Live Nation - Everybody Wants To Rule The World

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ByTim Heitman:

An investment in Live Nation ( LYV ) provides investors with an opportunity to buy into a unique set of assets that has an ecosystem to maximize that amount of revenue and profits available in the live entertainment industry. Unlike most of our typical investment reports -- which focus on free cash flow utilization, net asset value investing, mean reversion of margins or special situations -- this will look at the investment merits of a company that generates little free cash flow at the moment, and is somewhat of a growth investment if company management is successful in achieving its objectives.

Live Nation's dominant size is a competitive advantage. The presence of a significant, value creating long-term investor, Liberty Media ( LMCA ), provides additional margin of safety from a liquidity standpoint. The strategy is not without risks, and we will discuss those as well. What follows is our analysis of the merits of Live Nation's three-year plan to grow its adjusted operating income (( AOI )) by 30%-35%.

Background

Live Nation's current configuration was the result of a "merger of equals" in 2010 between Live Nation and Ticketmaster Entertainment. Ticketmaster shareholders received 50.01% of the combined company and Live Nation shareholders received 49.99%. The combined company had $6B in revenue and $500 million in operating income. The enterprise value at the time was approximately $2.5B. Today, LYV is the world's largest live entertainment company in the world. In 2012, the company connected with over 250 million fans and had over 180,000 events in 47 countries. The company is also the largest producer of live music concerts in the world, connecting 49 million fans to 22,000 events for over 2,300 artists.

In addition, the company owns, operates or has booking rights in 139 venues including the House of Blues, the Fillmore and the Hollywood Palladium. Live Nation is also the leading live entertainment ticketing sales and marketing company, selling 400 million tickets a year. Finally, through the ownership of Front Line, the company is one of the world's largest artist management companies and manages over 230 of the world's best known artists, such as The Eagles, Christina Aguilera, Van Halen, Kid Rock, John Mayer and Kenny Chesney.

While some investors may be attracted to the high profile artists and venues, the truth is none of those things are what attracts us to the company. If fact, because of the way the concert business works, the company makes very little money directly off of the artists or the venues, especially the small (1,000- to 3,000-person) venues that are often referenced in research or media reports (OK, we did it too.) What makes Live Nation an attractive investment in our opinion is the company's scale, which gives it the ability to monetize all aspects of the live music entertainment ecosystem in a way that is almost impossible to duplicate at a cost that is represented by the current enterprise value of the company. The company has publicly stated that it wants to increase its AOI from $460 million in 2012, to $600 to $620 million by 2015 ($140M-$160M or 30%-35% growth). Management has laid out several strategies it thinks will allow it to achieve these goals. In this article, we will analyze the various components of these strategies to gauge the likelihood of their success.

Understanding the Live Music Ecosystem

Before going any further, a brief discussion of the live music ecosystem is warranted. LYV's business model can be viewed as having two components: the content side composed of the artists and the concerts and the ancillary side which is ticket sales and advertising/sponsorships. We have rearranged the income statement into these two components. When LYV's business is looked at this way, it becomes clear what the strategy is.

Since artists and managers typically receive 85%-95% of the concert-related revenue, the strategy is to increase the number of events the company promotes, which drives more event attendees and is then monetized with high margin ticket fees and sponsorships. The events themselves are almost "loss leaders" in a sense. This strategy is similar to the movie exhibition or television show business. Since almost 90% of AOI is derived on the ancillary side of the business, it will be the focus of this article.

