[00:02:59] Shawn O’Malley: Today, I’ll be discussing the economics of Madison Square Garden Sports Corporation, ticker MSGS, a holding company with two main assets, the NBA’s New York Knicks and the NHL’s New York Rangers. It is uncommon to have the chance to directly invest in any major sports franchises in the U. S., let alone two flagship teams and two of North America’s biggest sports leagues.

[00:03:23] Shawn O’Malley: Based in the country’s largest market. I’ll go through all of this in more detail, of course, but what’s challenging about valuing MSGS is that while the business behind the Knicks and Rangers can fluctuate hugely, depending on how well the teams are performing, there is a major non-economic component involved with buying a controlling stake in a professional sports franchise.

[00:03:44] Shawn O’Malley: Not to be too cliche, but sports really do represent a whole lot more than just money. Major sports teams can be a city’s pride and joy for millions of people, and a sports team is really the ultimate crown jewel for many billionaires who already own everything else that money can buy. Sports teams are luxury goods.

[00:04:02] Shawn O’Malley: They’re the ultimate bragging rights for billionaires, and the attention and notoriety they can gain from their teams is really unrivaled. Billionaires like Jerry Jones and Mark Cuban would almost certainly not be household names if it weren’t for their ownership of the Cowboys and the Mavericks. And the pool of billionaires with disposable money to spend on teams is only growing, while the number of franchises to own remains essentially fixed.

[00:04:25] