Madison Square Garden Entertainment: Upside potential, but risks remain (NYSE: MSGE)
Madison Square Garden Entertainment Corp. (MSGE) owns and operates many iconic venues where live entertainment is offered. With various entertainment shows, dining and nightlife offerings, and music festivals, MSGE was able to engage approximately 12 million visitors per year before the COVID pandemic. Although uncertainties still exist, I believe this stock holds a lot of potential in the post-COVID era. I will share some of my thoughts here.
1. The MSG spin-off offers opportunities
As a spin-off of the former Madison Square Garden Company (MSG), MSGE inherited ownership rights to Madison Square Garden, Hulu Theater, Radio City Music Hall, Beacon Theater, Forum in Inglewood, CA , and the Chicago Theatre. Entertainment event booking activity, MSG Networks media inventory and arena licensing agreements with sports teams are also included. Historically, spin-offs provide increased flexibility for growth and more focused business strategies for shareholders. The companies involved often outperform the market, but MSGE has not so far as the stock price has lagged the S&P 500 and the COVID pandemic is negatively impacting stocks. sales.
2. Unique Intangible Assets
Live entertainment and face-to-face interaction is, and will continue to be, the basic need of human beings. Delivering decades of world-class customer experiences, MSGE locations have built the world’s most recognized brands and are often on many visitors’ wish lists. A long track record of successful marketing, ticket sales and venue operations has earned MSGE a reputation as the most admired platform for live events. Top performers and artists want to perform for MSGE, attracting more customers and sponsorships in return. Many customers also provide opportunities to use data to track market trends and make timely decisions. Overall, MSGE has unique intangible assets and brands that should do well in the future.
3. High Value Properties
MSGE owns Madison Square Garden (1.1 million square feet) and the Chicago Theater (0.07 million square feet). Madison Square Garden is one of New York’s icons and is worth at least $1.2 billion based on assessed value (many analysts have put it at $2 billion, but we start with $1.2 billion for the moment). The Chicago Theater was built with $4 million in 1921, which equates to $58 million in today’s value. So, these two sites alone will be worth at least $1.26 billion (a very conservative figure). Given their unique styles, stories, and locations, they are definitely worth the full price. The current inflation of real estate properties will also increase these real estate values.
4. COVID disruption creates uncertainty for the entertainment industry
MSGE earns revenue through tickets, suite/facility licenses, concessions, merchandise, sponsorship fees, advertising commissions, and dining and nightlife offerings. Many revenues are associated with traffic and events held at its venues. The COVID pandemic has had a significant impact on MSGE as many events have been cancelled. It is legitimate that future events are not as numerous as before since various virtual options are available these days.
The good news is that live events started to ramp up in mid-September 2021, which can be reflected in recent quarterly results (chart below), with the entertainment segment generating 34.2 million dollars in sales, compared to $7.6 million last year. MSGE is also anticipating a busy year ahead, so increased operational costs related to hiring and program development were reflected in the higher operating loss. All in all, I think the fourth quarter of 2021 will be very strong for MSGE and will give more color to its future earnings power.
5. MSG Sphere is a very big deal but also costs a lot of money
MSG Sphere is a giant sphere-like architectural marvel 366 feet high and 516 feet wide equipped with 19,000 by 13,500 resolution LED screens for future live entertainment. This is a bold move by MSGE, which can be another landmark in Las Vegas and attract millions of visitors every year. MSG Sphere is a physical building and entertainment platform invention for directing, programming, storytelling, etc., which will be trademarked. MSGE plans to push this model to other markets around the world. As MSG Sphere designs can be of a wide range of sizes and capabilities, they must be built the same way with the same technologies and operations. It could therefore be an evolutionary model if successful, just like the new Disneyland.
However, the MSG Sphere project comes at a huge price. In 2019, the estimated construction cost is 1.2 billion, it is currently around 1.86 billion with the opening scheduled for 2023. This is a very expensive building considering that Disney Land Shanghai ( covering 225 acres) costs only 3.7 billion. Additionally, content, technology and staff development cost 27 million last year, and higher spending is expected. While I don’t think the MSG Sphere project will totally fail, it might not be worth the hype.
5. Valuation is cheap with huge upside potential
MSGE currently has an enterprise value (EV) of 3.21 billion. According to operating data in 2019 before the pandemic, the former MSG entertainment segment could achieve adjusted operating income of 118M and sales of 819M. MSG network operations have sales of 141 million and adjusted operating profit of 55.8 million in Q1 2022 data, so we multiply that by four to get a full year of sales of 564 million and profit adjusted operating income of 223.2 million. Adding this MSG network annual estimate to old MSG entertainment data, we can expect sales of 1.38 billion and adjusted operating profit of 341 million (similar to the operating margin of Disney Parks ). Then we can get an EV to sales ratio of 2.3x and an EV to adjusted EBIT ratio of 9.41x. This rating is very similar to that of other live entertainment companies such as Six Flags Entertainment Corporation (SIX) and Dave & Buster’s Entertainment, Inc. (PLAY) during the pre-COVID era. But MSGE has more cash and equivalents (1.3 billion) with much less debt. Its assets are also more premium and will certainly still be so in 10 or 20 years. Moreover, our estimate has not yet taken into account all the growth drivers linked to the MSG sphere and the synergies with Tao Group. I think MSGE deserves a longer time horizon and shouldn’t have a similar valuation to SIX or PLAY. The stock is undervalued.
If the MSG Sphere in Las Vegas can be successful (I believe it will be), a huge runway will open up and put MSGE into hyper-growth mode. However, we will not have a clear picture of the effects of MSG Sphere until 2023, which involves many uncertainties. A lot can go wrong in two years.