With the launch of WWE Network in February 2014 and the subsequent crossing of the 1.3 million subscriber mark in March 2015, World Wrestling Entertainment (NYSE:WWE) is now at a tipping point. If WWE successfully grows the subscriber base for WWE Network and leverages on the growth opportunities embedded within international markets, it should experience significant top line and bottom line expansion. I arrive at a target price of $21.70 for WWE by applying a 15 times EV/OBIDA multiple to my estimated OBIDA of $104 million and adding net cash of $89 million. My target price implies a 28% upside from WWEs closing share price of $16.93 as of July 18, 2015.
Why I Like The Business
At first glance, WWE does not seem to fit the bill of a great business. It was free cash flow negative in FY2014, and suffered from a negative OIBDA (operating income before depreciation and amortization) of $15 million and a net loss of $30 million. Headline numbers are potentially misleading in this case, as WWEs operating profit and net profit were adversely impacted by its investment in WWE Network for future growth. While WWE Network was only launched in February 2014, WWE started to invest in content and brand initiatives supporting the launch of WWE Network since 2011.
In fact, WWE owns very profitable and cash flow generating businesses. In FY2012 and FY2013, WWEs OIBDA margins for its Media Division were as high as 100%, while its Consumer Products Division and Live Events business delivered OIBDA margins between 30% and 40% during the same period. In addition, WWE generated annual free cash flow in excess of $50 million between FY2009 and FY2013, excluding investments made as part of WWE Network.
Putting financial numbers aside, I outline three reasons below why I like WWE as a business.
Firstly, WWE has arguably one of the best brands among its sports and media peers. The numbers speak for themselves. Its videos shown on its official YouTube channel have attracted over 5 billion views for the 12 months ended May 2015, making WWE the number one sports channel on YouTube ahead of competitors such as NBA, MLB, NFL, NHL, ESPN and NASCAR among others. As of end-May 2015, WWE also had approximately half a billion followers on social media, including but not limited to, Twitter, Facebook, Instagram and YouTube. In 2014, WWEs RAW and SmackDown television programs delivered average prime time viewers of 4.6 million and 3.0 million respectively, significantly higher than competing cable network programs including ESPN and Discovery. In October 2014, Forbes ranked WrestleMania, WWEs annual flagship event, eighth on its list of Most Valuable Sports Brands for 2014, and valued the WrestleMania brand at approximately $105 million.
Secondly, WWE boasts a content library that is difficult, if not impossible, for new entrants and competitors to replicate. Its library comprises 130,000 hours of professional wrestling content dating back to the 1950s featuring more than hundreds Superstars and Divas, which is growing at a rate of more than 500 hours every year as new original content is created. In addition to its original content (brands like RAW, SmackDown and ECW), WWEs library also includes content acquired from other wrestling promotions which have since ceased to exist, such as World Wrestling Federation WWF, World Wide Wrestling Federation WWWF and Capitol Wrestling Corporation. Given that WWE has already bought substantially all of the historical wrestling content available and there are currently no significant competitors challenging WWEs dominant position, WWEs content library is likely to remain unique and valuable for the foreseeable future.
The best validation of the value of WWEs content library comes from a willing buyer. In November 2014, Warner Brothers Home Entertainment, the countrys largest distributor of home video titles, signed a multi-year agreement with WWE for the right to distribute the Companys library of pay-per-view events and documentaries on both physical digital formats in the US Warner Brother cited reasons such as WWE titles accounted for all of the top 10 sports DVDs of 2013 and WWE is an iconic brand that has one of the most passionate fan bases in sports and entertainment for the deal.
Thirdly, WWE operates on a profit multiplier model similar to Disney (NYSE:DIS). As the name of the model suggests, WWE is able to earn multiples of its profit from wrestling events by mining the value of its intellectual property via various channels. WWE has invested a lot of capital into creating or acquiring content, and building its brand over the years and this will pay off handsomely for the Company as it is able to reap profits from its content, Superstars and Divas multiple times in different ways. Similar to how Disney monetizes its favorite characters like Mickey Mouse via films, videos, apparel and books, WWE benefits from multiple revenue streams derived from its intellectual property. These include the new WWE Network, television rights, sales of tickets and merchandise from live events, pay-per-view purchases, movies, home videos, video games and other branded products.
