variety of approaches, including the business value, hidden asset, and franchise approaches, as well as by analyzing special situations. Through the business value approach, we evaluate a company’s long-term earnings power and financial strength, assessing its competitive advantages and capital allocation track record. Conversely, through the hidden asset approach, we identify companies holding valuable assets that are not reflected on their balance sheet—providing us with a margin of safety in the decision-making process. (For example, when we first analyzed The Madison Square Garden Company, we discovered that it was carrying its air/development rights on its balance sheet at a value of $0—an asset that we saw as being worth potentially hundreds of millions.) The franchise approach has been another source of profitable investment ideas: we have generally found strong consumer franchises that are masked by an unrelated corporate name to be a fertile source of investment opportunities. (News Corp is a good modern-day example of this—despite its lack of name recognition, it owns or holds a stake in a number of well-known consumer franchises, including The Wall Street Journal and Realtor.com.) Finally, we look for special situations, such as spin-offs: companies are often initially mispriced after being spun off when shareholders in the parent entity are forced by their investment mandate to sell their holdings in the smaller company. Additional special situations can include omission from a major index, lack of Wall Street coverage, and removal from an index.
After we publish an initial report on a company we consider whether we should purchase the stock for our money management clients. Because we believe in having a relatively concentrated portfolio, we do not buy every stock we profile—instead, we select the companies we believe to be appropriate for a given mandate.
At Boyar Asset Management, we use an individualized strategy for each account. When a client comes to us, we don’t turn to a model portfolio; instead, we begin with a blank canvas, creating a portfolio that suits the client’s unique needs—how concentrated the client wishes to be, for example, or whether the client wants to focus on dividend paying stocks. Additionally, unless a client specifically requests it, we do not become fully invested immediately. We prefer to invest slowly, entering positions in a disciplined manner.
SA: You stated that you are agnostic to market cap in your investment decision making process. Do you employ a different approach when evaluating small or even micro cap companies?
BVG: We do not; in general, we use the same approaches to evaluate smaller companies for our research publication and our client accounts. However, within smaller-cap companies, we do tend to favor companies whose management teams are strongly aligned with shareholder interests. Management teams that have a significant amount of their net worth tied up in the business they manage are more likely, in our view, to make decisions that are in the best interests of all shareholders—whereas it isn’t uncommon for the CEO of a small/micro-cap company who has minimal share ownership to be more concerned with his or her annual salary than with unlocking shareholder value. In 2018, REIS, an institutional database company serving the real estate industry, which had been featured in our micro-cap publication and which was owned in certain client accounts, was acquired for approximately 3x the value at which we had profiled its shares in 2010. At the time of our initial write-up, insiders—including the company’s cofounders—controlled ~30% of outstanding shares. Likewise, Townsquare Media, which we have also featured in our micro-cap research and which is owned in certain client accounts, currently boasts an inside ownership level of 6%, with several of the firm’s founders among the shareholders. In addition, Oaktree Capital Management, which was instrumental in the firm’s formation, currently owns about 45% of the company’s outstanding shares, so that its interests are strongly aligned with those of other common shareholders.
SA: Do you pay attention to insider buying and selling as part of your investment and research process?
BVG: Absolutely. We monitor both purchases and sales made by company insiders, but we give more weight to insider purchases (especially those made in large dollar amounts). An executive may sell a stock for many reasons (to buy a new house or a vacation home, to pay for a child’s college education, etc.) but usually has only one reason for making open market purchases—the belief that the company’s stock is undervalued. With Discovery Communication’s shares selling off by ~30% following the announcement of the acquisition of Scripps, John Malone purchased 332,523 shares at $19.72, today those shares trade at ~$27.40. More recently, Mohawk whose shares have been under significant pressure (going from a high of $282 in 2017 to $117 today) as a result of fears of disruption of the flooring industry by luxury vinyl tile has been the subject of significant open market purchases made by director Filip Balcaen who purchased ~$110 million worth of shares at an average price of $157 in 2018 and recently added to his position by buying another $1.3 million at $110 per share. While Mr. Balcaen’s purchases thus far have not worked out the way John Malone’s have, we believe over the long-term he will be proven to be correct and we are comfortable investing alongside a director with so much skin in the game (he owns almost 3% of the company).
SA: What are some of the most crowded trades in the market today? Is a catalyst required for a re-rating or is valuation alone enough of a catalyst?
