WORLD WRESTLING ENTMT INC WWE
April 05, 2012 - 12:06pm EST by
MJS27
2012 2013
Price: 8.30 EPS $0.58 $0.47
Shares Out. (in M): 29 P/E 14.3x 17.6x
Market Cap (in $M): 617 P/FCF 17.6x 0.0x
Net Debt (in $M): 2 EBIT 37 0
TEV ($): 463 TEV/EBIT 12.5x 0.0x

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  • Entertainment
  • History of shareholder friendliness

Description

Abstract

WWE is a great business with a strong moat that has a proven record of high returns on invested assets and returning cash to shareholders.  The stock is currently depressed due to the weak economy, a cyclical downturn in the popularity of its superstars, heavy investments in a film business that is not yet profitable, and pending heavy investments in the potential launch of a cable channel.    Buying at the current depressed multiples is not without short term risk as free cash flow will be impaired in the near term (2-3) years as these new business lines are pursued.  However, high insider ownership, management commentary that they will kill off non performing businesses, and a track record demonstrating a willingness to kill off money losing businesses should give comfort to investors with a longer time frame (falling knife concerns aside).  If these new businesses are successful, the stock will revert to historic multiples (20x PE average over last several years vs current 10x adjusted PE) in short order.  If these businesses are not successful I believe they will be killed off within 3-4 years.  This will allow the company to resume generating large amounts of FCF which will fill in the hole dug while trying to launch these new businesses, and allow the stock to once again trade at historic multiples.  Either way the result is a 50-100% gain in the next five years.

The entire investment comes down to two questions:

1)    Is the core business sustainable?

2)    Will management kill non performing businesses rather than throwing good money after bad?

 

Question 1:  Is The Core Business Sustainable?

The Core Business

WWE is a content producer that distributes this content primarily through live events, cable television, pay per view television, movies and a magazine.  Additionally, the company licenses their content to video game makers, toy makers, and apparel makers.  10 years of core business profitability (2003 saw a net loss due to the failed XFL experiment), wide margins, and high returns on invested capital point to this being a good business with a strong moat.

The company's moat is defined by their position as the preeminent professional wrestling organization in the world.  While obviously this is not a real sport (apologies if you were not aware...), it none the less displays many of the characteristics of professional sports leagues in the sense that wrestling in the WWE is akin to playing baseball in the MLB or hockey in the NHL.  Other leagues (farm teams) exist, but they have no where near the pricing power or penetration that the preeminent league has.  The moat is defended by the deepest pockets, most desirable stage, most effective marketing, and best licensing agreements in the business which helps insure that the most talented wrestlers aspire to wrestle for the WWE.

Note that until 2001 WWE faced significant competition from WCW and the ECW.  To make long stories short, WCW and ECW are now defunct, and WWE owns the rights to their trademarks and libraries.

The fan base (consumers) ranges from mostly male preteens to twenty something adults, and from casual fans to fans that can only be described as diehards.  Perhaps the best way to understand the WWE fan base is to tune in to one of their many weekly broadcasts.  Fans frequently bring and carry home made signs, wear t-shirts representing their favorite wrestlers, and generally scream and yell throughout the entire program.  Some of these fans are younger viewers captivated by the mystique and semi reality of the spectacle, some of these fans are older and are there for nostalgia reasons, and some of the fans are more casual but are attending the event simply because a WWE event is a good excuse to get rowdy.  Regardless very few of the fans are not completely engaged in the performance.

Beyond the casual fans, many of these fans are “hooked” by the weekly television programming which is essentially a soap opera targeted toward a male audience.  Any and all societal issues are worked into the story including relationships, politics, wealth divide, drug and alcohol abuse, physical abuse, etc etc.   These topics are timeless and all demographics can relate to some if not all of them. 

Additionally, other more macro themes related to current events are frequently worked into the script, and have been for decades.  For example, in the 1980s one of the more popular heels (wrestling parlance for bad guy) was known as Nikolai Volkoff – purportedly a Russian national who stoked Cold War era sentiments.  Similarly, during the First Gulf War, Sgt. Slaughter questioned the toughness of America and its ability to win the war.  It is a safe bet that the “Occupy” movement will be a theme in the WWE before long.  The net result is a product that is able to keep the audience engaged by staying relevant to the times.

