Madison Square Garden Co (MSG*) Spin-Off Details by Brian Langis
You probably just received your September portfolio statement and you are wondering about certain changes to your portfolio. Aside noticing the September losses in your portfolio, you also noticed that you are now the owner of two Madison Square Garden stocks, MSG and MSGN. You heard about the spin-off a couple months ago but didn’t quite know how it would go down and now the questions follow. Let’s review what happened?
As an aside, if you are interested in the valuation of the MSG Company, I wrote a research piece back in June 2014, Dear Oprah: Forget The Clippers, Buy The Knicks. The investment thesis was that MSG’s intrinsic value was severely undervalued under a Sum-Of-The-Parts (SOTP) approach. The Madison Square Garden Company is more than just a famous arena in New-York, it’s a juggernaut with a portfolio of trophy assets and brands, including the New-York Knicks and New-York Rangers among them. The stock has appreciated a lot since the publication but the majority of the thesis is still valid.
On October 27 2014, Madison Square Garden’s board approved a plan to explore possible spin-off. It came as a surprise since the Dolan family, the family that controls MSG, isn’t reputed for listening to shareholders or Knicks fans (see petition). The move followed some interesting events. First the blockbuster sale of the LA Clippers drew a lot of attention to the Knicks’ valuation. The line of thinking was if L.A’s “second” team is worth $2 billion, an argument can be made that the Knicks are worth considerably more. Then hedge fund JAT Capital Management LP filed an activist position in August 2014 with 9% of the company. Owing such a high number stake in MSG doesn’t carry any influence since the Dolans mainly have ~69.5% of the voting power. Maybe JAT played a behind the scenes role and if they did they were pretty quiet about it. This Bloomberg article claims that JAT has privately campaigned for better corporate governance, share buybacks, and a breakup of MSG, two people with knowledge of the matter said. Then at the October spin-off announcement MSG also appointed two new independent directors: Nelson Peltz, the veteran activist hedge fund manager from Trian Investment, and Scott M. Sperling, a co-president of the private equity firm THL Partners. On the top of that, MSG announced a $500m buyback.
The news was greatly appreciated by the market with an 11% jump in the share price. The call for reshaping Madison Square Garden activities was long overdue. Like I said, the Dolans were pretty dismissive about shareholder concerns. A lot of investors and analysts believed that the old MSG structure didn’t reflect the true market value. A quick peak inside MSG revealed a conglomerate made off media, real estate, venues, sports, entertainment and joint ventures. By making the company simpler, the market could attribute the appropriate market multiple to the appropriate assets.
Madison Square Garden decided to divide their various activities into two companies. MSG spun-off its sports and entertainment businesses from its media business. If you owned MSG on September 21 (record date), you were given shares of the MSG Spinco on September 30. For every three shares of MSG you had you received one share in MSG Spinco. So if you had 150 shares of MSG, you received 50 shares of MSG Spinco. Old MSG, is now MSG Networks and move to the MSGN ticker and MSG Spinco took over the MSG symbol.
I don’t know how detailed your portfolio statement is, but here’s a calculation example on how to determine your cost basis.
It’s Madison Square Garden that determines the appropriate cost allocation for cost basis. I won’t bore you with the details but Form 8937 filed by the company explained how they arrived at the number (explained in Part 2, point 16). The short explanation is that they relied on the volume-weighted average prices (VWAP) of October 1st, the first trading day. They even provided a worksheet for allocation of tax basis for common shares:
Source: MSG’s Form 8937
What does this achieve?
On September 11, 2015, ten days before the record date, Doc O’Connor, president and CEO of MSG said, “We are now one step closer toward our goal of creating two distinct, focused companies for investors. The live sports and entertainment company will comprise a portfolio of celebrated venues, legendary sports teams and exclusive entertainment productions, while the media company will continue to own and operate award-winning regional networks that deliver compelling sports and entertainment content. We are confident that this transaction will further enhance the long-term value potential of both companies as each continues to build on its considerable record of achievement.”
Basically the board and management of Madison Square Garden believes that the spin-off will provide much needed operational flexibility to both the companies. By splitting the MSG into two distinct companies, it provides an opportunity to enhance its focus on primary operations and growth. MSG is home to the venues (Madison Square Garden Arena, Radio City Music Hall…etc), sports teams and entertainment line. MSGN is comprised of regional sports and entertainment networks, MSG Network and MSG+.
There’s also a tax saving angle behind the spin-off. Splitting off Madison Square Garden’s sports teams and cable networks in one company will make a sale of the Knicks easier for the Dolans, because it can avoid a large tax bill a year after a spin-off, and because a buyer wouldn’t have to spend billions on lower margin real estate and entertainment joint ventures.
MSG and MSGN are now two independent companies with no stock ownership interest in each other but there are still some links however. MSG has entered into media rights agreement with MSGN to broadcast the games of the Knicks and Rangers for 20 years, as well as other programming. The annual right fee in the first year is $100m for the Knicks and $30m for the Rangers and is to increase annually. There are also other arrangements with MSG and its subsidiaries. There’s also an overlap between the executive officers of the MSG and MSGN. James Dolan will serve as Chairman of both companies and five of the board members will also serve as directors of both companies. And following the distribution both companies are still controlled by the Dolans.
Below is selected financial information of the stand alone MSG Spinco to give you an idea of the financial state of the company. Historically, separate financial statements have not been prepared for MSG Spinco.
Source: MSG Spinco Information Statement
The numbers demonstrate that the Media and Entertainment segment is growing pretty fast with a 17% jump in revenues last year (and the Knicks didn’t make the playoffs). The Entertainment segment represented approximately 39% of our combined revenues for fiscal 2015. MSG Entertainment presents or hosts live entertainment events, including concerts, family shows, performing arts events and special events, in our diverse collection of venues. The primary source of revenue are ticket sales. MSG Sports represents of FY2015 revenues. MSG Sports has several primary sources: ticket sales and a portion of suite license fees at The Garden, distributions from NHL and NBA league-wide national and international television contracts and other league-wide revenue sources, venue signage and other sponsorships, concessions and merchandising. And of course, fees from MSGN for the local rights. Madison Square Garden has reported net loss for the last four years but last year adjusted operating cash flow was $118m (there’s a lot of depreciation that weights on earnings).
The previous share repurchase program is terminated. MSG Spinco has authorized a new $525m share repurchase program for its Class A shares. This is due in part to the $1.45b in cash that MSGN contributed and cash flow from operations. I believe the company has the intention to buy back some shares. Under the former MSG share repurchase program, $241m worth MSG Class A shares have been purchased.
The breakup could be the beginning of bigger things. Who knows what the Dolans are thinking? They recently sold Cablevisions, a company they spent 37 years building. If the Dolans are exiting the cable business, would they be open to depart of MSGN? There’s already speculation that a cable company, such as Twenty-First Century Fox or Comcast, could make an offer for the MSG Network. The industry is in consolidation after all. Somebody could also make a move on MSG Sports & Entertainment with all its highly prized assets. It seems that the board and management have committed to enhancing shareholder value. The spin-off, the addition of two independent board members, the share repurchase program is definitely welcome.