Content: Artists and Concerts

Revenue

2012

2011

2010

Concert

$3,870

$3,506

$3,438

Artist

$400

$393

$362

Total

$4,270

$3,899

$3,800

AOI

2012

2011

2010

Concert

$31

$30

$15

Artist

$38

$47

$46

Total

$69

$77

$61

Margin

2012

2011

2010

Concert

0.80%

0.86%

0.44%

Artist

9.50%

11.96%

12.71%

Total

1.6%

2.0%

1.6%

Ancillary-Ticket Sales and Advertising/Sponsorships

Revenue

2012

2011

2010

Ticketing

$1,374

$1,319

$1,089

Sponsorship

$2480

$230

$200

Total

$1,622

$1,549

$1,289

AOI

2012

2011

2010

Ticketing

$294

$279

$234

Sponsorship

$175

$165

$141

Total

$469

$444

$ 375

Margin

2012

2011

2010

Ticketing

21.40%

21.15%

21.49%

Sponsorship

70.56%

71.74%

70.50%

Total

28.9%

28.7%

29.1%

Combined AOI

2012

2011

2010

2012

2011

2010

Content

$69

$77

$61

Content

13%

15%

14%

Ancillary

$469

$444

$375

Ancillary

87%

85%

86%

Total

$538

$521

$436

Total

100%

100%

100%

Elimination

$79

$84

$74

Total

$459

$437

$362

Analysis of Strategies Driving $140-$160 Million AOI Increase

As we mentioned, LYV has issued guidance for a 30-35% increase in AOI by 2015. This translates into an increase of approximately $140-$160 million on a starting base of $460 million. This is the main investment premise for owning stock in the company. If the company can meet or exceed this goal and investors place a higher multiple on the AOI, an investment in LYV could generate a 30%-40% increase in market value in three years. The company believes there are five components to this strategy. Below is a slide from a company presentation that summarizes the five components and the magnitude of their expected contribution. In this section, we will discuss the likelihood of successfully achieving each goal. If the company can achieve these goals, we would expect the total return over the next three years to be at least that. There is a possibility for EBITDA multiple expansion over that time as well, although with the caveat that investors only use "free cash" on the balance sheet when calculating the enterprise value.

As the slide below shows, increasing sponsorship AOI and reducing ticket costs are the main drivers of the AOI growth. While the increase in AOI due to cost reductions is fairly straightforward to understand and calculate, the ability of the company to increase sponsorship AOI is much more complicated. We have provided a table of our estimated range of AOI for each category.

Source: Company presentation.

Potential Increases in AOI By Category

Low

High

5M Fans

$25

$50

Social Media

$10

$15

Sponsorship

$40

$50

$0.35 per Ticket

$30

$35

Secondary growth

$20

$25

Total

$125

$175

Investing 501 estimates.

Increasing Fan Base by 5 Million Is a Three-Pronged Strategy

Live Nation has stated that it would like to increase attendance by 5 million fans over the next 3 years. It is the monetization of these new fans through sponsorships and advertising revenue that is a major contributor to the potential 30%-35% increase in AOI by 2015. The reason the increase in fans is so important is because of the synergistic effects that result from the ecosystem that LYV has created around the music entertainment business. When LYV merged with Ticketmaster, one of the primary reasons given for doing so was to "maximize ticket sales in the broader ecosystem around a live event."

We believe this has evolved into, "maximize total revenue and operating income in the broader ecosystem around a live event." We believe that major economic disruptions (36% of revenue is generated internationally) and an antiquated computer system have been major contributors to the slower than expected achievement of this goal. But it appears as though things are finally changing for the better. The company hopes to drive the 5 million fan increase through a combination of organic growth, acquisitions of venues or festivals and improved efficiency of its marketing and online strategy. The attempt to add 5 million fans comes from three areas of focus, electronic dance music shows, North American Festivals and emerging markets.

Source: Company presentation.

Electronic Dance Music

The current hot concert events are the electronic dance festivals. Their popularity has grown substantially in the last few years, and LYV has recently entered the market through acquisitions. In 2012, LYV acquired Hard Events, Coppel and Cream in order to boost its presence in the festival and electronic dance music ((EDM)) segments in the industry. These events have over 400,000 attendees every year and the company is hoping to expand their geographical presence. Similar to traditional concerts, the events are very low margin.

