Prospective Investors Should Look Twice at This IPO’s Financials

Following a previous segment in which analyst Nick Sciple and contributor Asit Sharma provided an overview of talent agency and content conglomerate Endeavor Group Holdings, The Motley Fool's Industry Focus podcast team pores through Endeavor's financials in the video below. Currently on deck for an initial public offering, Endeavor has enjoyed phenomenal revenue growth over the last four years. But other aspects of its financial presentation found in its IPO prospectus bear close scrutiny. If you're thinking of investing in this upcoming issue, don't miss our analysis below!

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

This video was recorded on July 09, 2019.

Nick Sciple: When you look at their financials, there are some questions about how these acquisitions have played out and whether they're going to fall to the bottom line, what synergies there might be with the business. Can you give us a brief overview of how the revenue has grown over time and what's been driving that in recent years?

Asit Sharma: Yeah, absolutely. Revenue has grown basically from a focus into its two biggest segments -- talent representation, which you mentioned. They have over 6,000 clients, $1.3 billion in revenue. That's 46% of their total revenue. That segment generates $335 million in EBITDA -- that's a word we're going to use a lot in this show. Listeners, as you know, earnings before interest, taxes, depreciation, and amortization. EBITDA is a good proxy for basically operating cash flow. When you get a company this complex, which has a lot of maybe arcane adjustments in its accounting, some investors like to cut right to the quick and see instead of net income or loss, what is that adjusted, or really the EBITDA number. They use an adjusted EBITDA number, we'll talk about that in a bit. So talent representation, that, again, is 46% of revenue. They've also concentrated in this entertainment and sports segment. That's their second major segment. It's actually 63% of their total. Last year, that segment did $2.2 billion in revenue and had $439 million in EBITDA.

Just looking at that entertainment and sports segment for a bit, they specialize in distribution and sales. They're one of the largest independent global distributors of sports programming. Here's a stat that you brought to my attention. This one wowed me, Nick. They sell media rights globally in over 160 countries on behalf of more than 150 clients. One of those is the IOC, the International Olympic Committee.

There you have it. They also have a smaller segment, the third segment is called Endeavor X. It's relatively new. That segment did $66 million in revenue last year and $45 million in EBITDA.

But let's talk about those financials. The company has had a phenomenal growth rate when you take a look at revenue. I calculated. This is a rough calculation, listeners. If there's a real number cruncher out there, don't call me on this. It might be a percentage or two off. But I counted that the company has had a 29% compounded annual growth rate in revenue over the last four years. In 2014, the company did $1.3 billion in revenue. That grew to $3.6 billion last year. They've done that through a combination of organic growth in some of the content areas, but through a lot of acquisitions, some of which Nick mentioned.

Now, here's the rub. If you look at this S-1 statement, this registration statement, Endeavor says, "Look, we did $3.6 billion in revenue, and we generated out of that some $552 million in adjusted EBITDA." But you hear that word "adjusted." They've taken a number which is already adjusted -- when you're looking at EBITDA, you are adjusting that income, you're taking away noncash items like interest expense, depreciation, and amortization, taxes. Some companies then adjust that number and want to remove other items that are typically one-time in nature. The problem that I've got with this adjusted EBITDA number is that it takes out a lot of items that are actually recurring from year to year to year on Endeavor's books.

Stock compensation is one. Okay, that one maybe I can grant because that is a non-cash expense. In other words, when you put an expense on your income statement, when Nick and I run a business, and he gets paid partially in stock, that doesn't hit cash. So we can grant them that. But they're also pulling out numbers like merger and acquisition costs, restructuring costs, certain legal costs and the like. The problem with this is, if you look over their financials for the last four to five years, Endeavor is a serial acquirer, as I said. They have ongoing restructuring costs every year, they have ongoing legal costs that are tied to acquisitions, they have ongoing merger and acquisition costs. These are actually recurring items that should not be pulled out.

When I added these back in, I got that they actually generated $267 million in adjusted EBITDA, with my selective add-backs. The problem with this is, if you buy my argument that EBITDA is a rough proxy for operating cash flow, the company really doesn't generate a lot of operating cash. You can go to the cash flow statement. Last year, they only generated $121 million in true operating cash off of that $3.6 billion in sales. Their cash-paid-for-interest bill last year was $267 million.

How are they supplying these deficits? The answer is, it's through their private equity investors. Yes, the company has borrowed a lot, but most of that's been tied to acquisitions. Where they're really getting funded is through about $2.3 billion in investments from Silver Lake, the private equity firm that I [mentioned]. That's paying the bills for acquisitions, it's covering deficits. And now, you, potential investor, are going to be asked to cover some potential deficits as well when this issue prices.

Thank you for bearing with me. That was a bit of a long explanation. But I'd like to throw it back to you, Nick. What are your thoughts on that overview of their financial structure? Maybe you disagree with me on that analysis?

Sciple: I think there's clearly some concerns with their debt. When you look at their EBITDA without adjustments, you're looking at about a 15 times debt to EBITDA, I believe. That's a pretty high multiple there. You really would have liked to see, with all these acquisitions over the past several years, some scale kick in where you start seeing some returns on those assets. Those haven't started to play out. And when you look at the way their debt is structured, the repayment schedule on their debt begins to accelerate around 2022, 2023. This business really needs to start generating positive cash flow to be able to support those debt payments in the coming years. Otherwise, it's going to be an issue for the company.

So, when you look at the issues with the debt, not having enough EBITDA to support the payments, at least as things are constituted today, that comes back to maybe why the company is going public. They mentioned that they're going to use the proceeds from their public offering to support working capital and corporate purposes, and may use it to pay down debt or to fund new acquisitions. When you look at Endeavor looking to use this IPO money to pay down debt, what are your thoughts looking at that as an investor, particularly when the debt and EBITDA is a concern for the business today?

Sharma: It doesn't necessarily bother me if -- as we're going to talk about in the second half of the show -- there's a viable path to take this phenomenal revenue growth and get some orange juice out of those oranges. If you take what's in the S-1, it's hard to gauge because as of yet, we just have an initial S-1 statement. Typically, listeners, you file your S-1, and then a few weeks later, you'll file what's called an S-1 amended statement, an S-1/A. Then you'll fill in placeholder numbers. There are not any placeholder numbers filled in. We don't know the expected pricing range, which tells us how much the company will raise. We don't know exactly how much would be allocated to working capital, how much debt. Those numbers typically get filled in. Nick will fill you in later in the show on why there hasn't been an S-1 amended statement filed yet. But absent that information, it doesn't bother me if the company can make a persuasive case on, "We'll pay down some debt, and here's how we're going to improve our margins and capitalize on this great intellectual property we have, our vast footprint in the market." But that is for us to toss around in just a few minutes.