The “product” is currently ~150 Superstars and Divas operating under exclusive contracts.  The more recognizable of these superstars are under multi year guaranteed contracts, while lesser known stars work under “developmental” contracts.  All wrestlers operate as independent contractors, and have upside earnings potential tied to revenue generation through merchandising sales etc.  WWE owns the right to “substantially” all of the characters, although in the past performers have been able to recreate themselves in other organizations by slightly changing their stage name. 

While a large stable of wrestlers is present at any given time, there is a certain cyclical element to the business as the popularity of individual characters and their story lines waxes and wanes over time.  I believe the popularity of WWE events is currently in a cyclical trough as several big names have retired in recent years and the new generation of characters has not yet captured the hearts of their audience.   This has impacted the top line in recent years. 

WWE has moved to fight this trend by bringing some big names out of retirement in an effort to re-interest lost fans, and introduce those old fans to the new generation of characters.  This strategy will be most visibly on display at Wrestlemania on April 1st when former WWE champ and now mainstream star The Rock faces current WWE super star John Cena.

Top line has been further impacted by a reduction in television offerings as the company prepares to launch a self branded cable network in 2H12 (estimated) and margins have been impacted as the company has attempted to develop an in house movie studio to further leverage their content.

 

2011

2010

2009

2008

2007

2006

Revs

483.92

477.65

475.16

526.46

485.65

400.5

These temporary issues mask a valuable underlying business that has produced reliable free cash flow for many years.

 

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

Cash From Ops

78.81

67.87

168.61

93.47

123.29

109.69

119.65

106.36

102.2

88.28

Cap Ex

-19.4

-16.37

-11.67

-24.13

-17.88

-17.07

-19.16

-18.08

-16.01

-13.88

Free Cash Flow ($M)

59.41

51.5

156.94

69.34

105.41

92.62

100.49

88.28

86.19

74.4

Business Lines

The company operates 4 main business lines with the following revenue contribution and sub business lines. 

Revenue Contribution

 

2011

2010

2009

Live and Televised Events*

70%

69%

70%

Live Event Revenues

22

22

23

Venue Merchandise

4

4

4

TV rights fees

27

27

24

advertising

0

1

2

pay per view

16

15

17

on demand

1

1

1

Consumer Products*

20%

20%

21%

Licensing

11

11

9

Home Video

6

7

8

Magazine

2

2

3

Digital Media*

6%

6%

7%

WWE.Com

3

3

3

WWE Shop

3

3

3

WWE Studios

4%

4%

2%

 

100%

100%

100%

*=Core Business

Consumer Products and Digital Media are relatively vanilla businesses so I won’t spend much time on them.  However,  Live and Televised Events has struggled in recent years, and WWE Studios has been nothing short of a disaster to date.

Live and Televised Entertainment

WWE targets performing 245 – 265 domestic (US & Canada) shows per year, and 75 – 85 international shows per year.  Year over year attendance and show count data is difficult to compare due to a shifting mix of geographies and venues, but on the whole live event attendance on an annual basis has been trending down. 

 

2007

2008

2009

2010

2011

NA Events

233

242

268

253

241

NA Average Attendance

?

6,400

6,500

6,300

6,000

Intl Events

75

77

74

74

80

Intl Average Attendance

7,700

8,500

8,500

7,800

7,100

A four quarter moving average of average quarterly attendance data should smooth out geographic and venue based effects, and seems to indicate that the decline in average attendance has stabilized.

2010 4Qs Moving Average Attendance

2011 4Qs Moving Average Attendance

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

7,175

6,575

6,425

6,175

5,750

5,950

5,875

5,975

Also of note, while the average attendance has declined, the average ticket price has been more resilient.  While the company bills itself as “the most affordable name in entertainment,” and low end seats for the June 17th show at the Izod Center in NJ (assumed to be on the high end of venue pricing) start at $35, premium seats have been ratcheted up by $5-$15 per seat depending on the venue.  For the Izod Center show, premium seats are $500.

