It Appears Expensive, But Is Worth an Investigation

Mike is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The Madison Square Garden Company (NASDAQ: MSG) is up by 27% YTD behind positive news from the NHL and, more recently, a well-received earnings report.  The damage from the NHL lockout to MSG’s earnings was less significant than the Street expected.  Earnings also benefitted from greater than expected cost savings.  Looking forward, free cash flow is set to improve at MSG as the large capex outlays of recent years return to more normalized levels.  Earnings will also benefit from higher revenues at the renovated facilities.  Strong cash flows, increased certainty of future earnings, and multiple expansions in the sector have acted as positive catalysts for the shares.  That said, the stock is expensive, so is there more upside?

The Madison Square Garden Company Description

The Madison Square Garden Company is a sports, entertainment and media company.  It reports in three segments, MSG Media, MSG Entertainment and MSG Sports.  In addition to owning Madison Square Garden Arena, it also owns The Theater at Madison Square Garden and The Chicago Theatre.  The company leases Radio City Music Hall and the Beacon Theater, both in New York City, and has a booking agreement at the Wang Theatre in Boston.

Key drivers for the MSG Sports Segment are revenues from the New York Knicks and Rangers.  Over 90% of operating cash flows are generated from MSG Media.  The MSG network is the primary driver behind MSG Media, but the Fuse network also contributes a bit under ~10% of segment sales and is important to segment growth.  Ticket sales from concerts and other events are reported under the MSG Entertainment Segment.

 

Recent Earnings

MSG recently reported fiscal 2Q13 earnings which were messy due to one-time items, NHL lockout and Hurricane Sandy related, but the fundamentals further rallied investors and pushed the shares higher.  The company was able to cut costs more than expected leading to a better than expected margin in the quarter.  Revenue in the MSG Media business was negatively impacted by the NHL lockout but a new agreement with Dish and improved ratings for the Knicks were a positive surprise.  MSG Sports, also impacted by the NHL lockout and the quarter was generally in line with expectations after adjusting for that.  In MSG Entertainment, strong sales from The Grinch more than offset lower sales from the Radio City Christmas Spectacular which was negatively impacted by Sandy.

MSG Positioned to Return Cash to Shareholders

Cash flow at Madison Square Garden is forecast to improve mostly as a result of declining capex. MSG had capex in FY12 of $401 million focused on renovating their namesake property.  Capex is forecast to decline to $256 million and $163 million respectively in FY13 and FY14 according to Thomson consensus estimates.  A renovated Madison Square Garden could also lead to higher ticket prices and concession sales, a positive for future earnings.

Madison Square Garden has a debt free balance sheet.  With cash flow increasing due to the decline in capex, management will likely return the cash to shareholders via dividends or repurchases.

Regional Sports Networks Increasingly Attractive

YES Network was partially acquired by News Corp and highlighted the value of regional sports networks (RSN).  Along these lines, Sports Time Ohio (STO) owned by the Dolans was also recently sold for $230 million.  As part of the deal, the STO agreed to pay over $400 million for the television broadcast rights to the Cleveland Indians, or $40 million/yr versus the $33 million paid in 2012. Also highlighting increased affiliate fees was the $6 billion/25 year deal between the LA Dodgers and Time Warner Cable.

Valuation

Since MSG generates 90%+ of operating profit from its Media Segment so other networks make sense to look at for comparable multiples.  MSG has a P/E of 34.4.  The other publicly traded comps to look towards are AMC Networks (NASDAQ: AMCX) and Discovery Communications (NASDAQ: DISCA).  AMC trades at a P/E of 28.67x and Discovery at 28x.  These are not RSGs and all carry debt.  AMC has $2.23 billion in debt and Discovery has $5.24 billion in debt.  The fact that MSG has no debt, has forecasted increasing cash flow, and is an RSG justify a premium for the shares.

Conclusion

MSG is well positioned to benefit from their recent capex.  The confidence in future earnings has improved as volatility from capex and labor negotiations are out of the way for some time.  In addition, a playoff run could result in earnings beats in the latter part of FY13.  The multiples are high at this point and buyers may be chasing the past performance of the stock.


mthiessen has no position in any stocks mentioned. The Motley Fool owns shares of Madison Square Garden. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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