This article is part of our Rising Star Portfolios Series.
If you've been following my Special Situations portfolio, then you know I like spinoffs. And the stock I'm buying on Monday is just such a play. Madison Square Garden
The business
Madison Square Garden is an asset play strapped to a cash-flow machine. You might guess that the company owns its eponymously named arena (a cookie for you!), but it's also the proud owner of the New York Knicks, the New York Rangers, and a couple other professional sports franchises. That's the asset play component of the business -- the trophy assets that are attractive to the billionaire who has it all (except for a sports franchise). It generated 31% of total revenue in the last four quarters and was essentially breakeven on operating profit.
The second side of the business -- the media business -- is the cash-flow machine. The company runs the MSG and MSG+ TV channels, which have exclusive regional broadcasting rights to New York area sports games. The media business also includes the Fuse Network, which distributes music programming to 55 million subscribers around the U.S. The unit produced more than 44% of trailing revenue, and produced effectively all of the company's operating profit. The unit runs at an impressive 40% EBITDA margin, and revenue has been climbing at a brisk pace.
The final unit of the company is its events business, which generates revenue from Garden events such as sports tourneys and from leasing other event facilities. This business loses money on an operating basis, to the tune of $38 million in the last four quarters. While that's not attractive, I'm less interested in this segment than in the other two, which is where my investing thesis resides.
The company is also planning to invest $800 million into renovating the Garden in the next two years. Management has stated that it expects to fund that investment with cash on hand (currently $325 million) and ongoing cash flow. For context, that investment is 40% of the company's current market cap.
Why I'm buying
The twin attractions of Madison Square Garden are its great cash-generating programming business and its sports teams. That programming business is particularly attractive for advertisers because it broadcasts sports, one of the few content areas where viewers will tune in live, rather than watch later and TIVO out advertisements. In addition, sports programming provides to advertisers an important and usually difficult-to-reach demographic – young men. You can see the attractiveness of the media business in its consistently increasing revenue and very high margins.
From a business perspective, there's little to like about the sports teams. But that's not why the wealthy buy them anyway. Playing records notwithstanding, the Rangers and Knicks are one-of-a-kind trophy assets, status symbols for those who own them. Major sports franchises like these don't stay on the public market long, and there are plenty of reasons to believe that this side of the business is what will have buyers sniffing around as soon as possible. There is a two-year lockout on the company being taken private from the time of its spin, and we're already one year into that term. And it wouldn't hurt things at all if the Knicks made the playoffs.
I'm allocating about 3% of our total capital, or $500, to MSG. On a pullback, I would consider adding further to the position, provided the situation remains the same.
Risks
There are a couple major risks for this investment. First, the Dolan family owns 20% of MSG stock and 70% of the voting rights. They are much-maligned for iffy business decisions at Cablevision, where they also own a nice stake, but I think their recent move to spin off not only MSG but their Rainbow programming unit suggests their desire to increase the value of these businesses.
This investment could also suffer if the NBA and NHL, which have collective bargaining agreements expiring this year, fail to reach a new accord. A work stoppage of any sort would hurt the media business especially. But such an event could likely present a bargain buying point, if shares were to fall.
Summary
While it's rarely a good idea to invest in a business solely on the prospect of it being acquired, I think we have a good reason to believe that MSG's sports franchises are a huge lure to prospective buyers, especially the Dolan family itself. Add in the lucrative media business, and I think you have the safety of an income-producing business married to an attractive trophy asset. In a future column, I'll go through my valuation.
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