The crown jewel of the live performance series is of course Wrestlemania which is billed a super bowl of sorts for Wrestling.  The event regularly draws more than 70,000 fans and sells out well in advance.

Televised events include “Monday Night Raw” on USA and “Friday Night Smackdown” on SyFy.  These 2 brands were originally meant to simulate the conflict between WWE and WCW that drove ratings while simultaneously eating profits for both organizations in the late 1990s.  According to WWE, they are both the top rated programs on their respective channels and attract twelve million viewers weekly.  Previous shows currently on hiatus or other wise inactive include WWE Superstars and NXT.  More on them later as their current dormancy is a significant hindrance to top line growth.

Additionally, WWE has stepped into the reality television world with “Tough Enough” which chronicles the lives of 12 individuals competing for a WWE contract, “Legend’s House,” which will presumably show the clash of egos between 12 former stars living in a house together, and  a show somehow based on the WWE’s “Divas” or female stars.

PAY PER VIEW

WWE typically holds one pay-per-view event per month, although at times they have added additional.  Each of these is billed as an “event” where storylines promulgated on the regularly scheduled shows come to a head.  In an attempt to further entice customers unique themes are often present such as, “Hell in a cell” where the matches take place in a 20 foot high cage, or “Survivor Series” in which the matches are four on four, six on six, or some other combination. 

Not surprisingly given the economy, revenue contribution from Pay Per View events has been trending down.  It is a tough pitch for a kid to get his parents to shell out $44.95 for an event in this economy, and outside of Wrestlemania total views are down.  However, the decline in revenues seems to have stabilized.

 

Pay Per View

Year

2009

2010

2011

Events

14

13

13

Revs

47.5

39.8

40.7

Consumer Products

The Consumer Products divisions consists primarily of revenues generated by sales of home videos, magazines, and license or royalty fees from WWE branded products such as clothing, toys and video games.  Additionally, WWE publishes original content books and composes and records original music under their CP division.

Video games are licensed with THQI and an updated version is released annually similar to other sports based games such as Madden Football or NHL Hockey.

Toys are licensed with MAT and consist primarily of action figures.

The Home Video segment distributes through Vivendi and produces titles based on new events as well as titles based on archived footage such as “Best of Wrestler X” or broader pieces that capture themes or eras in WWE history. 

The consumer products business combined with event merchandising is accountable for most of the inventory on the balance sheet.  Inventory has been kept consistently low, and has been trending lower.  Risk of inventory obsolescence is low barring the risk that a performer retires unexpectedly or is otherwise unable to perform.

Digital Media

WWE.com is maintained with information about upcoming matches, performer biographies etc etc etc.  2011 saw 12.7M unique visitors per month on average. 

Additionally, WWE streams video content on sites like Hulu and YouTube including episodes of “WWE NXT” and “WWE Superstars” which are not currently televised brands.

Is the Core Business Sustainable?

I believe that the answer is yes.  Recent downticks in performance are tied to the soft economy and will rebound with time.  Professional wresting has held a place in the American entertainment market for one hundred years, and I don’t think it is going away soon.  Adolescent males will always have an interest in super human type characters and the element of violence will always have a certain appeal.  Additionally, the story lines and characters are easily adjusted to fit with the times, so WWE should not have a problem staying relevant.

There are those that would suggest a decline in the future of live entertainment is underway due to the advances in the quality of the home viewing experience, however, I believe there will always be an attraction to the energy of the live event vs the home viewing experience, and WWE is very different than other professional sporting events or going to the movies in that on a local level it is a once or maybe twice a year experience.  In other words, a baseball fan has 80+ opportunities a year to see his team play at home.  A movie go-er has an unlimited number of opportunities to go to the movies.  This availability factor makes it easy to stay on the couch and go the next game or movie.  WWE events only come around infrequently, so fans are more motivated to get off the couch and experience them live.

There is of course the threat of upstart organizations to consider.  For example, TNA wrestling was founded in 2002 and has successfully established a niche for itself.  However, among wrestling purists TNA is considered the lesser brand, and does not have the distribution or deep pockets of WWE.   Also important to note, thus far TNA has declined to go head to head with their television programming against WWE.  This is notable due to the destructive head to head battles waged between WWE and WCW in the 1990s.