BVG: We are particularly concerned about the rise of passive investing and ETFs. As money flows in this direction at an increasingly rapid pace because of the liquidity and low fees, stock price movements have begun to be affected in significant ways. Examination of the companies we follow reveals that an increasingly large number count passive investors among their biggest owners—with passive vehicles sometimes owning well in excess of 15% of a given company. As a result, a significant percentage of the float is making the decision to buy or sell not based on fundamental analysis (i.e., the attractiveness of the particular security’s price/valuation) but rather because a stock is included in a given index or meets a quantitative factor requirement (e.g., a certain P/E or price/book ratio). Such a large a base of passive investors has increasingly prompted exaggerated stock price moves (in both directions), because today’s universe of investors who trade on fundamental information is significantly smaller than the number of shares outstanding would suggest. We do note, however, that such exaggerated share price moves could lead to opportunities for patient long-term active investors.
Our concern about passive vehicles is largely related to liquidity. What happens, for example, when everyone wants to head for the exit at the same time? In a recent interview, Michael Burry—one of the investors who made a fortune predicting the housing crisis back in 2007—said the following:
In the Russell 2000 Index, for instance, the vast majority of stocks are lower volume, lower value-traded stocks. Today I counted 1,049 stocks that traded less than $5 million in value during the day. That is over half, and almost half of those—456 stocks—traded less than $1 million during the day. Yet through indexation and passive investing, hundreds of billions are linked to stocks like this. The S&P 500 is no different—the index contains the world’s largest stocks, but still, 266 stocks—over half—traded under $150 million today. That sounds like a lot, but trillions of dollars in assets globally are indexed to these stocks. The theater keeps getting more crowded, but the exit door is the same as it always was. All this gets worse as you get into even less liquid equity and bond markets globally.
Simply put, today’s investors are facing conditions eerily similar to those that helped give rise to the housing crisis (i.e., Wall Street’s packaging illiquid securities into securities that would be perceived as being liquid). Although ETFs were tested by the 2008 market crisis, they were a significantly smaller percentage of the overall market—but now that they represent a more meaningful percentage of investment dollars, we’re concerned about the role they might play in a crisis.
SA: How do you see the future of active management playing out? What types of active managers will - and will not - survive given the well-known headwinds facing the industry? Are there any specific steps they can take to prove their worth?
BVG: We’re admittedly biased, but we see bright prospects for active management. Active investors could prove their worth by outperforming, but in the current environment, passive investing has significantly outperformed active management for quite some time. As a result, investors are questioning, quite reasonably, the fees they see themselves as having paid to underperform the market. But we encourage investors to think about why passive investing has been outperforming, calling their attention to what we see as essentially a self-fulfilling prophecy: The largest components of the index continue to increase in price, because investors view their shares as safe. As a result, the share price advance increases the company’s weight in an index—which drives still more buying. At some point, we expect the importance of individual securities’ valuations to matter once again—at which point investors who own undervalued companies will prosper at the expense of investors who made investment decisions without regard to valuation/price.
It is worth noting that according to Bloomberg, since the market bottomed in 2009, the S&P 500 has advanced ~336%. Almost 15% of that advance was the result of the performance of just three mega cap stocks (Apple, Microsoft and Amazon), so while the market has advanced markedly since the bottom, the performance has not been democratic. If you look at what happened to the S&P 500 from January 1997 to March 2000 (which was the peak of the dotcom bubble), the S&P 500 advanced 88%. However over 20% of that advance was the result of just three mega cap stocks (Microsoft, Cisco and General Electric). It is worth mentioning that after the dotcom bubble burst, many active value managers who significantly underperformed during the dotcom mania, more than made up for any underperformance in the years subsequent to the crash. We would not be surprised if a similar phenomenon occurs.
SA: Given the increasing reach for yield among investors, what are some unconventional (or at least unpopular) but attractive income ideas? Where should investors not be looking for yield?
BVG: This prolonged low-interest rate environment has investors looking for yield in all the wrong places. Each morning, Fidelity provides us with a sheet listing the typical yields investors can expect for given types of debt. Currently, investors wishing to achieve a yield of over 3.5% have only two choices of fixed income: BBB bonds having a maturity of 20 years (3.87% yield) or those having a final maturity of 30 years from now (3.67% yield). As a result, today’s investors are being asked to take on tremendous risk for very modest yields. At some point, rates will rise (although when they will is still anyone’s guess)—and investors who are buying low-rated corporate debt with a long duration could find themselves exposed to massive losses should they wish to sell their holdings if interest rates rise.
While there are certainly risks involved in doing so, we believe that long-term investors should consider investing in some of the large money center banks, such as JPM and BAC. JP Morgan Chase, the world’s second most profitable company, behind Apple, has a fortress like balance sheet, sells at roughly 11x earnings, and yields over 2.8%. Its dividend payout is about 30%, so it has the capability to materially increase this distribution over time. Seeing a flattening/inverted yield curve, investors have shunned the sector—but we believe that those who take a longer view can expect to be rewarded.
