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The Short Case for WWE
Posted by: amvona (IP Logged)
Date: March 17, 2014 01:32PM
The business World Wrestling Entertainment (WWE) is engaged in is sport or show (or maybe both) designed to manufacture emotions - to this end, the shows are replete with the kind of drama that apparently opens wallets
If the production of emotions however is transferred to the investing public and elicits the same visceral response to the stock as it does to the company's events, then there ought to be significant reason for caution on the long side, for sound investment policy has nothing to do with emotions.
Yet, when examining not only the stock price, but the commentary that can be found online regarding the justification for the significant premium the shares currently command, it is hard to characterize the sentiment as anything other than speculation based on what appears to be the very temporal popularity of the issue.
A few questions that might be worth asking:
1. If one projects into the future ten years and looks back at WWE shares today and the corresponding premium, how would the opportunity look? Will WWE as a company seem as promising then as it does now? For that matter, is the company really as auspicious as it seems today?
2. Is the current popularity of the company’s product easily translatable into profits? If yes, why has profitability been unremarkable despite a 34 year history and a virtual monopoly?
Is the company going to bring about a significant change (against historical averages) in its profitability with either its direct model or with a renewed network contract?
3. Even with a more lucrative network contract, say for example at 2x current revenue run rates, will the model translate into 2x profitability? And if so, would the valuation ratios make sense at such levels?
Putting aside the rising COGS which is at about ~64%, or nearly a ten year high, and somewhere around 10 points higher than historical norms consider the following:
- The 10 year average net profit of the company is about 39 M per year. Free Cash Flow has averaged a bit less at around 37 M per year.
- Assuming that 2x revenue still translates to 2x free cash flow (which is probably a stretch given rising operating costs amongst other things), and the company returns to its average historical profitability
– than such an increase in revenue would equate to about 73 M per year in free cash flow.
In such a case, the P/E ratio would come out to just under 32. The current S & P 500 PE Ratio after 5 years of a continuous rise in the market is 19.51.
To reiterate, there are two major assumptions required:
a. The company returns to at least average profitability even though its net income as a percentage and as a dollar figure has been steadily declining for years.
The company stated in their recent conference call and press release:
If understood correctly 2012 OIBDA was 63 M (importantly free cash flow was only 29 M), if that is doubled the total would be 126 M (and free cash flow 58 M) – the soonest such an outcome could come to fruition is apparently 2015, and the high cost (i.e. losses) of getting to this speculative figure is growing quarter by quarter, diminishing the company's current assets.
So a reasonable question to ask might be what 2014 losses may possibly need to be applied to the potential 2015 gain. What is known from the Q4 2013 conference call is:
i. The loss in Q1 2014 will result "in a net loss of 12 M" (see comments below)
Q1 2014 alone then would reduce the company's projection of 126 M of OIBDA by 2015 (a doubling of 2012 OIBDA) down to 114 M (the net change in cash is likely to be even more substantial). The optimistic scenario is that the company does not report any more minus figures in the next three quarters of the year - but that would be contrary to the company's ten year earnings trend (see section 2 below on the price-to-earnings ratio).
In sum, the company's average net income over the last four quarters was 688k per quarter (a positive figure). Yet, the company's net change in cash was depleted on average by 8.3 M per quarter (a negative showing every quarter), as the company hemorrhaged.
If the company is now indicating a net loss of 12 M on the P/L for Q1 2014, how significant is the cash drain going to be in the same period?
Feb 28th, 2013 – Financial Outlook Press Release
However, when the company finally did release the direct network product (about a year later), the price for the monthly subscription had dropped by as much as 33% of the projection down to just $9.99 per month. Presumably this would mean EBITDA would be reduced also by the same factor putting EBITDA projections between $33 and $90 Million. If the average of the two figures is 66 Million then the company would produce about the same EBITDA figure as it did in 2012. If the 2013 base line is only 30.8 M, then the increase would about .5 and not 2 - 3x, a scenario which assumes no cannibalization.
4. How is it possible to know if the company will command a significant premium in a renewed contract with a network? Without actually being at the negotiating table, isn't such postulation speculative?