The emergence  of mixed martial arts and its approach toward main stream popularity is often cited as a competitive threat to WWE.  I do believe this argument has some merit and that many young wrestling fans will evolve into MMA fans.  However, this does not mean that they will lose their interest in WWE.  I believe WWE fans are an oddball group – similar to Star Trek fans in a a sense in their odd devotion to wrestling.  Just as Star Wars didn’t destroy the Star Trek franchise, UFC will not destroy the WWE.

If one believes that the core business is sustainable, we must now look at the “problem businesses” and the effect that they have on the total business.

 

Problem Business Lines

WWE Studios

WWE Studios is the company’s attempt to further leverage the popularity of their super stars through the movie business.  While the idea makes sense on the surface – they have the stars, and they have essentially free advertising for their movies through their TV shows - so far WWE has not found a way to make this division profitable.  In the last 3 years non cash impairment charges related to writing down the carrying value of produced films has been ~$40M, $13M, and ~$4M.

Originally the company acted as a co-producer on movies that had some main street success such as The Scorpion King (2002) which co-starred The Rock who has since gained cross over success.

In 2009 the business plan switched to aiming to make more films with lower costs.  An average production budget of ~$5M per film and 4 films per year was targeted, with WWE taking 100% of the equity and distribution risk.  Obviously these are B if not C or D level movies intended for direct to DVD or direct to TV audiences.  The DVDs are available for sale at retailers like WMT.

In 2011 the company moved to reduce their risk by partnering with studios for production and distribution.  For 2012 the company expects to release between 3 and 5 films direct to DVD that were co produced and financed with 20th Century Fox.  They also plan to pre-sell international distribution rights.  Additionally, Michael Luisi joined WWE and became the President of WWE studios in September of 2011.  Luisi previously spent 12 years with Miramax as EVP of Worldwide Operations, and undoubtedly has more film experience than previous management.  Luisi has been buying shares in the open market in recent months, although in small lots.

Going forward, the company has forecast spending between $15-$25M on movie production per year.  Perhaps most importantly, on the Q4 conference call McMahon said, “if the new film strategy does not work, we will likely be out of the film business – I still think it will work” and “we will not throw good money after bad.”

Given that they are planning on spending $15-$25M on film production costs in 2012, it would realistically be 2014 before the company can make a judgment on whether or not the new strategy is working well enough to justify continuing in the business.  The company has stated that they think they can achieve mid teen ROI in films when they get their strategy straight.  Note that distribution costs have a separate P&L.

The direct to DVD market is a billion dollar industry, and several franchises – perhaps most notably “American Pie” – have been able to remain profitable in this market.   Given the popularity of the WWE stars and the essentially free marketing that WWE can leverage through their televised events I can understand why management is sticking with this business line… for now.

WWE Network

A branded network has been rumored to be in the works for the last few years, and launch is expected sometime in 2012.  Management has not provided guidance on what they think the revenue capability of a network is except to say that they think it is very large. 

The market is skeptical of this endeavor due to the perceived failure of Oprah’s OWN network.  However, there are important differences between a potential WWE network and the OWN network.

Most important is that OWN has been spending tons of money to produce all new content that at best appeals to the same demographic that Oprah’s eponymous brand targeted.  Oprah herself is only under contract to appear on the network for 70 hours per year.  Essentially this means that OWN is competing with several other established networks such as WE, and the “Oprah experience” is there in name only.

WWE on the other hand intends to stay true to their brand and deliver content that is directly related to what WWE viewers want to see: wrestling.  WWE already owns 100,000 hours of film that contains substantially all of the archival footage that has been recorded by the WWE, WCW, ECW and other wrestling organizations in their histories.   A quick review of what is contained in this library can be found here http://bleacherreport.com/articles/841122-wwe-news-guide-to-the-video-libraries-to-be-used-on-the-wwe-network-in-2012#/articles/841122-wwe-news-guide-to-the-video-libraries-to-be-used-on-the-wwe-network-in-2012 .  It should be noted that WWE controls all of the rights to this footage and it would take more than 10 years of the network showing film 24/7/365 with no repeats to go through that footage.

