Knicks, Rangers Soar in Playoffs but Wall Street Still Doesn’t Buy MSG

It has been a month to remember at Madison Square Garden as the New York Knicks and New York Rangers both reached the second round of the playoffs for the first time since 2013 and now are in control of their respective second-round series. Fans are going nuts.

On Wall Street, not so much.

Shares of publicly traded Madison Square Garden Sports are up 2.7% since the NBA playoffs started, versus 5% for the S&P 500. MSG’s stock is down 5.4% over the past 12 months, while the S&P has returned 27%.

Wall Street values MSG Sports, which includes the Knicks and Rangers, at a steep discount to the private valuations done by Sportico in its most recent NBA and NHL team valuations. The current enterprise value of MSG Sports is $5.6 billion, 43% lower than the $9.9 billion combined for the Knicks ($7.43 billion) and Rangers ($2.45 billion).

The Knicks were the higher seed but underdogs in their first-round series against the Philadelphia 76ers. Most stocks see a pop with an earnings beat or new positive news, but sports teams don’t trade like your typical stock. And while the extra revenue from hosting playoff games is a bonus, it does not impact the long-term financials of the business.

People point to a “Dolan discount” in refence to the controlling shareholder of MSG Sports, James Dolan. The reality is that sports teams have historically traded at a discount to what they might fetch in a private transaction.

The Boston Celtics have won 17 NBA banners, but were largely a dud as a publicly traded stock before it was taken private in 2002. In 1998, Richard Jacobs launched an IPO for the Cleveland Indians—now Guardians—at $15 a share. The stock dropped below $10 a share before Jacobs declared his intention to sell the team, which drove the price over $20. Larry Dolan—James’ uncle—agreed to buy the team for $323 million in 2000, and shareholders locked in their gains.

The same phenomenon took place when the Glazer family hired Raine Group to explore “strategic alternatives” for Manchester United. The team’s NYSE-traded shares were languishing at $13 but more than doubled on the hopes of a sale. Jim Ratcliffe ultimately bought 25% of the common stock at $33 per share, implying a valuation of at least $6 billion. The stock sank again to its current $15.75 for an enterprise value of $3.5 billion.

Manchester United ranked first this week in Sportico’s soccer team valuations at $6.2 billion, which is based on a control-sale transaction.

There are investors who are bullish on the Dolan sports empire.

“We have a lot of confidence in Jim Dolan,” John Miller, portfolio manager at Ariel Investments said in a video interview.  “He has done really well over the decades to enhance shareholder value. He’s a terrific visionary.”

Ariel holds large positions in MSG Sports as well as other Dolan-controlled, MSG-related stocks: Madison Square Garden Entertainment and Sphere Entertainment, which also owns MSG Networks, in addition to the $2.3 billion Sphere venue.

MSG Entertainment reported earnings Thursday that increased revenue guidance for the current fiscal year, citing the extra playoff games at MSG, as it owns the building and leases it to the teams. The stock still sank 7.5% on the day.

Miller says he looks at private valuations, such as those at Sportico. “There is a discount in the marketplace, because people don’t believe the franchise will be sold,” Miller said. “We are happy to hold, because we know the value is increasing, and we don’t see anything on the horizon that would disrupt our thesis.”

Ariel was the largest institutional shareholder of Manchester United with a cost basis in the $12 to $14 range. It cut back on its position and locked in gains when the stock rose after the Glazers hired Raine.

There are a couple of strikes working against publicly traded sports teams. Soaring valuations are partly driven by scarcity value. There is no scarcity value as a publicly traded stock. There are 8,000 securities traded on U.S. stock exchanges, yet just 124 teams in the four biggest U.S. sports leagues, which have added only three new franchises during the past 20 years.

The other issue with sports teams is they are not great businesses by themselves. Sports teams open avenues to other investment opportunities and are a great tax break when you buy them, but there is reason that investment bankers started valuing teams on revenue multiples—still the standard today—instead of earnings ones, like most companies with a price-to-earnings ratio. Sports teams historically lost money, and while the collective bargaining agreements have become more owner friendly and TV deals have soared, teams still have low profit margins or can lose money, with the exception of the NFL.

MSG Sports generated $927 million in revenue over the last 12 months and operating income was $81 million. Net income was $24 million for a 2.6% margin, and diluted earnings per share was $0.99. That translates to a P/E of 189, based on trailing earnings.

“On a valuation basis, unless you’re looking at it on a private market value, it looks ridiculously expensive,” said Miller, who thinks the traditional investor metrics are not appropriate with sports teams. He equates MSG Sports and its two big market sports franchises to owning a piece of real estate in New York City without anything on it. The property is not generating any income and could be losing money after taxes, but the value keeps climbing, particularly if in a good location. The value will ultimately be monetized.

The Atlanta Braves are another publicly traded sports team. The club’s enterprise value of $3 billion is much closer to the private valuation that Sportico has of $3.4 billion. The Braves benefit from a multipronged business that includes steady cash flow from their 60-acre development around Truist Park, The Battery. It generated $39.5 million in adjusted operating profit on $59 million in revenue last year.

MSG Sports highlighted Sportico’s NBA valuations, where the average team rose 33%, during its second quarter earnings remarks.

“These rising third-party valuations reflect not only the scarcity of these assets but the strong underlying business fundamentals and significant growth opportunities for both of our leagues,” David Hopkinson, former MSG Sports president, said during the earnings call. “We don’t think that our stock price today appropriately reflects the value of our assets.”