After 2018’s selloff, a significant amount of the money that has come back into the market has gone into companies that offer steady dividends, driving up their valuations. Such companies are often perceived as bond substitutes, with investors—rightly or wrongly—seeing their profits as less vulnerable to economic contractions. As a result, according to data compiled by the Bank of America, equity fund flows into utilities, consumer staples, and real estate shares have accelerated. Utility firms that are offering yields of about 3.15% look particularly pricey by historical standards: they currently fetch an average of ~19.2x trailing earnings versus their 20-year historical average of just 14.8x earnings.
The poster child for this “utility mania” is American Water, which currently commands a price/earnings ratio of ~35x—the kind of valuation more often associated with a fast-growing technology company. Unfortunately, however, investors’ unwavering faith in the safety of utility stocks doesn’t have a solid basis in the historical record. The sector’s recorded volatility is roughly in line with that of the S&P 500, and its peak-to-trough performance during recent big selloffs has been similar to that of the broader index. Indeed, during the aftermath of the 2000 stock market bubble, utilities actually fell by more than the leading stock market indices did.
SA: For readers who may not have read it yet, can you summarize your recent letter to James Dolan about how to unlock (or at least not destroy) value at Madison Square Garden (NYSE:MSG)? Since this involves a venture in Vegas, what do you think the odds are he abandons the Sphere project and adopts one (or more) of your ideas?
BVG: MSG which owns trophy assets like the Madison Square Garden arena, the Knicks, the Rangers and many other valuable assets has an enterprise value of a little under $5 billion. In our opinion, the company is massively undervalued. To provide some context, Forbes estimates the value of the Knicks alone to be $4 billion. Today MSG trades at $253, and if you do a sum of the parts analysis, you can get to ~$400 per share pretty easily. James Dolan over the years has done a good job at creating value for shareholders despite the persistent “Dolan Discount” the Street assigns to entities he controls. He however is planning to build essentially a concert venue in Las Vegas (and a subsequent one in London) called the Sphere that his contractor estimates will cost $1.7 billion. We think due to the price tag and lack of visibility on the potential return on investment, it is too risky of a project to take. The Street due to the recent price action seems to agree with our thinking. We recently wrote a letter to James stating that he should either abandon the Sphere project or sell the teams and take the company private so he can pursue the Sphere on his own dime. We also sent the letter to each of the members of the Board of Directors. Since he has voting control of the company, it is hard to handicap what he will do, but we would not be surprised if he at least ends up selling all or part of the sports teams. It is worth noting that there are two well-known activist investors on the shareholder registry and activist investor Nelson Peltz is a member of the board.
SA: What are the similarities and differences in the new issue market today compared to the dot-com boom? Are any of the recently public unicorns a short or just an avoid?
BVG: The new issue market is reminiscent of the dot-com boom—and most of us remember just how badly that ended. Today’s new issues have much more revenue and have been in business far longer, but their lofty valuations are just as troubling. The vast majority of the companies going public today are “unicorns”—privately held startups valued at over $1 billion, most of them unprofitable. They financed their growth via the private equity market, but now their investors want to liquefy their investments via the public markets. Interestingly, a great many are doing so simultaneously—perhaps foreseeing a more difficult market environment on the horizon, perhaps worried that the door to the new issue market is about to close. And perhaps, too, sophisticated investors fear that the elevated valuations currently being accorded these companies will become less attractive. So far, 2019 is on track to be one of the biggest years on record for public offerings, as measured by the amount of money raised. By the end of June, 108 companies had gone public in the U.S., raising $38.8 billion—the largest sum by that point in the year since 2000, at the height of the dot-com boom. A prime example of the frenzy over new issues in 2019 is RealReal Inc. (founded by Julie Wainwright, the former CEO of Pets.com, which became a symbol of the insanity of the dot-com bubble), which soared 45% in its first day of trading. RealReal’s revenue increased 55% from the prior year, to $200 million, but the company incurred a loss of $75.8 million during that same time frame. The San Francisco-based company sold 15 million shares, raising $300 million, for a market valuation of $1.65 billion. Or consider Beyond Meat, which expects to reach $210 million in revenue in 2019. At the end of May, the company went public at $25 per share, and as of September 5 it was selling for $160 per share, for a market valuation of $9.6 billion—almost 2x the market value of Wendy’s.
SA: Are out of favor industries good places to find attractive investment opportunities?