According to the 2012 10-K, the company generated $95 million in incremental revenue from the Coppel and Cream events and incurred $92 million in expenses. Some of those expenses could be related to the acquisitions, but it is clear that the events are low margin events from a purely operational standpoint. LYV has also been mentioned as a possible acquirer of Insomniac, whose main event, Electric Daisy Carnival, drew 230,000 attendees in Las Vegas last summer. LYV's interest in EDM events is not in the operating profit of the shows themselves, but in the monetization of the fan base.

According to the company, a typical concert produces about $2.50 per fan in sponsorship revenue. However, a festival produces about $8-$10 per fan in sponsorship revenue. The reasons are fairly obvious. Since festivals are outdoors and sometimes are multi-day events, there are significantly more things to monetize than an indoor concert at an arena. For example, at a festival there can be sponsors for showers or sun screen or hospitality tents or water or camping space or almost anything, none of which are usually possible at an arena. LYV believes there is a potential of $50 million in incremental industry profits from tickets sales, artist income, venue revenues and other ancillary income available by 2015.

North American Festivals

In 2011, over 4 million fans attended festivals in North America. The most popular festivals are Lollapalooza, Coachella and Austin City Limits, whose combined attendance is over 750,000 fans. This segment is growing at approximately 25% a year, or 6x-8x the traditional concert business. Similar to the EDM segment, the opportunities for LYV are in the monetization of the fans through increased sponsorship. We believe that LYV will attempt to grow this market organically and supplement that growth with acquisitions. The company believes there is approximately $50 million of incremental industry profits available from the above mentioned areas by 2015.

Emerging Markets

LYV's market share in the emerging markets of Latin America and Asia is estimated to be only 7% (1 million out of a total of 15 million fans). The company has no presence in Latin America and only has 1 million out of the 10 million concert going fans in Asia. Rising disposable incomes of the middle class is an obvious theme here.

The total incremental industry profit from these three platforms could be as high at $240 million. For each 1000 market share points, LYV would achieve $25 million in incremental AOI. Considering the company's dominant position in the industry, we think it is reasonable that the company could capture 20% of this profit potential or $50 million. We believe the wild card that could negatively impact this estimate is more related to lower than expected growth rates in the various segments and not execution.

Increased Attendance Drives High-Margin Sponsorship Revenue Opportunities

Since festivals and EDM events produce 3x-4x the amount of sponsorship revenue per fan, there is a multiplier effect in place. The direct increase in AOI from the increase in events and fan attendance, combined with the multiplier effect of the sponsorship AOI from those fans account for 50%-65% of the estimated increase in total AOI by 2015.

As we showed in previous tables, sponsorship revenue is by far the highest margin revenue line on the income statement at over 70%. In spite of the number of sponsors being held relatively steady around 800, sponsorship revenue is up nearly 25% in the last two years. The company has been able to partner with larger sponsors and produce more revenue per sponsor. By our estimate, the company expects to generate nearly one-third of the total increase in AOI or $50 million from this segment. In 2012, the combination of Sponsorship and advertising AOI was about $175 million. This is an increase of about 25% since 2010 or an 11%-12% growth rate. If the company's strategy can produce a 9%-10% growth rate over the next three years, the $50 million in incremental AOI would be achieved.

Strategy Risks

While increasing attendance by 5 million fans is a huge opportunity for LYV, there are substantial risks as well. One of the risks comes from Robert F X Sillerman, the founder of FX Entertainment which was acquired by Clear Channel for $4.4 billion in 2000. FX Entertainment is the foundation on which Live Nation was built. In 2012, Sillerman pledged to spend $1 billion on acquisitions to rollup the festival and EDM segments of the market. In 2013, he acquired the North American division of ID&T Entertainment, the world's largest dance music concert promoter. He recently tried to buy the organizers of the Ultra Music Festival in Florida. The $20 billion ad agency WPP has reportedly invested $10 million with Mr. Sillerman. Mr. Sillerman has also hinted at a possible IPO in the future. He is a very strong competitor and could be a disruptive force in the LYV strategy. If he is successful in acquiring more organizers and promoters, it may be difficult for LYV to reach the critical mass it desires in this market and make it difficult for the company to achieve its 5 million fan goal.

