Valuing Madison Square Garden Entertainment Before Its Upcoming Spinoff (MSGE)

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What's happening?

Madison Square Garden Entertainment (

NYSE:

MSGE

The ) will be split into two. The new MSGE is being split into two. This is a tax-free spin-off of the old MSGE MSGE MSGE. The old

MSGE will be renamed SPHR.

This transaction is particularly intriguing because the MSGE current iteration is complex, and there are several assets that I would be interested in purchasing. Madison Square Garden, the Tao hospitality group, and the upcoming sphere are all unique assets.

A simplified equity structure can be a catalyst for realizing value. Even though the stock's current valuation isn't compelling, prices can fluctuate post-spin-off. It is worth doing your homework now to see if there are any bargains.

The MSGE spin-out logic

MSGE stands for

Being spun off as the "good company". It has the assets that investors love. It includes Madison Square Garden and MSGE's other entertainment venues, both leased and owned. Investors will likely be more willing to invest in infrastructure similar to multiple assets by spinning off these simple-to-understand assets.

Relations with MSGE investors

This is attractive because investors don't have to do a sum-of-the-parts analysis. They can instead do a cash flow analysis and then add a multiplier. Let's see if we can achieve that goal. Below is a simple cash flow breakdown with explanation. This calculation is based upon fiscal 2023 guidance, which was provided by MSGE's

Recent investor presentation

The spinoff and

company's S-10

The same topic. The MSGE fiscal year ends June, so we are now halfway through. This would indicate that management's most recent guidance is quite accurate. All figures are in millions of US dollars.

Cash operating income

150

This is the midpoint of management's direction. This is cash flow from operations less taxes and interest.

Maintenance capex

19

Average of the last three years of capex in entertainment (2020, 2021 and 2022).

Cash flow to pay off debt

131

Cash operating income less maintenance capex

interest expenses

61

$675 Million in debt with a 9% rate

Taxes

0

MSGE will not be considered a significant taxpayer, per guidance, until 2027.

Free cash flow for equity

70

Cash flow to debt, less interest and taxes

Comp based on share

20

Management's direction

Earnings of the owner

50

Equity less share-based comp: Free cash flow to equity

Here I applied a 6% rate of growth to cash operating income maintenance capex and share-based comp. Cash operating income grew at 15% between 2019 and 2023, but I'm not comfortable giving them this kind of credit moving forward. According to management's direction, I made the company pay taxes in year 4.

MSGE discounted cash flow analysis (Author’s work)

You can also use a 20 multiplier on 50 million owner's earnings to get a similar valuation. I believe MSGE equity should be.

Worth $900-1000M

.

How to deal with large amounts of debt

MSGE is now insolvent with 675 million dollars. According to the company, its primary objective after spin will be to reduce balance sheet debt. It seems sensible, considering that interest payments currently consume a greater percentage of the company's cash flows.

The floating rate of debt is used. Although the exact interest rates are complicated, I believe they can be reduced to SOFR plus 3.5% at the moment. I find it quite foolish to choose a floating rate of interest at 100%. It's possible that I am biased, but when the loan was first issued in June 2022, interest rates should have been top-of-mind. Additionally, MSGE cash flows are not impacted by rising rates so borrowing at a floating rate creates an imbalance.

The loan does not affect Madison Square Garden, which is the stock's crown jewel. This implies that all other theaters support these loan payments. It makes them appear very high-levered. This is a good idea in theory, but I am not sure how it will work in practice.

Complementary share-based

I was shocked to discover how much of the free cash flow in 2023 is being consumed by share-based payments after breaking down the earnings of the owner. The entertainment division has also had share-based compensation expenses in 2023.

$40M

In each of the three previous years. It seems a bit greedy to make about 70 million in equity free cash flow and 20 million in share-based compensation.

It is especially difficult when you consider the fact that much of the comp will go to James Dolan, his family and friends. MSGE already has over 13% ownership by the Dolan family. It is not clear why they would want to give so much equity to the business. Special voting shares that the Dolan family owns more than half of MSGE's voting power, give them more than 50%. They decide how much they will be paid.

