Madison Square Garden Entertainment Stock: Investor Black Box (NYSE:MSGE)

The following segment was excerpted from this fund letter.

Madison Square Garden Entertainment Corp. (NYSE:MSGE)

I have written and spoken on MSGE extensively, and I will not rehash the same basic valuation arguments. For a refresher, please visit my public presentations here and here. Instead, I want to explain why I believe MSGE’s misfortunes will reverse this year, specifically highlighting two large 2023 catalysts: the spin of the MSG Arena occurring in Q1 and the opening of the Las Vegas Sphere in H2.

For the past two years, MSGE has been a black box to investors. Intuitively, most investors familiar with the company understand that MSGE owns iconic assets, yet the company is burning cash because they are funding a large development project. However, I believe the complexity of teasing out profitability from the various segments’ accounting, along with a perhaps warranted fear that the Sphere is a money pit, has kept many investors on the sidelines who otherwise would be attracted to MSGE’s durable cash flows. By year’s end, I believe this complexity will dissipate, attracting a new cohort of investors.

First, MSGE plans to spin the MSG Arena, along with the Rockettes and a few smaller venues, into a separate company in Q1. Previously, MSGE had intended to spin the MSG Networks business as well. However, after discussions with shareholders, MSGE decided spinning their iconic assets without a troubled one would maximize value, and I agree with their decision. Regarding the SpinCo, I believe many investors fail to understand the underlying profitability of these businesses and would be interested in owning these stable assets if they fully understood the returns. For instance, more than occasionally, other investors have told me that they do not believe the MSG Arena is profitable, to which I reply, “they sell $40 vodka sodas, where do you think the profits are going?” Thankfully, soon this debate will be put to rest. The form-10, containing pro forma financials, should be filed in February and management believes the spin will be completed by the end of Q1. I believe the SpinCo will earn $2-$3 in FCF/sh. and that many investors will be attracted to these stable assets on a standalone basis. A 15x multiple yields $30-$45 in value, with the caveat that MSGE shareholders will only receive 2/3rds of their SpinCo shares at first, with the other third likely distributed later. While I cannot be sure exactly how the SpinCo will trade, personally, I sleep comfortably owning the MSG Arena on an unlevered basis at a >10% FCF yield.

For the RemainCo, the clear catalyst is the opening of the Sphere in Fall 2023. Unlike the SpinCo’s stable assets, the Sphere is an aggressive growth project with a wider array of potential outcomes. To the downside, the Sphere could be a bust, with underwhelming crowds and a lack of star powered residencies, and MSGE management could end up reinvesting in the project for a few years in the hope of turning it around. To the upside, the Sphere could be a transformational Vegas asset with sold out crowds and an exciting pipeline of future development projects. There are, of course, a variety of mixed results between these two extremes. As a rule, in “moon shot” growth investments, I only invest when I am comfortable underwriting to a worst-case scenario, while being optimistic that its upside potential comes to fruition. For RemainCo, in my worst-case scenario, I value the Sphere at $500MM, or ~20% of construction costs, supported by my belief that the Sphere can generate at least $50MM in high margin marketing dollars and only a slight premium to the recently completed Las Vegas T-Mobile Arena, which cost $375MM. I also assume a $200MM stub equity value for MSG Networks, despite its $1B equity purchase price 18 months ago, which combined with RemainCo’s other assets and debt yields roughly $1B in equity value, or $30/sh. To the upside, if Sphere can achieve management’s targeted “double-digit” return, I believe a 20x multiple on $250MM in EBITDA is reasonable, or roughly $150/sh. Regardless of the outcome, by year-end, the market will receive substantial updates and indications on the health of the Sphere and I believe the current pricing, at a discount to my punitive worst-case scenario, is excessive.