Perhaps most importantly, most of that footage is archived and time stamped by date, performer, location, theme, and even particular moves that are used in the film.  In other words, if WWE wanted to use archival footage to create, “Best of Body Slams” or “The Macho Man” or whatever else, their costs would be minimal… all they would have to do is check the time stamps and splice the film together.  This creates a near infinite supply of content for a very low price. 

I have no idea what this library is worth and it doesn’t really make an appearance on the balance sheet.  I essentially look at it as one of those things that is worth whatever someone will pay for it outside of the hands of WWE, but it is extremely valuable to WWE if they successfully launch a cable network as it is essentially free content for them.  I am tempted to try to value it by simply saying it is worth substantially more than zero, and substantially less than the ~$900k per film that Disney got for its Miramax film library.  Just for conversation sake as related to the success of a WWE network I am tempted to assume that the library is worth $1,000 / hour, or $100M.  However, the value of the library is unimportant to the current investment case in WWE.  Best case the network is a success and the value of the library is just gravy on top of the value of the core business.  Worst case the network is a failure, but the core business is able to shine through and the value of the library is immaterial.  More on that later.

Also of note is that the WWE is able to offset the cost of new production for wrestling related events through ticket sales.  Other networks typically spend money on a studio audience and the production costs etc, while WWE has fans that pay to be there during filming.

Furthermore, WWE expects to continue airing at least one of their brands on a non branded channel as part of a strategy that will use this existing show as a way to build awareness for the channel… essentially free advertising. ( “RAW” is under contract with USA through 2014.)

As of the Q4’11 conference call management expected 2012 spending on launching the network to be $35-50M made up of $5 million to $10 million to create new programming content, $15 million to 20 million of capital expenditures for facilities and equipment, and $15 million to $20 million of operating expenses to provide the broader infrastructure, personnel, and systems to support the effort.  

 

Valuation

This is an asset light business, but I will start with the balance sheet.  The balance sheet is rock solid, although cash has been depleted by dividends that exceeded FCF for the last few years and the recent spending on the movie business and potential cable channel.  As of Q411, with 28,626,143 class A shares and  45,850,830 class B shares outstanding (controlled by the McMahon family), $52,491 in cash and $103,270 in short term investments, vs almost no debt, the company has about $2.07 / share in cash.  There are $10M in investment securities as well, but it is not clear what if any value can be realized from these so I will disregard them in a nod toward conservatism.

Moving past the balance sheet, given the uncertainty surrounding the film business and potential cable channel it is important to recognize how good the core business is.  The company has always held a high cash balance while needing minimal cash on hand and maintaining minimal maintenance cap-ex needs, ROE is a poor metric, and likely results in WWE slipping through many investor screens.  However, if we look at ROIA (return on invested assets defined as Net Profit / (total assets – (intangibles+cash)) ) we get a number that normalizes around 25% over the last 3 years – note that these have been difficult years.

If we kill the film business and eliminate the drag on earnings that the write downs have had over the last 3 years while conservatively not reducing cost of revs and SG&A that would surely be lower if the film business was really killed, the number is obviously higher – somewhere around 28%.  Keep in mind that this does not reflect increased spending on the possible cable channel.

If were to adjust earnings over the last 3 years to reflect earnings w/o the drag of the film business, earnings for the most recent year would  almost double, and for the last 2 years would move up considerably.

 

2011

 

2010

 

2009

Pre Tax Income

36,881

 

81,940

 

79,430

Add Film Impairments Back

28,000

 

13,000

 

3,916

Adjusted Pre Tax Income

64,881

 

94,940

 

83,346

Provision for Income Taxes

22,708

 

33,229

 

29,171

 Adjusted Net Income

42,173

 

61,711

 

54,175

           

VS.

