It's hard to find a hot new consumer brand to invest in before it takes off to an eye-watering valuation. But Sphere Entertainment (SPHR 1.17%) might just be one of those names.
The company has a strange mix of assets, including the MSG network, which televises the Rangers, Knicks, Giants, and other New York sports teams, along with ownership of The Sphere auditorium in Las Vegas.
Obviously, with the company renaming itself Sphere Entertainment in April of 2023, management seeks to focus on its revolutionary new entertainment venue and not the struggling sports networks that are declining due to cord-cutting.
Judging from the first quarter of Sphere operations, it appears a big new consumer brand could be ascending -- and at a reasonable price, too.
NYSE: SPHR
Key Data Points
Not bad for the first three months
The Sphere began operations on September 29 just two days before the start of the company's fiscal second quarter ended in December. During the subsequent three months, the venue was home to part of a 40-date concert residency by the band U2, along with 191 performances of Postcards from Earth, a 50-minute film by acclaimed filmmaker Darren Aronofsky. In addition, there was one "marquee" sporting event held during the quarter, along with advertising revenue from the Sphere's giant spherical exterior.
In the quarter, the Sphere segment brought in $167.2 million in total revenue, of which about $92.9 million came from screenings of Postcards from Earth, $55.2 million from concert revenue (plus the one sporting event), and another $17.5 million from advertising.
Segment-adjusted (non-GAAP) operating income was $14.1 million. While that's not that much of a profit, this was only the first quarter of Sphere operations. Thus, there is likely to be a learning curve associated with optimizing future revenue and costs.
How Sphere plans to inflate profits even further
First on revenue, which can grow from several avenues. One could come from expanding content for The Sphere Experience beyond just Postcards from Earth. CEO Jim Dolan noted:
[W]hat our plan is that -- is to replace it, right, but still run it and keep building up a library of content, right, that, of course, when we open up new Spheres, they'll have a whole -- they won't be dealing with the first pancake syndrome... How much does the content draw versus just the pure medium or the technology? And I'd say it's a mix of both. Right? But over time, it will move closer to content, and we're preparing for that.
More on the ambition for "more Spheres" in a bit. On the content, it's unclear if Sphere would finance more content itself or just host it. But it's clear that if the Sphere can run more pieces of content per day, it can likely run more and more screenings than it did in the December quarter.
In addition, management is looking for ways to get more event throughput from the Sphere each day. For instance, it appears from the conference call that the Sphere didn't have screenings of Postcards from Earth on the same day as U2 concerts. But it intends to in the future and perhaps even add a third type of late-night event:
[W]e do want to have a concert and a Sphere Experience on the same day. And we think actually that will be quite lucrative. But there are other things, too, that we can -- that we're looking at, including, we're looking at a late-night EDM show. How far we can stretch this thing, we've talked about it. I don't know if we're going to get to three different kinds of events in a day, but we can definitely do two... there's a great deal of refinement that is still to come on this, both on the expense and the revenue side.
Finally on costs, it's possible that Sphere may be able to lower its selling, general, and administrative costs (SG&A) relative to what it spent in the December quarter. This is because as the Sphere becomes more of a well-known tourist destination, there may not be as much reason to spend so much on advertising.
It's not an insignificant number. In the third quarter, SG&A accounted for a whopping $97.8 million of the segment's operating costs, with the venue only undergoing $67.3 million in direct operating costs. While SG&A will likely never go to zero, that's a massive chunk of last quarter's costs in the Sphere's first quarter of operations. I'd say it's likely that Sphere Entertainment won't have that much advertising spend per dollar of revenue going forward, especially as the Sphere becomes better known.
Image source: Getty Images.
And the big growth lies in franchising
How was McDonald's (MCD +0.18%) able to expand its burger-and-fries empire all over the world? Franchising. And it's what Sphere intends to do with its venue model over time. With the venue profitable in its first quarter of operations, that has likely proved the model and set the Sphere up for more openings in other international cities.
If franchising gets going, the good news is that the Sphere will be generating capital-light revenues for years, boosting profits. Moreover, management noted on the conference call that its in-house construction division will be building those Spheres for other owners and will get paid for it. So, unlike the Sphere Las Vegas, which the company owns outright, it won't incur other costs for new Spheres, but will actually take in revenue:
[W]e have a construction development division that services that franchise model. They don't work for free. And so, yes, they will be generating revenue right from the start to support the build and construction process. So we're -- there's different revenue streams that go along with the franchise model, but the construction model has revenue associated with it. And essentially, our minimal goal here is to -- that there won't be any losses associated with Sphere with construction. Most likely, there will be profits.
A bargain valuation for a new hot franchise?
The Sphere made a total adjusted operating income of $51.4 million in the December quarter, which includes $37.3 million of profits from the MSG sports networks, which were down 22% year over year.
But the company trades at just a $1.5 billion market cap, or just about 7.5 times last quarter's annualized operating income. That certainly seems cheap, especially with the Sphere showing strong results.
There are other factors to consider of course: The company currently has about $1.4 billion in debt against $615 million in cash. So on an enterprise value of around $2.3 billion, the stock trades at about 11.5 times last quarter's adjusted operating profits. Moreover, it's unclear if the MSG network will continue its decline, stabilize, or eventually turn around.
However, it looks as if the exciting growth potential of the Sphere outweighs these other factors and risks. The Sphere is a hot new consumer brand investors shouldn't ignore.