BVG: Over the long run, stock markets are fairly efficient. In the shorter term, however, valuations can go to extremes on both the low and the high sides. Investors usually create these anomalies by piling into whatever is in vogue while indiscriminately selling whatever has fallen out of favor.
For example, in 1992, when a bubble in the pharmaceutical industry popped, drug stocks lost 40% of their value, on average, as growth slowed and profits began to erode due to increased discounting and competition from generics. As a result, when the Clinton administration tried to enact healthcare reform, some investors began questioning the long-term profitability of the pharmaceutical industry.
As we are contrarians, we wrote an extensive report for our research clients outlining why we saw this series of negative events as having created an excellent opportunity to invest in pharmaceutical stocks. When an industry falls out of favor on Wall Street, herd behavior sometimes drives the market caps of companies within that sector far below what an acquirer would pay for the entire company. As a result, buying opportunities await discerning investors who have the patience to let the industry right itself. Of course, it’s anyone’s guess when the tide might turn—investors might need to suffer through years of underperformance before their investments pay off. Doing so is often well worth the wait, however—in our example, investors who looked past the alarmist headlines and purchased stock in pharmaceutical companies during a time of uncertainty were rewarded when the industry bounced back a few years later.
SA: The investment holding period among institutional investment managers has compressed over the years. In 1990, institutional investment managers turned over their portfolio every ~5 years, today it is about every year. How do you view this trend and are you able to capitalize on it?
BVG: We believe that investing with a long-term horizon is a competitive advantage for us. The volatility associated with portfolio turnover presents us with opportunities since we are typically able to look past headwinds that may last a quarter or two, but which most managers can’t due to the pressure to generate outperformance on a yearly or even quarterly basis. When we see a company penalized because it has decided to invest in its business that negatively impacts near term earnings/cash flow, but should help drive long term growth we’re inclined to give the company the benefit of the doubt (especially if insiders own a significant amount of stock). A recent example of this is UniFirst (where insiders own over 20% of the company), a uniform rental service firm that we recently profiled when its shares were under pressure due, in part, to a temporary increase in capital expenditures to increase efficiency and drive long term growth. After boosting its capital expenditure outlook in June 2018 for FY 2018 (followed by a material step up communicated for FY 2019 in October 2018), UniFirst’s shares declined by ~30% at which point we profiled the shares in our research service in early 2019. Subsequent to our profile shares have retraced all of those declines and then some. Despite the run-up in the shares (an ~40% increase since our profile) we continue to believe the Company’s valuation to be attractive and note that the Company operates in an oligopoly type industry that offers a favorable competitive landscape and good growth opportunities.
SA: Can you give us a current stock idea?
BVG: MSG Networks is an example of a stock in an out of favor industry. We think the Street’s view of the long-term prospects of the business are extrapolating recent negative trends as if they would occur forever. The company has done an excellent job of capital allocation. They have used the massive free cash flow they generate to significantly delever, and they just announced a massive share buyback authorization. Shares have gone from ~$28 per share to $17. This share price weakness reflects a number of factors, including precedent industry transactions that have occurred at lackluster multiples, disappointing team performance of the Knicks and Rangers (key content broadcast on MSGN’s regional sports networks [RSNs]), an acceleration in subscriber losses to MSGN’s RSNs, and the Knicks’ inability to land a marquee free agent despite the hopes/expectations of the team’s fans—and, apparently, a few of MSGN’s investors. Despite these factors, we believe that the Company should continue to generate good future growth in revenue and profitability and produce strong levels of free cash flow (FY 2018 FCF: $207 million; FCF yield: 15%). Although the outlook for the cable networks industry is uncertain, MSGN’s differentiated live sports content should enable it to navigate industry challenges while also offering meaningful growth opportunities, especially on the advertising front.
Despite the disappointing multiples of recent precedent industry transactions, including Sinclair’s purchase of 21 RSNs from Disney (at ~6.5x on an EV/EBITDA basis) and the Yankees’ acquisition of an 80% stake in its RSN from Disney (although details have not been made public, we estimate the YES Network transaction occurred somewhere between ~8.75x and ~11.0x), we note that these transactions were the result of a forced sale that needed to be completed within a set time frame. It should also be noted that the implied value of the RSNs based on Disney’s initial offer for 21CF in December 2017 was ~12.5x (on an EV/EBITDA basis) but that Disney had to pay 36% more to complete the 21CF transaction (Comcast emerged as a competing bidder for the same assets, including the RSNs), implying an ~17.0x multiple for the networks (note: Rupert Murdoch stated the initial RSN implied value of 12.5x in announcing the transaction with Disney and Disney ultimately agreed to pay 16.2x for certain of 21CF’s media assets including its RSNs). Admittedly, Disney’s primary motivation for the transaction was its interest in certain global media assets and a desire not to see these assets end up in the hands of a competitor. Nevertheless, Disney did see value in the RSNs and initially thought that they would complement its national ESPN cable networks platform.
