The Sizzle Is Fading For Sphere Entertainment

seekingalpha04-23

Sphere Entertainment Co. shares have rallied 35% since its split from Madison Square Garden Entertainment in April 2023.The opening of the Sphere venue in Las Vegas, featuring a sold-out U2 residency,...

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ALFSnaiper Shares of entertainment venue and media concern Sphere Entertainment Co. (NYSE:SPHR) have rallied some 35% since it was split off from Madison Square Garden Entertainment (MSGE) in April 2023, even with a recent pullback in the shares. Reviews after the opening of its namesake destination in Las Vegas – featuring a sold-out, 40-concert U2 residency – validated the pre-launch hype regarding the immersive experience venue. Dragged down by its lower-margin network business and not slated to turn a net profit until FY27, the recent insider buying into Sphere merited further investigation. An analysis follows below.   Seeking Alpha Company Overview: Sphere Entertainment Co. is a New York City-based entertainment and media concern with its chief assets the Sphere concert venue in Las Vegas, as well as its regional sports and entertainment networks, MSG Network and MSG Sportsnet. With a history spanning back to 1923, the modern iteration of the company began when Cablevision spun off Madison Square Garden Company, which housed the New York sports teams, Radio City Music Hall, Beacon Theatre, and MSG Network (among other assets), in 2010. In 2015, the network was split from the other assets. Then in 2020, the venue assets, including Tao Group Hospitality (2017) and the Sphere project in Las Vegas, were split from the sports teams, forming Madison Square Garden Entertainment, with its first regular-way trade transacted at $31.41 per share (adjusting for another spinoff in 2023). It then reacquired MSG Network in 2021. In April 2023, MSG Entertainment split off its sports and entertainment venues (save Sphere), bestowing them the Madison Square Garden Entertainment moniker, leaving the newly named Sphere Entertainment with the networks, the namesake venue, and the Tao Group, of which it divested of its majority interest in May 2023. The first trade of new Sphere stock was conducted at $27.65 a share. It now trades near $39.00 a share, translating to a market cap of approximately $1.35 billion. Sphere operates on a fiscal year (FY) ending June 30th. For the avoidance of doubt, the 12-month period ending June 30, 2023, is FY23. The company is capitalized by two classes of stock. The 28.3 million shares of Class A stock confer economic interest, one vote per share, and can collectively elect 25% of Sphere’s board of directors. The 6.9 million shares of Class B stock bestows economic interest, ten votes per share, and can collectively elect the remaining 75% of the company’s board. Owing to this arrangement, CEO James Dolan and his family control 72% of the voting power and ~25% of the economic interest. Reporting Segments That long preamble aside, Sphere views its operations through two segments: Sphere and MSG Networks. Sphere. For those unaware, Sphere is the new concert venue in Las Vegas that opened in September 2023, with U2 as its opening act and first resident artist playing 40 sold-out concerts that concluded March 2, 2024 after selling 661,456 to 662,530 tickets (depending on the source), raising gross ticket revenue of ~$245 million to ~$256 million. It also generated more than $1 million a day from its original content immersive spectacle called The Sphere Experience, which ran 191 times in 2QFY24. The entertainment medium with world-class, one-of-a-kind production values can seat up to 20,000 concert-goers and can convert to host sporting and corporate events. Costing $2.3 billion, the 336 ft tall and 516 ft wide dome with its exosphere covered by ~1.2 million LEDs that can make it appear as if the moon landed in Las Vegas, only to take on the image of a baseball moments later, confers it with obvious and significant advertising, marketing, and merchandising potential. The structure is supported by Sphere Studios, located in Burbank, California, which includes a quarter-sized replica of the Sphere (dubbed Big Dome) that serves as a test lab for content. In its first quarter of full operation (2QFY24), Sphere generated Adj. operating income of $14.1 million on revenue of $167.8 million – more on the definition of Adj. operating income below. The top line consisted of $121.8 million from ticketing, $23.4 million from sponsorship and advertising, and $21.8 million from food, beverage, and merchandising. MSG Networks. The company’s MSG Networks segment houses regional sports and entertainment networks, MSG Network and MSG Sportsnet, as well as its streaming service MSG+. These media serve the New York City Metropolitan market and Pennsylvania, showing New York Knicks basketball, New York Rangers, New Jersey Devils, New York Islanders, and Buffalo Sabres hockey, with significant non-game coverage of the New York Giants and Buffalo Bills football teams. It accounted for 2QFY24 Adj. operating income of $37.3 million on revenue of $146.4 million, representing declines of 22% and 8% (respectively) versus the prior year period as lower distribution revenue ran into higher direct operating costs, a function of more consumers streaming content. 