Another company that could negatively impact LYV's plans is Anschutz Entertainment Group (( AEG )). AEG is the world's second largest live show promoter and was recently up for sale (subsequently taken off the market). If AEG was acquired by a company like Comcast, who is always looking to add content to its cable systems and already competes with LYV through the Paciolan ticket business (500 venues) the company divested as part of its merger agreement with Ticketmaster, the competition for festivals, talent and attendees would increase substantially. A bidding war in the "hot market" is very possible. This is especially true since this is the area that has the highest visible growth, something that investors crave and usually eventually overpay for.

There is also the risk that festivals and EDM have become too "corporate," especially as additional large sponsors are attracted to the market, which could lead to a decline in attendance at the major festivals and hurt revenue. Unlike the traditional concert segment where LYV has strong relationships with artists that span years or decades, we believe that because the company is relatively new in this area, its competitive advantage of having such long term relationships with performers in a segment is much weaker. There is also the danger of oversaturation of the market. The attendance at the top 10 festivals is less than 2 million and the ultimate size of the market is unclear. We believe these risks are very real and represent a significant risk to LYV achieving its goal of 5 million new fans. Falling short of this goal would also have negative consequences for the estimated $50 million in sponsorship AOI goal.

Ticketmaster Upgrade Provides Significant Cost Savings

Ticketmaster is a significant piece of the ecosystem. While it is only 23% of revenue, Ticketmaster produces nearly $400 million or 64% of LYV's AOI. in 2012, the company's ticketing services sold 148 million tickets and another 108 million tickets through its venue clients' (over 12,000-15,000 with a 100% renewal rate) box offices. Operating margins are over 20%. This division is one of the main ways LYV monetizes the live event attendance. The ticketing segment produces 4x the AOI of the concert and artist management division combined. For 2013, the company has guided for flat AOI growth as the technology upgrade costs are incurred for another year. Since this division is key to the company achieving its 30%-35% AOI growth through 2015, investors are a bit leery considering there is no growth in the first year and the highly valued "visibility" into future years is hazy. However, as the upgrade is completed, new direct expenses associated with it will cease and a potential additional savings of $30-$35 million could accrue to the company.

According to management, the ticketing system is almost 30 years old. The costs associated with maintaining and operating such an old system are significant. The lack of functionality is also proving to be an impediment to generating additional revenue through improved pricing functions and user interfacing. Therefore, we believe the expenses are necessary in order to improve the long-term profitability of the company. Below is an example of the user interface currently seen by an employee. It looks like the system we used in high school. We have also provided an example of the new interface.


The company is spending tens of millions of dollars to upgrade the system's infrastructure and functionality. Management believes it can save $0.35 per ticket sold in the U.S. once the upgrade is completed in 2014. The size of the cost savings is a pretty straightforward calculation. The company sells about 148 million tickets through its system. Approximately two-thirds, or 95-100 million tickets, of those are sold in North America. Multiplying $0.35 per ticket by 95-100 million tickets gets us to the $30-$35 million increase in AOI (or reduction in cost) that the company is striving for. Since the result is entirely under control of management, we believe that this component of the $140-$160 million increase in AOI is the most achievable. Increasing the functionality of the system should also help the company achieve its goal of boosting AOI from digital and social media and the secondary ticket market.

Digital and Social Opportunity to Boost Ticket Sales and Advertising Exists, but Tough to Quantify

The rise of mobile Internet activity has provided many companies with the opportunity to engage directly with fans and customers and provide a more one on one relationship with them. According to LYV, concerts are the top shared social activity. Therefore there is a natural potential synergy for LYV to boost advertising and ticket sales. The company cites research that states that 31% of fans would have gone to a concert if they had known about it, as showing an opportunity for social media to boost ticket sales. While this sounds plausible, it is also difficult to quantify the AOI opportunity. Since most of the large shows are well promoted and sold out anyway, we would expect that most fans are already aware of them and chose not to go for whatever reason. The opportunity would be for smaller, lesser known shows and artists that don't get a lot of publicity. In addition, since festivals generally are open seating type events, there should always be room to accommodate those 31% that learn of a show in town and decide to attend.

