Key Metrics Summary

Recommendation: Short Common Stock

Company: World Wrestling Entertainment

Ticker: WWE

Price: $22.21

Market Cap: $1.7bn

Enterprise Value: $1.6bn

Daily volume: ~ $30mm

Short Interest: 16%

Price Target: $12.82

% Gain to Target = 42%

Thesis Summary

WWE stock had tripled from $10 to over $30 over the past 6 months due to management guiding 2015 EBITDA to $125-190mm from the $63mm level achieved in 2012.  The primary drivers of this growth were going to be renegotiation of their TV distribution agreement and the launch of an Over-the-Top (“OTT”) network dedicated to 24/7 WWE programming.  For the reasons listed below we are skeptical of their ability to achieve anywhere near the targeted EBITDA and believe they will substantially disappoint by coming in at $89mm of EBITDA in 2015.

• We forecast EBITDA (’15) of $89mm, versus sell-side expectations of $139mm, and versus historical EBITDA generation ranging from $50 to $100mm over the last decade and EBITDA of $30-60mm in last few years.
• Assuming 10x EV/EBITDA on ~ $89mm of EBITDA results in the price target of $12.82 per share

Management has a history of making aggressive multi-year assumptions and not delivering

Steady decline in Pay-Per-View viewership suggests long-term structural challenges to the company’s core business engine (i.e. consumer interest in its content)

Valuation is not compelling, even if you believe aggressive consensus expectations

Lack of sell-side coverage by large banks has made WWE underfollowed and easily misunderstood

Business Description

World Wrestling Entertainment (WWE) is an entertainment company that monetizes its key assets (i.e., its wrestling programming and brand) through TV licensing deals, live events, Pay-Per-View (PPV) television matches, consumer products and other outlets.  The Live and Televised Entertainment segment accounts for 71% of EBITDA (’13) (excluding the loss-making WWE Studios and Corporate expense), Consumer Products is 24%, and Digital Media is 5%. 

The Live and Televised Entertainment segment is comprised of TV Distribution license sales (42% of segment sales (’13)), Live Events ticket sales (29%), PPV sales (22%), Venue Merchandise (5%), and other (2%).  TV Distribution license fees are received from Cable Networks (e.g., USA and Syfy, both owned by NBC Universal) in exchange for allowing the Networks to carry WWE-produced content.  PPV revenues are generated from live distribution of its 12 annual main events via Pay TV providers (i.e., Cable MSOs, Satellite, and Telco’s).  The flagship “Wrestlemania” is one of these PPV events.  Typically, the WWE collects ~ 50% of what the consumer pays for access to this PPV content, with the Pay TV provider receiving the balance.

The company launched a new “over-the-top” online subscription service, called the WWE Network, on February 24, 2014.  The subscription goes for $9.99 a month, and includes all of the PPV events in addition to archived footage and other filler content.

The company is controlled by Vincent McMahon (Chairman/CEO/Founder) through special voting rights for his B-shares.  

Thesis

WWE stock had tripled from $10 to over $30 over the past 6 months due to management guiding 2015 EBITDA to $125-190mm from the $63mm level achieved in 2012.  The primary drivers of this growth were going to be renegotiation of their TV distribution agreement and the launch of an Over-the-Top (“OTT”) network dedicated to 24/7 WWE programming.  For the reasons listed below we are skeptical of their ability to achieve anywhere near the targeted EBITDA and believe they will substantially disappoint by coming in at $89mm of EBITDA in 2015.