         
           

GAAP Net Income

24,832

 

53,452

 

50,303

 

At a market cap of ~$670M, WWE w/o the movie business trades at 12x adjusted earnings net of cash.  If we were to kill the cable channel as well and add back the $12M in television licensing revenue that was written off  due to the shelving of WWE Superstars and add back the $4M of op-ex spent on beginning to put things in place for the launch of the network , WWE would trade at 10X adjusted earnings.  Over the past 4 years WWE has traded at an average of 20x.  Of course historical multiples should not be relied upon as a certainty, but if we were looking at only the core business current multiples are far too cheap for a company with a deep moat, high return on invested assets, and a long history of returning capital to shareholders via dividends. 

Unfortunately, we can not just kill the problem businesses.  However, we can make a judgment on their cost and their likelihood of succeeding or being killed off. 

The movie business is easy.  The company has said they will spend an average of $20M per year on the movie business for the next 2 years, and then kill it if it not profitable.  Being conservative lets assume that the company takes 3 years to kill the business and does not realize any revenue from it at all – that’s a total loss of $60M, an unlikely but conservative estimate.  It would take a bit more than 1 year of normalized FCF to fill in this hole.

The cable channel is more difficult. The company has estimated costs to start the cable channel are $35-50M in 2012.  This number may sound low given the reported $200M spent to launch OWN, but as noted above, WWE has programming in place due to the existing library, and can produce new content in a cost effective way due to their paying fan base.

Complicating the picture is the fact that cable companies are starting to push back against new channels as the cost of cable goes up and buzz builds around an a la carte pricing model.  In fact, cable companies are now in favor of a la carte pricing in some cases (specifically the expensive sports channels).

There are 3 main ways that I can see the development of the cable channel playing out.

1)      Cable companies refuse to carry the channel, and WWE abandons the idea.  This is a real possibility as cable providers have been pushing back against subscription fees for channels that have only modest popularity or limited target audiences.  If WWE is unable to get the channel off the ground, total cost to WWE is likely less than the low end of the start up costs they have estimated as they will pull the plug early.  In this case free cash flow replenishes the money wasted in attempting to start the network in 1 – 1.5 years.   Add the ~1+ year of FCF related to the movie business that is needed, and it takes ~2.5 years  to get back to the core business as it stands now.  At this point, the strength of the core business shines through and the stock enjoys multiple expansion back toward its historic level within 3.5 years (at which point the movie business is either dead or successful) and the stock moves up 50-100%. 

2)      Cable companies agree to carry the channel under the traditional subscription model where WWE gets a per subscriber fee.   It is impossible to guess which cable cos will carry the channel and how much WWE would realize per subscriber.  According to the National Cable and Telecommunications Association, approximately 130 million American homes have cable TV. 

The top 4 providers (Comcast, DirectTv, Dish, Time Warner)control approximately half of those homes, and WWE has said they will not launch without a major partner, so it seems that at least one if not 2 of these companies would have to be on board.  The smallest of the 4 is Time Warner with 12,109,000 subscribers.  Again it is impossible to know which tier of service the WWE channel would wind up in and how many subscribers actually had to pay for WWE, but lets assume that WWE winds up in the most basic level of service for the moment for the time being.

Now the question becomes how much can WWE get per subscriber.  Again, it is impossible to guess the outcome here, but it may be useful to back into a rate that would make the WWE network a break even business.  The company has not offered any clear guidance on what they think the channel would cost per year, but from the most recent conference call it seems as if they anticipate $15-20M / year in in OpEx that is primarily people, systems, and marketing dollars, and then $5-10M in programming expense.  There will obviously be maintenance CapEx costs associated w/ the channel as well, so $40M per year seems like a conservative estimate of what the channel will cost on an annual basis.  Note that this does not include initial start up costs.

 The following link below gives an idea of what other channels get per subscriber http://mediamemo.allthingsd.com/files/2010/03/cable-sub-fees.png .  I think it is safe to assume that WWE will not be able to get more than .25 per subscriber per month.   The following matrix shows at what rate and subscriber number the network becomes breakeven on a stand alone revenue basis.