2QFY24 Financial Report Shares of SPHR have enjoyed an excellent run, rising 65% since the spinoff 11 months ago. Part of the rally was on the back of very positive buzz concerning Sphere, with the proof provided in the company’s 2QFY24 financial report of February 5, 2024, when it reported a loss of $1.55 a share (non-GAAP) and Adj. EBITDA of $37.7 million on revenue of $314.2 million, versus a loss of $0.58 a share (non-GAAP) and Adj. EBITDA of negative $36.6 million on revenue of $159.5 million from continuing operations in 2QFY23. It should be noted that Sphere did not provide those metrics but rather its own non-GAAP figure that was a hybrid of the two, which removed depreciation and amortization and some other line items typically reserved for Adj. EBITDA as part of its firm-wide Adj. operating income. The above figures present more of an apples-to-apples comparison to typical non-GAAP reporting protocols. Howsoever one chooses to present the financials, it’s challenging to interpret the data as they include the first full quarter from Sphere. However, one item was certain in the 2QFY24 results: gross margin at its Sphere segment (59.9%) was significantly better than at MSG Networks (36.8%). That said, SG&A was substantially higher at Sphere, coming in at an eye-popping $97.8 million versus $17.7 at its lower margin counterpart. This imbalance could certainly be excused by significant advertising and promotion spend at its namesake venue, which was only a week into operation when the quarter commenced. Either way, the market liked what it heard, rallying shares of SPHR 10% in the subsequent trading session and 29% overall since the release. Balance Sheet & Analyst Commentary: Like its income statement, Sphere’s balance sheet is challenging to navigate. It held \"unrestricted\" cash and equivalents of $614.5 million against debt of $1.42 billion as of December 31, 2023. However, the cash balance included advanced ticket sales of $120.9 million, most of which is due to (presumably) U2, as well as $82.7 million that is unavailable for distribution due to covenants in its $890 million MSG Networks debt due October 2024. The cash position was bolstered by a privately placed 3.5% convertible bond offering that raised net proceeds of $237.3 million after giving effect to a capped call transaction in December 2023. Street analysts are not as ebullient as the market. Since the beginning of February, five analyst firms, including J.P. Morgan and Morgan Stanley, have either initiated, downgraded, to or reissued Hold/Neutral ratings on the stock. On average, they expect Sphere to generate a non-GAAP loss of $4.31 a share on revenue of $1.06 billion in FY24, followed by a loss of $1.91 a share on revenue of $1.22 billion in FY25. They don’t see the company moving into the black until FY27. It should be noted that the embroiled CEO James Dolan has been a buyer of his stock on the way up after the earnings release. He purchased 245,669 shares of SPHR at an average price of $43.60 between February 26th and March 4th. Verdict: The rationale for attaching MSG Networks with Sphere in the April 2023 split was possibly to offset the higher-risk, higher-margin property with an unexciting, declining, low-margin but somewhat stable asset, providing time for Sphere to get its sea legs as its SG&A expenses fall over time. That’s a guess, as the pairing ostensibly makes little sense. That said, short of an extended Taylor Swift, Rolling Stones, or Bruce Springsteen residency, it is difficult to imagine selling ~660,000 tickets at an average price near $370 per ticket, like U2 accomplished. In other words, investors probably have a snapshot of what a strong revenue quarter from the Sphere will look like. It will certainly become a more efficient operator in Las Vegas and will eventually birth the concept as a franchisor elsewhere (after abandoning a similar project in London that resulted in an impairment charge of $116.5 million), but substantial new revenues are a long way into the future – the first Sphere concept took five years to become a reality. Since evaluating the company on price-to-sales and earnings metrics are challenging exercises now, the best value guesstimate can be derived from the EV/Adj. EBITDA metric. Generously assuming all its unrestricted cash is actually unrestricted, and efficiencies lead to Sphere generating Adj. EBITDA of $225 million over calendar 2024 (aided by Super Bowl week), that would put its EV/CY24E Adj. EBITDA at around nine. That better-case scenario, for a company that analysts don’t think will be profitable on a non-GAAP basis until 2027, is not terribly compelling.  The Sphere Entertainment Co. venue is hot. However, the valuation, especially with the drag from MSG Networks, still seems ahead of itself. As such, the recommendation is to stay on the sidelines.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.24.2","shortVersion":"4.24.2","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2429974229"}