While the monetary opportunity is hard to qualify, the positive impact of mobile on the business is impressive. We have penciled in a potential $10-$15 million in incremental AOI by 2015, but we do not have any particular insight into the likelihood of that amount of AOI being achieved. Due to the "networking effect" potential of this strategy, is not a linear process with linear outcomes. However, here are some examples LYV cites in its presentations to give an investor a sense for the possibilities.

Secondary Market and Dynamic Pricing Provide Revenue Opportunities

With the emergence of StubHub (owned by eBay ( EBAY )), the secondary or "scalper" market for tickets has entered the mainstream. In fact, most teams and major sports leagues have now partnered with LYV or StubHub to offer fans the ability to purchase tickets on the secondary market. LYV currently has only 10% of the $4 billion secondary market and hopes to triple this business through a combination of partnerships and improved functionality of its Ticketmaster system.

It should be noted that 75% of the secondary ticket market is for sporting events. Because of its ownership of Ticketmaster and its high-profile partnerships with the NBA, NFL, New York Yankees and Chicago Cubs, many investors focus on the sports opportunity for LYV. However, only 20% of the tickets sold by Ticketmaster are for sporting events. Capturing more of the concert secondary business is also a big opportunity. For example, one reason LYV is spending tens of millions of dollars to upgrade its Ticketmaster systems is its lack of ability to capture demand in the secondary market. The way the system currently works, once a concert is sold out, anyone coming to the Ticketmaster website will find that there are no tickets for sale. If the concert sells out months before the event takes place, Ticketmaster currently has no opportunity to sell that fan a ticket and that potential incremental revenue goes to StubHub or a scalper or an individual selling the tickets on sites like Craig's List. This is a key point about the LYV ecosystem.

If the company can keep ticket buyers within the Ticketmaster ecosystem and sell a fan either a primary or secondary ticket, the company can capture a higher percentage of the total ticket spend and also monetize the additional time spent on their site with advertising. The fact that the secondary market exists in the first place means that there is also opportunity to improve the pricing of the primary ticket market. This is where LYV's dynamic ticket pricing solution comes into play.

As an example, let's assume that a sold out event produces $1 million in ticket sales. Let's also assume that tickets to that event are sold on the secondary market for $300,000 in total. Therefore, the true demand for tickets for the event was $1.3 million and not $1 million. As it stands today, the secondary market is capturing that additional $300,000 in ticket "sales." So there is leakage in the system. With dynamic pricing (driven by data on 100 million fans), LYV can help artists and promoters and venues capture some of that $300,000 up front when the ticket is originally sold and therefore reduce the demand or the "arbitrage" opportunity currently taking place in the secondary market. The more tickets that are sold on the primary market at the real demand price, the more money everyone in the ecosystem makes and this is a direct benefit to LYV. As the promoter, venue operator, ticket seller and artist manager, LYV is making incremental revenue in all aspects of the event.

Like other parts of LYV's strategy, the actual amount of incremental AOI is difficult, if not impossible to quantify, but intuitively the strategy has merits and a reasonable chance of success.

Adjusting Enterprise Value for "Free Cash" and Calculating Free Cash Flow to Determine Future Valuation

Cash available to the company is overstated on the balance sheet. We constantly preach that serious investors need to do their own analytical work and read all of the SEC filings in order to improve their investment results. While most of the data is accurate, there are situations where the reported numbers need to be examined more closely. The business model of LYV creates a situation where this is necessary. Investors who just take the data from these websites at face value are missing an important aspect of LYV's available cash balance and subsequently overstating the enterprise value of the firm.

If investors look at the cash balance on any of the popular websites that aggregate financial data or even just glance at the balance sheet in the press release, they will see a cash balance of $1 billion on the balance sheet. However, according to the company, the actual amount of "free cash" available to it is $340 million. Anyone that just takes the $1 billion at face value is overstating the company's liquidity by $660 million and also underestimating the enterprise value by the same amount. To the company's credit, it is very clear and open about disclosing the free cash balance and the difference should not be a surprise to an investor that does his own work.