WWE Network Brings Unexpected Benefits
WWE Network is an important extension of WWEs profit multiplier model discussed in the section above. Launched in February 2014, WWE Networks makes all of its 12 pay-per-view events, including WrestleMania, and over 3,000 hours of VOD (video-on-demand) content available to subscribers in more than 170 countries globally. As of 1Q2015, WWE Network boasts a subscriber base of 1.3 million, more than 2.5 times what it achieved in 1Q2014 a year ago.
There are two key factors to consider in assessing the future potential of WWE Network and its value to the Company apart from being just another revenue stream.
The first factor is scalability. Management provided estimates of the 2015 OIBDA contribution from WWE Network based on different paid subscriber levels in its Investor Presentation. It is worth noting that WWE Network has already crossed the OIBDA breakeven point of a million subscribers. However, what is even more interesting is the operating leverage embedded within WWE Network. According to management estimates, when WWE Network doubles the number of subscribers from a million to two million, the OIBDA contribution will increase by between 2.7 and 3.4 times. Similarly, if WWE Network increases its subscriber base by 67% from 1.5 million to 2.5 million, WWEs OIBDA generated by WWE Network is estimated to double. This disproportionate increase in operating profit relative to subscriber additions is due to the low marginal cost nature of the WWE Network business. Since it requires little incremental costs or capital to service an additional subscriber, every new subscriber for WWE Network results in revenue dollars flowing straight down to WWEs bottom line.
The second factor is data. This benefit of customizing WWEs content to suit consumer preferences by mining data from WWE Network is vastly underestimated. WWE is a unique hybrid of a live sports entertainment company and a media business, particularly with respect to its ability to script content. In comparison, for other sports events such as soccer matches, it is impossible to create exciting episodes such as a great goal or a perfectly-executed set-piece. Prior to launching WWE Network, WWE was limited to obtaining customer feedback via interviews and surveys where respondents may not necessarily communicate their true preferences. Having the privilege of collecting and analyzing data on WWE Network to sift out the most popular programs, WWE will be able to optimize its content offerings to maximize consumer utility and its revenues at the same time. In other words, there is another multiplier effect at play here, as WWEs other revenue streams outlined above are likely to benefit from increased demand resulting from more popular content.
Long Growth Runway
Looking ahead, WWEs most significant growth driver will be international markets. WWE generated a mere 21% of its FY2014 revenues from markets outside North America, despite the fact that WWE is a global brand with strong international recognition. For example, television viewership for WWE programs is ranked third in India, one of the worlds most populous countries, behind national sport cricket and soccer.
Based on a consumer survey done by WWE, the global addressable market is huge compared with the Companys current revenue contribution from international markets. WWEs research found that among 311 million homes equipped with broadband in the 16 largest global markets (including the US), approximately half or 159 million homes have affinity for WWE. Even if I were to be conservative and include only passionate or casual WWE fans (as defined by survey responses) in selected international markets such as India, Mexico, Canada, Australia, Germany, Japan, the UK and France and a 4% penetration rate, WWE has the potential to add at least 2 million new international subscribers based on my calculations. This number is significant compared with a mere 196,000 international subscribers that WWE Network has as of 1Q2015.
WWEs revenue contribution from international markets grew by a 6% CAGR from $62 million in FY2004 to $112 million in FY2014. Going forward, WWE is targeting to capitalize on the huge international market opportunity by expanding the reach of WWE Network and signing a greater number of TV distribution contracts in new territories. WWE Network is currently still not available in certain countries like Germany, Japan, India, China and Thailand among others. Chief Financial amp; Strategy Officer George A. Barrios guided that WWE should launch WWE Network in all of these markets within the next 12-18 months at the latest. With respect to television rights, WWE signed new distribution agreements or renewed existing ones in the UK, India, Canada, Thailand, Mexico and UAE last year.
I arrive at a target price of $21.70 for WWE by applying a 15 times EV/OBIDA multiple to my estimated OBIDA of $104 million and adding net cash of $89 million.
I forecast that WWE grows its revenue by a two-year CAGR of 13% from $543 million in FY2014 to $693 million in FY2016. I assume that the Companys OIBDA margin normalizes to approximately 15% by FY2016 as investment in the WWE Network moderates, resulting in an estimated OIBDA of $104 million.
My target price implies a 28% upside from WWEs closing share price of $16.93 as of July 18, 2015.
If WWE either fails to sign up new subscribers or retain existing ones for WWE Network, the growth prospects for the Company could look very different. In particular, due to the operating leverage embedded within WWE Networks low marginal cost business model, WWE Networks future earnings are likely to vary significantly depending on subscriber take-up rates.