In the words of management:
Q4 2013 WWE Earnings Conference Call
5. What evidence exists that the WWE direct channel (while perhaps a great idea) will be more profitable than the historical network agreements? That is to say, how can the direct network costs be correctly understood when it is yet a "start-up"? And if successful, what will the impact be to legacy broadcast network revenue?
Is it possible to know so early if it the new model will be viable in the long term?
6. Why was the stock on the (HTB) or "Hard-to-Borrow" list of brokerages by Friday March 14th, 2014? If the price made sense, or had upside, surely large institutional holders, and brokerages alike would make their shares available to short-sellers in exchange for the additional income such a transaction provides.
By Monday March 17th, 2014 the cost of borrowing the shares had continued to rise.
If this were "Texas hold'em" wouldn't the appearance on HTB lists be a "tell"?
Even if all the stars align, and the company performs an operational and fiscal miracle (even though it has never exactly done so before), is the WWE brand premium (at a forward P/E of >30) worth 64% more than the S & P 500 which itself is priced in the midst of an incredible bull market? Should the pricing premium be 145% of the Apple brand, and if so, why?
Sans miracles, is the brand worth 4,226% more than the S & P 500?
A few more figures worth noting:
1. The share price is at an all-time high (15 years since IPO) – in fact, the price is even higher than it was in the late IPO / Stock market mania years of the late nineties / early 2000.
It may also be worth stressing again that the price is achieving all-time highs in lock-step with a 5 year bull run. If it is true as John F. Kennedy once said that "a rising tide will lift all boats" then, the physics of rising tides ought to be included in any examination of the stock price's "metacentric height".
2. The trailing Price-to-Earnings Ratio (the only one based on fact vs. estimation) might be considered, by value-oriented investors as a little rich at something like 844.
Pundits will argue about the value of the brand, but other companies, such as Apple (AAPL), have not only good brands, they have great brands, and yet trade at a paltry PE ratio of just 13 – and this despite an extraordinarily consistent track record of generating consistent profits and free cash flow. Last year around this time, Apple was taken to task for reporting another record quarter of profits and unit sales – an event that was discussed in the Amvona article "Apple's Crime and Punishment" – the same psychology discussed in that article probably applies to the present discussion.
If you go ex-cash on Apple's share price, then the PE ratio is something around 8.4. this is valid reasoning for companies that print cash, but for companies that burn it, the aggregate loss over a measured period of time ought to be added to the share price (vs. subtracted) when trying to determine a realistic PE ratio. In the case of WWE they've been losing about 8.3 M per quarter (see above), and the situation appears set to worsen before it improves. If the company loses just 12 M in 2014 (or ~.16 per share) which apparently is a foregone conclusion, then a more accurate PE ratio might be 848.
If a company with Apple's brand strength and virtually unmatched fiscal record can be "taken down a few notches" for reporting good news, and even though it wasn't trading at a particularly rich premium, then isn't it within the realm of possibility that investors (or perhaps more accurately speculators) in concerns such as WWE might also eventually come to the conclusion that there is such thing as a price that is too high?
Stated in another way, it would take just 831 fewer years for apple to recover its entire market cap. through profits than it would take WWE.
The 10-Year earnings growth rate of the company is -17.3%. The 5 year earnings growth rate is something more substantial at -46.2%. The one year earnings growth rate is a remarkable -91.6%. According to the measurable data there is a faithful "trend" in the wrong direction which has existed for some time.
That is to say, the rate at which earnings are diminishing has been accelerating, yet in the last year the share price has appreciated ~262%.
3. Earnings Per Share and Free Cash Flow have been declining meaningfully in recent years. Dilution has not helped - shares outstanding have increased from roughly 69 Min 2004 to almost 76 M by YE 2013, an increase of about 9.5%. In the last twelve months the company earned just 3.5 cents per share, yet the share price has continued to march higher, closing Friday March 14th, 2014 at $30.94.
The following chart illustrates the point (gray areas represent recessions):
4. The Short Interest ratio and the possibility of a squeeze are real. Given the extreme nature of the share price run-up (almost 32% in the last month in the absence of tangible data that would support a sea change in the company's outlook) and given the fact that about 16% of the float (an increase of about 30% from the prior month) was short as of February 14th, 2014, it is possible that some short sellers may have been covering adding to the apparent adulation surrounding the stock.
At the current price the value of the 4.09 M shares short as of Feb. 14th, 2014 is almost 127 M. The sellers of these 4.09 M share have lost an astounding ~32% in just 30 days, and can be forgiven if some may have felt, well... skittish. If this is true, then short covering may be a real factor in the recent price movement.
That is to say, there may be a dual prong cause for the extreme valuation, which cannot last. If the short interest ratio is 3.9, then it would take less than 4 days of trading volume for all of the shorts to be covered. If short covering ends, then buying would be notably diminished by this group at more or less the same time the stock was reaching for the stratosphere – and it's not hard to imagine that it would only take a whisper for sentiment to change at such highs.
If the most recent short sellers are right, than day traders, technical analysts, chartists, momentum buyers, astrologers, palm readers and all others groups notable for their stable and rational approaches to selecting stocks will have joined faithful WWE fans in counting themselves amongst the group of happy new owners of the shares by the time this article is published.
5. EV/EBITDA and Short Interest Ratio have both increased dramatically. Enterprise Value divided by EBITDA (a rough proxy for free cash flow) is a quick way of looking at the real value of the enterprise to a prospective acquirer based on about how much cash the company is generating.
In this case, the EV/EBITDA ratio is currently at just over 51, but was recently even higher (~71) as can be seen below. In short (no pun intended), it would take just over a half of a century for a buyer of the entire business to cover the costs of the acquisition through EBITDA earnings (and much, much longer if free cash flow is the divisor). Such ratios have never been seen in the company's history.
It would have been more accurate to use P/FCF (Price to Free Cash Flow) for such a purpose, but since the company has recently had a negative free cash flow position, such a calculation is impossible.
Is 2.3 Billion a fair price for a company that earned 2.76 M last year, and reduced its cash position by about 33 M? The answer may not be clear, and perhaps the problem described is not a trend afterall... conceivably the following quotes will aid in answering the question:
Q4 2013 WWE Earnings Conference Call
Not to fret, the most pressing corporate issues were still prudently attended to, using debt of course (since the price tag would have represented about 30% of cash) – unfortunately this largest outlay of capital (30 M) did not include references to any sort of future ROI or ROA.
And coincidentally another reference to a 30 M figure:
"Page 16, shows our free cash flow which declined about $30 million from the prior year..."
Q4 2013 WWE Earnings Conference Call
Actually the decline is closer to 33 M – rough numbers are usually ok, but 10% is a little more than a rounding error - it is more than the company's entire 2013 profit?
Management controls the company's voting (class B) shares.
6. .59 Cents. Value investors like Discounted Cash Flow models because they provide some guidance on what the future earnings power of a concern is based on available data (versus sales projections). A look at a discounted cash flow model for WWE based on 10% growth for the next ten years, 4% terminal growth for another ten years and a 12% discount rate produces a fair value for the stock of .59 cents, and a margin of safety of -5,144%.
As a note on assets - Intangible assets (the kind you can't sell easily when things turn south) increased from roughly 100k in 2010 to just under 27 M in 2013, an increase of 268 fold in 3 years – these "ghost assets" of course can bolster a balance sheet nicely.
7. Dividends and losses are depleting current assets / cash rapidly.
In 2013 for the first time in at least ten years the company's net cash position went negative, while the NCAV (Net Current Asset Value) has dropped precipitously to just .57 cents or slightly below the firms discounted cash flow value.
In fact, the NCAV value has declined every year since it reached a high of 3.56 per share in 2006.
Current price exceeds tangible book by a factor of nearly 10x.
An asymmetrical business by design
Perhaps Amvona being called out by SeekingAlpha again has led to some sort of complex about being right... and maybe the present thesis will be wrong... after all there is a first time for everything and it (being wrong) is bound to happen sooner or later.
That having been said, the odds seem handicapped in favor of the current proposition.
Wealth is never "destroyed" in the stock market. It is only transferred. This is important. A large gain by a few is almost always paid by the loss of a large number of others – these transactions take place with varying degrees of unpleasantness.