 

   

Subscribers (Millions)

   

9

10

11

12

13

14

15

16

17

18

    Rate / Month

$0.15

$16.2

$18.0

$19.8

$21.6

$23.4

$25.2

$27.0

$28.8

$30.6

$32.4

$0.16

$17.3

$19.2

$21.1

$23.0

$25.0

$26.9

$28.8

$30.7

$32.6

$34.6

$0.17

$18.4

$20.4

$22.4

$24.5

$26.5

$28.6

$30.6

$32.6

$34.7

$36.7

$0.18

$19.4

$21.6

$23.8

$25.9

$28.1

$30.2

$32.4

$34.6

$36.7

$38.9

$0.19

$20.5

$22.8

$25.1

$27.4

$29.6

$31.9

$34.2

$36.5

$38.8

$41.0

$0.20

$21.6

$24.0

$26.4

$28.8

$31.2

$33.6

$36.0

$38.4

$40.8

$43.2

$0.21

$22.7

$25.2

$27.7

$30.2

$32.8

$35.3

$37.8

$40.3

$42.8

$45.4

$0.22

$23.8

$26.4

$29.0

$31.7

$34.3

$37.0

$39.6

$42.2

$44.9

$47.5

$0.23

$24.8

$27.6

$30.4

$33.1

$35.9

$38.6

$41.4

$44.2

$46.9

$49.7

$0.24

$25.9

$28.8

$31.7

$34.6

$37.4

$40.3

$43.2

$46.1

$49.0

$51.8

$0.25

$27.0

$30.0

$33.0

$36.0

$39.0

$42.0

$45.0

$48.0

$51.0

$54.0

   

 

   

 

                           

Given the highly desirable primary demographic of males age 18-34 that WWE attracts I would think that they could charge something similar to what SPIKE (.20) or the Golf Channel (.25) charge.  Meaning that they would need somewhere between 14 and 18 million subscribers to be break even pre tax.  I am assuming that additional revenues from advertising and merchandise sales via the channel would bring the channel to break even levels post tax here. 

Regardless of how many subscribers there are and what each subscriber pays, the important thing is that WWE would have some kind of visibility on revenues, which means they would know sooner rather than later if the channel should be pursued or abandoned.

Worst case, WWE spends $40M / year for 2 years and sees $0 revenue from it.  Realistically there will be some revenue as McMahon has said they won’t launch w/o a major partner, but I believe using a $40M loss per year is conservative because as revenue increases, management may increase spending.

If the company loses $80M over 2 years, they kill the channel, and need 2-3 more years of FCF to fill in the hole.  Add ~1+year to fill the movie business hole.  After 5-6 years the core business shines through, multiples expand toward historic levels, and the stock is up 50-100%. 

3)      Cable companies move to an a la carte model, and WWE is available via all cable companies.  Again, it is impossible to guess how many customers would sign up for the channel, what they would pay, etc, but the argument is essentially the same as above.  Management will have visibility on costs / revenues and move to kill the business  - or even better not even start it – and within 5-6 years the core business shines through and the stock is up 50-100%

The key take away from all three of these scenarios is that a successful movie business and cable channel are not needed to make an investment in WWE a success.  If the movie business and cable channel fail, the core business will shine through resulting in a gain for shareholders.  If the movie business and cable channel succeed, that is just extra gravy on top of the already successful investment in the core business.

Of course, the above statement is predicated on management being sensible and killing non performing business lines.

 

Question 2: Will Management Kill Non Performing Businesses Rather Than Throwing Good Money After Bad?

Management

This investment requires a strong faith in management’s ability to walk away from the movie and cable business if they do not become profitable in the next 2-3 years.

Given his on screen “role” as Mr. McMahon, the evil face of corporate greed in the wrestling world, it is somewhat comical that Vince McMahon is in fact the real life CEO and Chairman of the company.  McMahon was introduced to the wrestling word at an early age by his father, who was a promoter for the first modern professional wrestling company, Capital Wrestling Corporation.   His father eventually came to own his own wrestling promotion, known as World Wide Wrestling Federation (WWWF).  To make a long story short, Vince became a force in his father’s company as a master promoter.   In 1982 he purchased the company from his ailing father.