• Our belief that EBITDA (’15) estimates should be cut by ~-36% is premised in our belief that (1) TV Distribution deals will be renegotiated at much lower licensing fees than management guidance or the sell-side expects and (2) that the WWE Network incremental EBITDA opportunity is much lower than the sell-side anticipates
• TV Distribution re-negotiation is likely to underwhelm
  • TV Distribution revenue in ’13 totaled $161mm (Domestic is $106mm and International is $55mm).  Of this total revenue, ~70% (i.e., $113mm) is up for re-contract by late ‘14/’early ’15, with the deal economics expected to close in April/May ’14.
  • Management claims that the TV Distribution license fees up for re-negotiation (i.e., $113mm) could at least double.  In fact, CEO Vincent McMahon goes so far as to state that he’ll “allow you to put a hammerlock on me” (Q2 ’13 Earnings Call) if they don’t achieve this.
    • There is no explicit guidance for TV Distribution revenue in management’s EBITDA (’15) guidance of $125 to 190mm, but we believe that implicitly management is expecting ~ 50% increase in TV Distribution revenue.
    • The underlying assumption behind management’s expectation is that the WWE is underpaid per gross rating point (i.e., total annual ratings for its programming) versus Sports content given the live nature of their broadcasts which make them less susceptible to DVR recording like Sports
• We believe the fundamental flaw in management’s thinking is that WWE’s programming does not enable its customer (i.e., the Cable Network) to bring in advertising or affiliate revenues (per ratings point) in line with Sports programming, and thus the Cable Networks have no incentive to aggressively bid for this content
  • Based on calls with cable network and advertising executives who understand the advertising potential of WWE’s programming, we believe that the WWE’s Domestic TV Programming generates ~ $130 to 140mm of Advertising Revenues for Cable Networks, and that depending on margin expectations for the network, this leaves very little room for the distribution license fee to increase.  This Advertising Revenue assumption is based on a bottom-up analysis of WWE’s ad rates and number of spots per show, and is premised on conversations with ad executives and confirmed with multiple industry specialists.
  • This is further exacerbated because we believe the cable networks can generate no incremental affiliate fees from Pay TV providers for WWE programming, given it is not viewed as “must have” content.
  • In addition, Sports programming rights fees have benefited from the recent launch of Cable Networks like Fox Sports 1, and the incremental competition these new networks introduced into the bidding process.  The WWE will not benefit from this dynamic, given none of these new Sports bidders are likely interested in the WWE’s content, per our industry calls.
• Advertising rates for WWE’s programming will remain at depressed levels, regardless of who ultimately wins the bid for their content, because major advertisers refuse to be associated with WWE’s brand.  This is corroborated by the fact that the USA Network has had the opportunity to attempt to increase ad rates for the last 5+ years, but historically rates have only increased by inflation, according to our industry calls.
  • Per calls with advertising buyers, major categories like autos, retailers and certain packaged goods don’t advertise with WWE, which structurally limits ad potential
  • Storylines for the WWE involve necrophilia, miscarriages, sexual assault and other “tasteless” plots in an attempt to shock and bring in viewers.  While possibly good for ratings, this has negative ramifications for advertising monetization of these ratings.
  • Given some portion of Cable ad buying is done on a bundled basis (i.e., the advertiser can’t choose which specific program their ad will show up on), the WWE taints other programming ad slots, and thus puts pressure on ad rates across the Cable Networks’ entire programming line-up.
• NBC Universal has walked away from its exclusive negotiating period with the WWE in February of 2014. Although NBC Universal does have the right of last refusal if the WWE is able to negotiate a price with another Cable Network, we believe there is a good deal of risk that NBC Universal will not renew or, if they do, it will be at unattractive rates for WWE.
  • NBC Universal, or more specifically, USA Networks, is in a much better position than its prior negotiation when they needed ratings.  From our diligence, the view is that the network can stand alone at this point and may benefit from disassociating itself from the WWE.
• WWE Network is likely to underwhelm
• Management does not give explicit expectations for the incremental steady-state EBITDA generation from its WWE Network, but lays out a range of scenarios from $0mm of EBITDA at the low end to $235mm at the high end, assuming 1mm to 3mm Domestic subscribers and 0.25mm to 1.5mm International subscribers at steady-state (respectively), and assuming some level of existing business cannibalization
• Management does state that it believes WWE Network subscribers will reach 1mm by YE ’14.
• We believe that management’s EBITDA (’15) guidance implicitly assumes anywhere from $25 to 80mm of incremental EBITDA from the WWE Network for ’15,  effectively assuming YE ’15 Domestic subs of 2mm to 3mm (at end of period).
• The key question when assessing the ultimate success of the WWE Network is whether there will be an expansion of viewers due to either (1) the change in distribution model or (2) the change in price.  We believe that it is unlikely that WWE will expand viewership much beyond the current base of PPV customers.
  • Most of the WWE Network’s value is in its giving the customer access to the PPV live-events.  There will be access to some original reality shows and archived footage, but this other type of content is largely similar to what can be accessed for free currently on the USA or Syfy Networks.
  • Wrestlemania is their single most watched PPV event and that had 1.1mm viewers in the last year globally.  That was a decline from the prior year and this viewership has been stagnant for some time now.  We also believe that pricing is not as significant a factor as we believe much of this is viewed in group settings where costs are likely shared.
  • We believe that tripling or quadrupling subscribers implied by their long-term guidance is difficult given (1) there is nothing “broken” about the current distribution model for PPV content that the WWE Network “fixes” and (2) the pricing elasticity likely is not great given (a) the WWE has historically had the opportunity to lower pricing to bring in more customers on PPV, yet has decided not to, suggesting they know it won’t make a big volume difference, and (b) many people watch these PPV events as a part of a group, so the absolute dollars of savings is low
•  Satellite Pay TV distributors may no longer carry PPV events, which could significantly impact PPV profitability.  We do not account for this risk in our base case.
  • DISH released a statement saying it is no longer distributing WWE’s PPV, and DISH accounts for ~14% of total Pay TV subscribers.
  • DTV released a cryptic statement suggesting it could follow suit with DISH, but is seemingly yet undecided.  DTV accounts for ~20% of Pay TV subscribers.
• We also believe the recently released subscriber number of 667,287 for the WWE Network is not as impressive as it may seem at first.  First, if you were going to sign up for the network, we would assume that you would want to sign up before Wrestlemania which is the main annual event resulting in front-loading of subscribers.  Second, there is an interesting footnote to the subscriber number possibly indicating some risk to it which states “Current subscriber number does not account for potential failures to comply with subscription terms and six month commitment”.
• Key catalysts that should highlight the inability for WWE to meet its financial targets include (1) the TV Distribution contract should be finalized in April/May ’14, and given all the attention on it as a key value driver, the company will likely need to announce its results, and (2) the progress of WWE Network subscriber figures to achieving the long-term subscriber targets

