Shares of events organizer and ticket distributor Live Nation Entertainment (NYSE:LYV) are mighty pricey at a glance. Total earnings have landed on the unprofitable side over the last four quarters, making it impossible to pin a trailing price-to-earnings ratio on the stock. Looking ahead instead, Live Nation shares are trading at 155 times forward earnings -- right up there in the nosebleed seats.
These numbers are like catnip for short-sellers, who had borrowed and sold 10.5% of Live Nation's available shares at the last count. They are also deal breakers for traditional value investors.
But what if I told you that Live Nation's soft earnings and sky-high P/E ratio simply mask a fantastic cash machine that looks downright affordable in a different light?
Have you seen this cash machine?
That's exactly what's going on here. The Tickermaster parent runs its taxable earnings close to zero, and often below that point. Over the last four quarters, operating profits added up to just $2 million below breakeven. The company received a $17 million tax refund during the same period. On the bottom line, GAAP net income available to Live Nation's common shareholders fell all the way to a negative $102 million, or a GAAP net loss of $0.50 per share.
At the same time, free cash flows landed at $376 million. Yes, that's on the positive side and roughly in line with the annual free cash flow totals in fiscal years 2017 and 2016. GAAP earnings stayed sharply negative across all of these periods, but the cash production was fantastic.
How can Live Nation pull this off?
There are many differences between accounting-level earnings and free cash flows. Chiefly, companies like Live Nation often post large depreciation and amortization expenses against their bottom-line earnings, because a deduction a day keeps the tax man away. But those are not cash payments -- they are accounting constructions with big impacts on the company's tax schedules. So when you see a company reporting low earnings but respectable cash profits, its tax department deserves a fruit basket and a bonus. Live Nation is doing it right.
Now, there's more to it in this particular case. Live Nation paid out $95 million in preferred dividends over the last year, which reduces the profits available to common owners but enters the cash flow statement below the calculation of free cash flows. In other words, Live Nation chooses to deploy that much of its cash profits in the form of preferred dividends, taken out of the incoming cash flows. These payments go to Liberty Media (NASDAQ:LSXMA), which owns 34% of Live Nation.
That's perhaps not the most shareholder-friendly stock structure in the world unless the shareholder is Liberty Media and its controlling mogul John Malone. But Live Nation is still a great cash machine at the end of the day -- even after backing out Liberty's preferred dividends.
Cheaper by the cash flows
From that perspective, Live Nation's stock trades at a more palatable 28 times free cash flows -- or 38 times cash flows minus preferred dividends. It's still not a fantastically cheap stock but this is a perfectly acceptable valuation ratio for a company posting 24% revenue growth in 2017. With a focus on music festivals and higher-quality food items at each event, Live Nation hopes to keep that trend going.
Live Nation's stock deserves a premium to its cash-based valuation, and you can forget about the earnings calculations because they're all about tax efficiency.