At the time, wrestling was essentially a regional business, and competing promotions generally did not invade one another’s territories.    McMahon would spend the 20 years turning wrestling from traveling low budget productions to an entertainment mega industry, consolidating the wrestling world into the WWE along the way.

McMahon and his family own more than 60% of the company through class B shares.  As if the simple majority was not enough in terms of voting rights, the class B shares have 10:1 voting power.  Quite clearly their interests are strongly aligned with potential investors.

Not surprisingly given their ownership stake, management has been share holder friendly.  A dividend was first instated in 2003, and over just the last 5 years more than $360M has been returned to share holders.  Of particular note, in February of 2008 the dividend was increased from .24/share to .36 for share, but only for the Class A shares.  The shares controlled by McMahon and his family continued to receive the lower dividend.  (Following Q1’11 the dividend was reduced to .12/share.)

On multiple occasions over the years McMahon and his team have made it clear that their priority is doing what is in the best long term interest of the company.  However, they have made mistakes in the past.

Most notable is the willingness to “deworsify” into business lines, including the XFL – a professional football league that was a complete failure – and a short lived themed night club in Manhattan.  While the night club idea may be considered excusable given its relative small size to the company and the opportunity to leverage the night club as a way to showcase the core business through pay per view events and merchandise sales, the XFL experiment is really just bizarre. 

Whether it is suggestive of an extreme ego or awful market judgment it is a black mark on McMahon’s record.  However, potential investors in WWE can take solace in the fact that these failures were quickly killed off when it became clear that they were not viable.

I believe that McMahon and his team will not hesitate to kill non performing businesses again in the future.  For starters, McMahon is on the record having said, “if the new film strategy does not work, we will likely be out of the film business” and “we will not throw good money after bad.”

While he has not made similar comments regarding the cable channel, he has indicated that he won’t even attempt a launch without the proper distribution partners in place.  This is clearly a rational stance to take and shows that McMahon is not so emotionally involved in the launch of a cable network that he will stop at nothing to have one.  If the network does not become profitable within 3 years, I believe it will be killed off.

For investors with an eye on exit strategy, it may be worth noting that on the Q2’11 conference call an analyst asked if there was a level where McMahon would consider selling to a Berkshire Hathaway type organization.  He responded with a one word answer…“No.”  This is not necessarily a negative, but investors should be cognizant that a take out is not in the cards at least while McMahon, 65, is at the helm.

Summary:

I believe that investors with a longer time frame will be generously rewarded for their investment in WWE.  An investment at this time is an investment in the core business at historically low multiples with potential for even greater returns if the film and cable channel business are successful.  If the film and cable channel are not successful, management will kill them off allowing the core business to shine.

For investors with shorter time frames, note the below:

Short Term Down Side Protection

With the stock at 52 week lows, there is obviously a falling knife factor here, but some solace can be taken in the high dividend and success of the recent Wrestlemania

Dividend

WWE currently yields more than 5%, and over the last five years WWE has returned more than $350M to share holders (primarily the McMahons) in the form of dividends.  While the company has been free cash flow positive for each of the last 10 years, not all of these dividends have been funded by free cash flow, and the company has substantially reduced the cash and short term investments on its balance sheets from over $250M several years ago to $155M today.   

Of course dividends offer less comfort than they used to be given the unclear nature of dividend taxation in the future.  Additionally, the dividend has already been cut from .36 to .12 per share per quarter in February of 2011 and the sustainability of the dividend at its current level has been called into question given planned spending on the cable channel.  However, this is not a foregone conclusion as the company still holds a lot more cash than they need and continues to generate FCF.  In response to questions about the current dividend level McMahon has stated that he does not foresee a need to cut it further.

Wrestlemania

Wrestlemania, effectively the Super Bowl of wrestling, took place April 1, 2012.  With the return of mega star the Rock, a live performance by Flo-Rida, and several other super stars that have not been active in recent years, this year’s Wrestlemania  was the highest grossing live event in WWE history ($8.9M).  While pay per view stats are not available yet, all available anecdotal evidence seems to point to big numbers.  The impact of this event will be seen in Q2 numbers.

 

Catalyst

New business lines either succeed or are killed off.  Either way investors win.
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