Do MSG spins unlock value?

Madison Square Garden Sports has been a fixture in the Madison Square Garden Sports scene for many years.

MSGS

MSGE was the source of the genesis of ). Then Madison Square Garden Networks (

MSGN

MSGE was merged into ). MSGE is now being divided in two. Separation of MSGE from all other.

The merger of MSGN and MSGE is particularly concerning. Despite protests by many minority shareholders, this merger was carried out

This led to a lawsuit

On a

Recent earnings call

Management admitted that the merger was motivated by the funding of the development of the sphere.

MSG Networks was acquired by us last year. We have enjoyed a number important benefits from the transaction, including substantial cash flow that we've redirected towards our Sphere initiative.

It's reasonable to ask if these equity spinoffs actually do anything. With their super-voting shares, the Dolan family still owns all MSG companies. They have shown that they will do whatever is best for the Dolan empire as a whole, and not just any one equity.

Breaking down Sphere Co

SPHR co will be made up of three units: Tao hospitality group and MSG networks. These assets don't really make sense together. MSG networks was going to remain with MSGE when the spinoff was first announced in April. MSGE would have legacy businesses that generate stable cash flows, while Sphere co would be home to "growth" assets. They decided to add MSG networks and Sphere co to their portfolio, and are reportedly looking to sell Tao.

According to my knowledge, the only thing that links all three assets is that investors don’t like them. MSG networks are seen as in terminal decline. The sphere is regarded as inefficient shareholder money use, and investors struggle with understanding the normalized earning potential of the Tao group.

We are now left to calculate the parts value.

Evaluation of Tao

Tao is reported to be up for sale at an asking price

More than $500M

For the past twelve months, the group has been able operate at full capacity. Despite having difficulty controlling costs, this has had an impact on their profitability. It seems that the past twelve months have given us a good idea of what to expect going forward.

Cash operating income

57

Twelve months of cash flow from operations less interest and taxes.

Maintenance capex

23

Capex for trailing twelve months

Cashflow to pay off debt

34

Cash operating income less maintenance capex

interest expenses

6

At 7.2% interest rates, 83 million debt

Taxes

5

Cash operating income less D&A, interest expenses times 21%

Free cash flow for equity

22

Cash flow to debt, less interest and taxes

Comp based on share

8

Twelve months trailing share-based comp

Earnings of the owner

14

Equity less share-based comp: Free cash flow to equity

Because this business has been historically unstable, it's difficult to estimate how much the owner earnings are worth. It does have strong brands that are able to invest more capital. Tao currently owes slightly more than $83M. To reach the $500M asking price, someone would have to be prepared to pay more than $400M for equity. The equity would be worth between $200M to $400M, according to me. This is a large range, but we don't have enough data to show how it looks under normal operations. TAO is 67% owned by MSGE so it's safe to say that their equity stake is substantial.

$130M-$260M

.

Evaluation of MSG Networks

MSG Networks, a regional sports network, is in serious decline. They want to move from making money with the cable bundle to streaming paid content. Here's a look at the normalized earnings of owners. All numbers are round to millions.

Cash operating income

158

Twelve months of cash flow from operations less interest and taxes.

Maintenance capex

6

Capex for trailing twelve months

Cashflow to pay off debt

153

Cash operating income less maintenance capex

interest expenses

68

$973M at a rate of 7%

Taxes

16

Cash operating income less D&A, interest expenses times 21%

Free cash flow for equity

69

Cash flow to debt, less interest and taxes

Comp based on share

9

Twelve months trailing share-based comp

Earnings of the owner

60

Equity less share-based comp: Free cash flow to equity

This business is again being affected by a huge debt load that is all floating rate. We are experiencing negative leverage as the cash generated by this business is decreasing. This is due to increasing interest rates and large floating rate loans. Due to the declining financial performance, it may prove difficult to refinance the debt in 2024. Cash operating income decreased by 45% between Fiscal 2018-2022 and Fiscal 2018. If the rate of decline continues, the business will cease to generate earnings for owners within five years unless interest rates fall significantly. Since I am using a TTM number for this, I should be decreasing it by some expected decline percentage.