So why is there a difference between reported cash and "free cash"? LYV's business model requires the company to collect the face value of the tickets it sells on behalf of its clients and then remit them to its clients when a show occurs. Since the company may be selling tickets months before a show is performed, the company is constantly collecting cash on behalf of its clients. LYV segregates this cash from its own cash.

As of Dec. 31, the company reported that out of the $1 billion in cash, $442 million was ticketing client cash. In addition, there was approximately $220 million in cash on the balance sheet that the company has committed to other aspects of the concert and sponsorship businesses. Taken together, these two items reduce the company's portion of its stated cash balance by $662 million. Any investor that is using the $1 billion on the balance sheet to net against the company's debt to calculate its enterprise value is actually understating the company's enterprise value that $662 million. We believe it is more appropriate to use the "free cash" balance to calculate the enterprise value.

Free Cash Flow Should Increase, but It's Hard to Calculate

Large swings in deferred revenue at Live Nation make it difficult to calculate true free cash flow. In fact, like many companies today, Live Nation's definition of free cash flow does not consider changes in working capital. They simply take AOI and deduction cash expenses like interest, taxes and capital expenditures. While this shortcut method can be used to get a basic estimate of free cash flow, investors need to take into consideration a company's business model and calculate a working capital adjusted free cash flow.

Using the company's definition of free cash flow, LYV generated $215 million in 2012 and $155 million in 2011 or about $185 million per year. Just using CFO for each year, we can calculate that free cash flow averaged about $180 million per year, although the amounts in each year differ greatly from the company's numbers due to swings in deferred revenue. We always like to analyze multiple years of cash flow statements in order to see what might be a sustainable amount of cash flow. Swings in balance sheet items like deferred taxes, deferred revenue and inventory can distort cash flows in any given year, but over a multiple year period these items tend to swing back into balance. If we adjust CFO for the changes in deferred revenue, we see that the average free cash flow is about $150 million a year and the swings are even greater.

Company Calculation of Free Cash Flow

Investing 501 Calculation of Free Cash Flow

2012

2011

Avg.

CFO before W/C changes

$309

$283

Cap Ex

$124

$107

Free cash flow

$185

$ 176

$181

CFO before W/C less change in deferred revenue

$185

$347

Cap Ex

$124

$107

Free cash flow

$61

$240

$151

We do not view an investment in LYV as one of our typical free cash flow accretion investment ideas, so the variance in the calculation of free cash flow is important but not a game changer. The important point is that the company does generate sufficient free cash flow to upgrade its computer systems and still acquire festivals or venues to grow its attendance, which should grow AOI in the future.

LYV has said that it believes its normalized capital expenditure run rate is about $100 million a year. This amount is split about 60/40 between maintenance capital expenditures and "revenue generating" expenditures, which are mostly software development and other expenditures. Starting in 2014, the $20 million or so that the company is spending on its Ticketmaster systems upgrade should cease, resulting in a boost to free cash flow.

Bringing It All Together

I could rise above on higher love -- Steve Winwood

So after all this analysis, what have we learned? We have learned that LYV has a unique business model that has no public peers and that it has several moving parts with enough unknowns to make it difficult for Wall Street types to make nice neat earnings models and price targets. When markets and stocks decline significantly or have low multiples, we are told by the media and "experts" that investors do not like "uncertainty". However, we are also told by Warren Buffett that "the future is never clear, and you pay a very high price in the stock market for a cheery consensus. Uncertainty is the friend of the buyer of long-term values."

We believe that an over dependence on models and price targets and multiples creates an "illusion of control" of an investor's outcome. However, we also believe that you have to make a few basic assumptions to help in the decision making (yes, we know the saying about never assume because it makes a you-know-what out of you and me). But we make assumptions all the time. For example, I still eat that meal at the restaurant because I assume the meat was cooked properly and the waiter washed his hands. So assumptions are not inherently wrong or bad. With that out of the way, let's make a bunch of assumptions and see what could happen to LYV stock price in the future.