The average retail investor has access to a huge variety online brokerages that continuously encourage a great deal of fee-generating "activity". Indeed entering "orders" has become so easy, that executing on a mobile device should be no problem while driving and brushing your teeth simultaneously if needed – there's a reason for this "ease" – its' so that the slightest change in state of mind can be acted on.
Perhaps it is a question for behavioral psychologists, but it's worth contemplating what happens when you cross the DNA of a WWE fan in all of their adrenaline-filled glory, with the DNA of a highly profitable (to the brokerage) e-trade mobile app. - perhaps the love-child is a stock with a PE ratio north of 800?
In case any doubts exist about the coalescence of the two desperate parties, that is to say whether or not a marriage can really be made... just consider how and where the company intends to report critical fiscal data:
Q4 2013 WWE Earnings Conference Call
What a curious choice of venue.
Despite this, there is no ethical imperative that comes to mind against shorting the stock.
The average retail investor does not usually grasp the concept of short selling very well, and rarely has access to the appropriate tools to execute on short ideas even if he does.
What could the numerical imbalance between long and short participants mean? What if only a drastically smaller number of participants can benefit in the case of the latter?
The greatest promoter... possibly ever.
Imaginably every CEO promotes their own stock, it seems reasonable, especially if they believe in their company. However, not every CEO is by profession a professional promoter - so some may be better at the task than others.
Any discussion of the ethics of the WWE business model and its founder are not necessary – they have been indited enough.
The central question the present article deals with is, has the management team delivered consistent profits in the past that would be indicative of the ability to deliver profoundly improved profits in the future, such that even the current rich forward P/E might be justified?
The answer seems clear.
That isn't to say judging by the ubiquitously bullish sentiment, that the stock hasn't been masterfully promoted – but that of course is a separate issue.
Nonetheless the risks of selling short are real
The following are some of the risks inherent in shorting WWE:
a. The cost associated with borrowing shares is typically higher than the cost of capital when going long – this is particularly true in HTB situations.
b. The ability of the market to stay irrational seems from time to time to be boundless.
c. The company will announce a new distribution agreement with a major network (probably at a higher rate than before), and possibly a large number of subscribers for their direct network (given their customer loyalty) – how the market will react to such news is unknown given the pre-existent run up in stock price. However, as far as the direct network is concerned it seems while initial subs. are likely to be strong, it is hard to foresee large numbers signing up on an ongoing basis.
d. It would be preferable if something more tangible were uncovered, such as creativity in the accounting or something of that nature, that could be pointed to, but in the present case the argument rests squarely on an intangible (intangible does not mean less real) – that is to say, the present excitability of investors over a stock that has almost never produced very good or consistent profits, and to be sure has often wedded poor results to poor judgment.
e. For example, if the company delivered 3x 2012 OIBDA (189 M – or the high end of company estimates) in 2015, and did not sustain a net loss again in 2014, then the forward PE ratio at today’s price would be only 12.3. The Price to Free Cash Flow (PFCF), a more important ratio, at 3x 2012 FCF (or 87 M) would be 27.
The current PFCF ratio of Apple is 10.6, almost a third of what WWE’s would be in the aggressive outcome scenario.
Using your children's college tuition fund to short the stock may require above average conviction.
Execution has been sub-par
The short thesis rest on whether or not execution will approximate Managements projections.
Consider the following analysis of past comments from management:
The first comment made in the earnings conference call proved to be about 110% wrong. 2013 EBITDA arrived at 30.8 M, or ~52% below the 64.4 M 2012 figure.
The follow up comment in the press release was even more problematic, not only because it affirmed the 2013 guidance, but because by the time it was made (2 months into the first quarter), the company would have known that based on how Q1 was already progressing, it was probably a good idea to temper expectations for the fully year 2013 performance.
That is to say, Q1 2013 came in at just 10.4 M in EBITDA and only 3 M in net earnings. Looking back over the years, the first two quarters of the year are typically the strongest from an EBITDA and Net Income perspective. By Feb. 28th the company would have known things were not great, and that coming within +/- 10% of 2012 EBITDA was increasingly a long shot – in fact, Q1 EBITDA was less than half of Q1 2012, while Net Income on a year over year basis would fall by ~80% from 15.33 to just 3.03 - yet the company affirmed guidance.