To calculate the DCF, I used a 11% expected decline in cash operating income, maintenance capsex, D&A and share-based comp. As per the model, there will be very little cash flow after year 5.

MSGN Author's Work: Discount cash flow analysis

The model is too simple. A change in interest rates, or the success of DTC businesses could make it look very different. It's close to the truth. I assign the MSGN equity

Value of $150M

.

Assessing the sphere in itself

It is difficult to call the Sphere a disaster. Originally envisioned to

Cost $1.2B

Forecasted to open

End of 2020

It is almost three years late and more than a billion dollars above budget. The project's head was

Recently, let go

.

Management has deflected when asked about the returns on this investment. I find it disappointing that management is not willing to provide concrete numbers on profitability so close to launch.

Leakage

Although some clues have been provided about potential revenue, we still have a lot to guess at.

In the first year, The Sphere is expected to attract between 3-4 million and 5 million customers for its unique movie experiences. This is assuming that $30 per customer will be spent on tickets and concessions.

Movies bring in $90-120M of revenue

They anticipate hosting 40 to 80 concerts per year. They have 17500 seats and make around 2 Million per concert. However, a lot of it will go to artists.

This is an amount of $80-160M in annual revenue.

They are also seeking advertising and naming rights. They should also be able to make smaller advertising deals through the large sphere display screen. Let's assume this brings in $500,000

Revenues between $25 and $75M

This brings us to $195M to $355M in revenue. MSGE converts revenue into cash flow from operations at a high teenager rate of 17-18%. The cash flow mix for the sphere is similar to MSGE. This means that the sphere's operations generate cash flow of $33M to $64M.

This would be disastrous for a project that has cost over $2.2B and took almost five years to complete. Although I am open to the possibility that I'm missing something, until management gives me more specific guidance about their expectations for profitability I will continue to base my model on rumors.

At a floating rate, $275M of debt is owed to the sphere. The debt cost will be around 10% at current interest rates. After subtracting interest payments, we get $30M in owner earnings. We are left with an equity value if we multiply it 20 times.

$600M to purchase the sphere.

It all comes together

Based on cash flows, we have these value estimates for equity.

MSG Entertainment

$900-1000M

MSG Networks

$130M-$260M

Tao entertainment

$150M

MSG sphere

$600M

We have a total equity value between $1,780M and $2,010M. The current market capital of $2,120M makes the company fully to slightly overvalued.

In cash, the company has almost $400M in its balance sheet. This cash will be used to either complete the sphere, or for working capital in various businesses, according to my calculations. There are also equity investments in the form ownership in DraftKings (

DKNG

Townsquare (

TSQ

).

There are many variations. The current MSGE balance sheet has $18B of floating rate debt. If interest rates drop, things could turn around. The future profitability of MSG networks as well as the sphere are still uncertain. It will be interesting to see if the sphere is utilized at a higher level than what is currently being reported or if MSG network can reverse its decline.

Stocks post spin

MSGE is quite simple, so I would give it a fair market value of

$900M-$1000M

.

SPHR will still own 1/3 of MSGE after the spin-off. Therefore, I expect SPHR to have a market capital of around $1 billion.

$1.1B-1.4B

.

How I play the spin

At the moment, I won't be taking any equity stake. However, I will be keeping an eye on the components after spin. If they are selling at a significant discount to my current estimate, I would be happy to own one or both of them. Management could provide updates and guidance about how the sphere will perform, which would allow me to update my valuation.

Particularly, any negative news about the sphere could lead to a significant sell-off of SPHR. It is clear that investors don't like the sphere, and that it has been plagued with bad news since its inception.

SPHR may have 33% ownership of MSGE. This could also lead to some excess MSGE. SPHR management has indicated that SPHR might sell its MSGE block in order to provide liquidity, if necessary. It may be possible to get liquidity in an exchange offer if it is not required.