Management has a history of making aggressive multi-year assumptions and not delivering

• Management provided guidance on 11/5/2009 of achieving average annual earnings growth of 15% to 20% from ’09 to ’12, versus an actual decline in earnings that ended up transpiring. 

Steady decline in Pay-Per-View viewership suggests long-term structural challenges to the company’s core business engine (i.e. consumer interest in its content)

• Total PPV buys have declined at a -6.7% CAGR from ’06 to ’13.
• Competition for viewership has only increased over time, whether due to the rise in popularity of the UFC, or just the greater access to entertainment options in general (NFLX, iPad apps, etc).  Directionally, this could continue providing a headwind to viewership trends over time.

Valuation is not compelling, even if you believe aggressive consensus expectations

• Before the stock’s recent run-up on the back of expanding EBITDA expectations, historically WWE has traded in the 7x to 8x forward EBITDA range.  If you believe the sell-side estimate of $139mm, this implies the WWE is currently trading at an 11.5x EV/EBITDA (’15) multiple.  If you believe in our $89mm of EBITDA (’15), this implies a 18.0x EV/EBITDA (’15) multiple.
  • This compares to other entertainment/media companies that trade at ~9.5-11.5x forward EV/EBITDA.

Risks

• Difficult to “know” how successful the WWE Network will end up being, and so bet is that the valuation does not take into consideration the real risk that it will ultimately not meet expectations.  However, this is a relatively new business model transition, with limited data points from other businesses that have attempted this transition, and so this inherently creates risks when attempting to forecast its impact.
• WWE Studios consistently loses money, and if shut down could benefit EBITDA by 10mm or greater.  The mitigating factor is that management likely views this as brand building (i.e., if you shut this down, it may have an impact on the rest of the business which is dependent on branding), but the savings would be immediate.
• The TV Distribution contract comes down to what a single buyer will end up paying for the programming, which always presents the risk that the buyer ends up making an uneconomic deal that benefits the WWE.