The first thing we are going to do is use the company's definition of "free cash" on the balance sheet of $340 million and not the $1 billion that is reported. This has the impact of increasing the enterprise value since cash is a contra entry to debt in the net debt calculation. That gives us a basis for calculating the future EV.

Determining Free Cash Flow

In this particular instance, we are going to look at 2015 EV/EBITDA to get a sense for what the equity might be worth. Therefore, we need to calculate the amount of free cash flow that could accrue to the balance sheet to determine net debt in 2015. As we have discussed previously, LYV's business model distorts the cash on the balance sheet that is available to the company and also distorts

Various methods to calculate cash flow from operations:

2012

2011

2010

Revenue

$5,819

$5,383

$5,063

CFO before W/C changes

$309

$283

$184

% of Revenue

5.3%

5.3%

3.6%

2012

2011

2010

Revenue

$ 5,819

$5,383

$5,063

CFO after W/C changes

$367

$135

$159

% of Revenue

6.3%

2.5%

3.1%

2012

2011

2010

Revenue

$5,819

$5,383

$5,063

CFO adj for Deferred Rev

$243

$199

$116

% of Revenue

4.2%

3.7%

2.3%

In order to calculate the enterprise value in 2015, we have had to make numerous assumptions. Some of our assumptions might be considered conservative and some aggressive. Generally speaking, we like to do basic back of the envelope type calculations to keep it simple. To determine the enterprise value of LYV in 2015 we have made the following assumptions to get us to our net debt calculation of approximately $1 billion:

  • Adjusted starting cash balance of $340 million.

  • Starting and ending debt of $1.7 billion.

  • Consensus revenue estimates (this could be aggressive).

  • CFO adjusted for deferred revenue as a percentage of revenue of 4.2% (this could be conservative).

  • Capital expenditures of $340 million

  • Acquisitions for cash $150 million

  • Cumulative free cash flow of $300 million (we are assuming working capital changes are negative to be conservative)

  • 190 million shares outstanding

The table below brings all these assumptions together so we can calculate a 2015 enterprise value and the implied EV/AOI valuation today and a potential valuation in the future. At today's prices, the company is trading at an implied 5.5x 2015 AOI. It is important to note that our EV is than some investors might use because we have adjusted the cash balance to reflect only cash that is available to the company. Using an 8x EV/AOI multiple would value the equity at $19-$21 a share in 2015 or 60% higher than today. We believe that Liberty Media would continue to be strong buyers in the $9-$10 range so there is about a 4-to-1 upside to downside risk/reward ratio if our analysis proves correct. At the time we started our one-hour analysis the ratio was almost 9-to-1.

2015

2015

2015

2015

Cash

$640.00

$700.00

$640.00

$700.00

Debt

$1,700.00

$1,700.00

$1,700.00

$1,700.00

Net Debt

$1,060.00

$1,000.00

$1,060.00

$1,000.00

S/O

190

190

190

190

Price

$12.40

$12.40

$19.05

$21.47

Mkt Cap

$2,356.00

$2,356.00

$3,620.00

$4,080.00

EV

$3,416.00

$3,356.00

$4,680.00

$ 5,080.00

AOI

$585

$ 635

$585

$635

EV/AOI

5.8

5.3

8.0

8.0

Debt Structure Not a Liquidity Risk

As always, one of the most important parts of our analysis is a company's liquidity profile. While LYV is not trading at a "liquidity risk" discount nor do we expect that to be a risk to our investment thesis, we do want to understand the credit facility terms and debt structure should the worst-case scenario happen. Because of the unique business model, there are a few things investors should understand about the company's balance sheet. For example, the $1 billion worth of cash on the balance sheet is not entirely available to the company and cannot be counted on in a crisis.