The NY Knicks are a big driver of the overall economics of MSGN’s RSNs, and recent team performance has been poor—and that is putting it kindly. Despite the disappointing results of the Knicks and the Rangers, the Company has posted solid results owing to a business model that is characterized by a large base of recurring revenues. Approximately 90% of the Company’s revenue is derived from affiliate fees received from pay-TV distributors, secured via long-term contracts (~5-7 years), which contain annual price escalators. Although team performance could have an impact on MSGN’s negotiations with its distributors, we note that MSGN operates in a highly competitive market that includes overbuilders (FiOS, RCN, etc.). Accordingly, we believe many distributors are reluctant to drop content that appeals to a highly passionate fanbase for fear of losing subscribers to the higher-margin products of their other businesses (e.g., broadband). In addition, the Company’s content is differentiated and is one of the only genres (other than news) that is predominantly viewed live. This is important because distributors receive select advertising inventory on MSGN’s RSNs, and this inventory is becoming increasingly sought after by prospective advertisers. It also should be noted that the Company recently completed a large renewal with a major distributor. Thanks in part to the visibility that the renewal provides, management reiterated its belief in its ability to generate continued growth in affiliate revenues.
After 3 consecutive years of improving subscriber trends (with MSGN’s RSNs having seen a deceleration in the decline of subscribers), the rate of subscriber decline accelerated (on a sequential basis) in FY 2019. Although the subscriber trends are worth monitoring, we believe that there are a few factors that should help stabilize MSGN’s subscriber trends. MSGN’s RSNs are carried on only two virtual multichannel video programming distributors (vMVPDs): DirecTV Now and fuboTV. MSGN does not have distribution with the top 3 vMVPDs (Sling, YouTube TV, Hulu + Live TV), but we believe that it could garner carriage in the not-too-distant future, and we note that two of its peer RSNs in the New York metropolitan region have secured broad distribution with vMVPDs (notwithstanding Dish’s recent decision to drop the YES Network on its Sling vMVPD service). In addition, we believe that there could be distribution opportunities with tech companies such as Facebook, Amazon, and Twitter, all of which have become increasingly active in professional sports programming.
We have historically viewed advertising as meaningfully underpenetrated at MSGN’s RSNs. At present the Company generates just ~10% of its overall revenues via advertising—well below the ~50% commanded by mature cable networks. In our view, there are a number of factors that could have a meaningful impact on MSGN’s future advertising revenues including the Company’s differentiated sports content, sports wagering, and branded content initiative. Live sports is becoming increasingly attractive in today’s fractured media landscape because of the genre’s ability to command large live audiences. Accordingly, we believe that the genre will command good future pricing power, with improvements to team performance potentially serving as a meaningful catalyst. According to MSGN management, sports wagering presents an “enormous” opportunity for the Company, and the prospect for mobile sports betting in two of MSGN’s key markets, New York and Connecticut (with sports betting already legal in NJ), could serve as a nice tailwind. The Company’s MSG GO app, redesigned this past October, offers additional advertising inventory for the Company, and new interactive features are being rolled out for the upcoming 2019/2020 sports season. Finally, the Company has had success with its branded content initiatives, whereby it integrates sponsors’ content within MSGN’s RSN programming. Notable companies implementing branded content offerings include Anheuser-Busch and BMW.
At current levels, MSGN trades at ~6.5x TTM EBITDA, which represents a meaningful discount to the range for peer YES Network’s acquisition and recent precedent cable network transactions that have occurred at an average of ~14x EV/EBITDA. However, as already noted, the YES Network transaction multiple might not be a good comp, reflecting the forced sale.
Applying a discounted 9.0x multiple relative to recent cable network precedent transactions, our estimate of intrinsic value is $36 a share, representing over 100% upside from current levels. If shares continue to languish, we would not be surprised if the Company were to find itself as an acquisition candidate. We continue to believe that MSGN would be a good fit for a pay-TV distributor, and we note that Comcast and Charter both have a presence in MSGN’s footprint— and that they own/operate RSNs. In addition, with leverage down to manageable levels, we would not be surprised if the shares were to attract the attention of a private equity suitor.
Thanks to The Boyar Value Group for the interview.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Boyar Asset Management is long MSGN, MSG, UNF, NWSA, TSQ, DISCA, MHK, MSFT, CSCO, JPM, BAC, WEN.