Money Matters - Simplified

Today's Buy Opportunity: Madison Square Garden

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Sports fans have few choices when it comes to investing in athletics. You've got Disney's (NYSE: DIS) 80% ownership of ESPN, athletic apparel makers Nike (NYSE: NKE) and Under Armour (NYSE: UA), and not much else. But Madison Square Garden (Nasdaq: MSG) provides a new opportunity for investors to get in the game. MSG, which was spun off from Cablevision (NYSE: CVC) in February, lets you invest directly in one of the largest sports markets in the world: New York City.

MSG fast facts

Market cap

$1.55 billion

Cash/debt

$320 million / $0

Revenue ('09)

$1.1 billion

Media segment EBITDA

$162 million

Source: Capital IQ, a division of Standard & Poor's.
EBITDA = earnings before interest, taxes, depreciation, and amortization.

What can we find inside the Garden?
MSG's most valuable assets include the NBA's New York Knicks, the NHL's New York Rangers, Madison Square Garden (commonly known as "the world's most famous arena"), and two regional sports networks (RSNs), MSG and MSG Plus. The company's other assets include the New York Liberty, the Hartford Wolf Pack, the Fuse network, the Chicago Theater, and long-term lease or booking agreements with Radio City Music Hall, the Beacon Theatre, and the Wang Theatre.

MSG's collection of assets is likely worth much more than the company's current market cap. These investments take time to work out, but their valuable underlying assets can often offer downside protection. In MSG's case, the assets include two sports franchises which just so happen to be the second-most-valuable teams in their respective leagues. When assessing the value of MSG's sports teams, we'll use Forbes' published annual franchise values: $586 million for the Knicks and $416 million for the Rangers at the end of last year.

Forbes franchise values are typically conservative relative to the actual price paid when sports teams trade hands, especially major-market teams. Just ask Dan Snyder; he paid $800 million in 1999 for the Washington Redskins, which were valued at $403 million by Forbes in the fall of 1998.

The New York Knicks are a train wreck!
Why would anyone want a piece of the disaster that the New York Knicks have become? Well, owning an iconic arena above Penn Station in Midtown Manhattan, along with a passionate and loyal fan base, is certainly appealing. How about a little downside protection? Despite not having a winning record since 2000, the Knicks and the consistently solid Rangers have grown in value at a 6% rate annually over the past decade.

Finally, the Knicks come cheap, and they have a good chance of becoming a playoff contender with a revamped roster, plenty of salary cap room for the next two years, and interest from stars such as Carmelo Anthony, Chris Paul, and Tony Parker. Talent and winning are the major drivers of franchise value. The Miami Heat increased in value 73% in the three years after it landed Dwyane Wade; the San Antonio Spurs leaped 166% in value over six years after Tim Duncan came to town; and Dwight Howard boosted the Orlando Magic's value 48% in three years.

Sports teams typically lose money each year, right?
For shareholders, the most valuable assets produce healthy, defensible free cash flow. MSG owns two RSNs: MSG and MSG Plus, which was formerly known as FSN New York. RSNs that operate in large sports markets are big profit centers, with operating margins in the 30% to 40% range, and fees that can reach as high as $2 per subscriber. The RSNs have raked in more than $100 million in EBITDA annually over the past three years, including $161 million last year.

If we use a conservative seven-times-EBITDA multiple on $150 million, we end up with a value of $1 billion for MSG's sports networks. Add that to the $1 billion in value for the two sports franchises, and you can see why I believe the stock is worth more than $2 billion. A conservative sum-of-the-parts valuation of MSG's core assets adds up to a $700 million premium to today's current market cap of $1.5 billion.

Why you may want to take a pass on MSG
There are many moving parts inside MSG, including a less-than-stellar owner-operator in James Dolan, and a potential NBA and NHL lockout after next season. Also, the arena is currently in renovation, which is expected to cost more than $800 million over the next four years.

The possible lockouts would restrict cash flow for one year, while the new collective bargaining agreement in the NBA will likely be more owner-friendly in terms of player contracts. A lockout in either league is certainly not good news for investors, but should ultimately do little to the long-term value of the franchises.

The renovation of the Garden is being funded with cash on hand, along with future free cash flow. All things being equal, a renovated Garden is worth more than an outdated one, but it's unlikely to be worth $800 million more. There will ultimately be a modest return on this investment in the form of added space for advertising, seats, and luxury boxes, and higher ticket prices. The interesting thing to me is the fact that management refuses to use debt to fund the renovation.

Finally, the Dolan family owns more than 15% of the shares outstanding, and 70% of the voting rights. As any Knicks fan knows, the Dolans have hardly been stellar stewards. But for all of the negatives that come with management, there may be one big positive for shareholders. Sports franchises rarely trade in the public markets, and in the rare occasions that they have, they typically get taken private at a premium before too long. Dolan was unsuccessful in his attempts to take MSG private in 2007, when it was under Cablevision. MSG's recent spinoff from Cablevision, and its lack of debt financing for its renovation, could very well mean that another offer will be coming once the company's tax-free lockout period ends in a year and a half.

The Foolish bottom line
Investors looking for a safe haven for their hard-earned dough may want to search out assets that not only store value, but also can increase along with inflation. Many investors look to gold to do the trick, but in my opinion, Madison Square Garden is a solid alternative with a cheap ticket price.