No Significant Debt Maturities in the Next Three Years

There are many aspects of the concept of "margin of safety." One is certainly starting valuation relative to something like tangible asset value or sustainable earnings or revenue. Another part is minimizing the chance that the company suffers a liquidity crisis before the investment thesis can play out. The main source of a liquidity crisis is a company's inability to rollover debt or receive working capital financing from creditors. After examining LYV's balance sheet, neither of these situations seem to be a risk, even if the company significantly underperforms our expectations.

As of Dec. 31, the company had $1.776 billion in debt outstanding at a cost of 5.2%. The most significant portion of that is the Term B loan tranche of the senior secured credit facility at $863 million. The loan matures in November 2016 and requires a nominal $10 million a year in principal payments. The maximum leverage ratio steps down from 4.25x in March of 2015 to 3.75x in March of 2017. The current ratio is around 4x. The only near term maturities are a $220 million convert in 2014 and $80 million of the Term A loan. In 2012, LYV was able to retire a $300 million bond with a 10.75% coupon by issuing a 7% senior note with a 2020 maturity date.


Liberty Media Is a Significant Investor and Continues to Buy Shares

You've got a friend in me -- Randy Newman

One aspect of an investment in LYV is the fact that John Malone's Liberty Media is the largest shareholder. We view Liberty's investment favorably and believe it provides LYV with a partner that can help with revenue enhancement opportunities through its 50% ownership stake in XM/Sirius. Since both companies are focused on the creation and distribution of music, there is a natural synergy between the two companies. For example, a Live Nation channel on the satellite radio network is possible as well as numerous cross promotion and sponsorship opportunities In addition, Liberty has the ability to acquire up to 35% of the company. Liberty has consistently increased its ownership in LYV and we expect that to continue.

When Live Nation merged with Ticketmaster in 2010, Liberty Media exchanged its ownership stake in Ticketmaster for 24.8 million shares (14%) of the new company. Soon afterward, Liberty announced a tender offer for 35 million shares at a price of $12.00. The stock was trading around $10.50 at the time. Interestingly, the tender expired with Liberty buying only a token number of shares. Since that time, Liberty has consistently acquired shares, boosting its total holdings to approximately 50.4 million shares, including the recent purchase of retiring CEO Irving Azoff's 1.67 million shares at $8.98 per share. The fact that Liberty bought Azoff's shares gives us confidence that his loss will not have a long-term negative impact on LYV's operations or reputation. In 2012, Liberty acquired 11 million shares for $107 million, included 9.5 million at $9.68 in a forward purchase contract agreement. It also acquired 7 million shares at an average cost of $10.50 in 2011.

It is clear that Liberty Media still desires to increase its stake in LYV and we have every reason to believe that it intends to eventually acquire the 35% stake it is allowed to have. With a well financed, motivated buyer of up to 16 million shares in the $9-$10.50 per share range, we believe investors should accumulate shares in this range whenever the opportunity arises.

Summary

The merger of Live Nation and Ticketmaster in 2010 created a company that has attempted to build an ecosystem to capture the maximum amount of revenue and profit from the live entertainment industry. A severe recession in Europe, combined with an antiquated IT system has prevented the company from fulfilling that goal. Additionally, there is no real comparable public company and little Wall Street coverage, investors have been drawn to less complex investment ideas.

Finally, while the company has made it clear it wants to increase AOI 30%-35% by 2015, outside of the cost savings potential on the Ticketmaster system upgrade, there are not many parts to that guidance that can be counted on with much certainty or are easy to comprehend . We believe that it is all these factors that have provided patient, long-term investors the opportunity to invest in a unique business model and a more than reasonable price. Of course, if the stock would get back to $10 for any reason, we would be buying more right along with John Malone.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in [[LYV]] over the next 72 hours.

Business relationship disclosure: Investing 501 is a pair of investment professionals with over 60 years of experience. This article was written by Tim Heitman, one of our Founders. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.

See also Options On VeriFone Eye Further Weakness As Stock Tumbles To Multi-Year Low on seekingalpha.com



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Stocks

Referenced Stocks: AEG , AOI , EBAY , LMCA , LYV

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