The company did not actually launch the network in 2013, and yet the reduction in EBITDA and Net Income was much more severe than stated (more than 2x what was projected by the company) as noted above while Q1 2013 EBITDA dropped by almost 11 M.
2013 was the lowest EBIDTA and Net Earnings Figure going back 10 Years – and continued a multi-year trend. Yet, despite the comment above from the Q4 2012 Conference Call, the company seemed to indicate during the Q4 2013 Conference Call that the increased spending was in no way abating.
It might have been worth going back further to get quotes, but what would be the point? In the above comment the company is admitting to not meeting targets previous communicated going at least back to 2010.
Without a clear explanation the company also shifted in 2013 from references to the more common EBITDA to OIBDA (Operating Income Before Depreciation and Amortization). These two measures are similar except for the income numbers they use. In the case of OIBDA, the calculation begins with GAAP net operating income. In the case of EBITDA, the calculation begins with GAAP net income.
The matter is probably not significant in this case, but it does add an additional aspect of complexity when tracking managements historical comments and references.
With the above quotes as well as the unexpected 33% reduction in monthly membership fees to the direct channel, but absence of a revision to OIBDA guidance, there seems to be a pattern - financially, the company consistently over-promises and under-delivers.
WWE from a business perspective may be suddenly full of possibilities. It could be that the company will deliver on an extraordinary increase in profits, change the way sports content is distributed and become a model for other sports syndicates to follow.
However, such theory can only be considered speculation at this time, and cannot be reasonably deduced from management's track-record.
In fact the flip side of the argument might ask about the wisdom of competing with a large number of established networks versus trying to cooperate with them. It may be that the direct content delivery model is the future, but how likely is it that WWE of all companies will be the one to effect such change? Is creating disruptive technology models counted amongst their core competencies?
Indeed, there is almost no tangible evidence in the company's financial track record that would indicate such an aptitude – and importantly for shareholders, if private jets are used as a proxy, management cannot be designated as "brilliant" when it comes to allocating capital.
Reviewing the sentiment of buyers of the stock seems to indicate, as is often the case in technology shares, that strong feelings about the company's product may have confused thoughts on earnings and its relation to share price, without regard to underlying fundamentals or history.
It is also worth asking if the company's best case scenario does materialize by 2015, if the enlarged capital base will be wisely managed by the company going forward (particularly in light of the near complete absence of shareholder rights).
Recent rumors regarding a possible buy-out of WWE by AMC (AMCX) networks is hard to imagine given AMC's own financial profile which would make it very difficult for the company to acquire WWE (without extraordinary amounts of debt) – at least at today's prices. Further, given WWE's declining profitability over the years culminating in consistent net minus', the acquisition would hardly be accretive to AMC. It is also hard to imagine that other possible acquirers would be willing to pay such a significant premium over their own valuation ratios.
The following is a table showing the valuation of prospective suitors:
Consider the following:
a. If WWE's terrible 2013 performance is omitted as an anomaly (even though it fits nicely into a trend) and the EPS for the 5 years between 2008 and 2012 is averaged, the result is .55 cents.
Based on the historical average, and giving the company the benefit of the doubt by excluding 2013, the share price should be around $11.88.
However, given what has been outlined above, the company isn't worth a PE greater than 15 (which is still higher than Apple). A PE ratio of 15 would place the share price, based on average historical performance, at about $8.25.
The shares are probably overpriced by at least 275% (and maybe more).
WWE's financial track record tells a story.
History of course is not a precise guide to the future, but it is usually a fairly good indicator of what is likely to happen next. As Mark Twain once said, "history doesn't repeat itself, but it does rhyme"
Stocks Discussed: WWE, AMCX, CMCSA, MSG, DIS,
The Short Case for WWE
Posted by: Tannor (IP Logged)
Date: March 17, 2014 04:46PM
Thank you for the thoughtful write-up worth reading.
Stocks Discussed: WWE, AMCX, CMCSA, MSG, DIS,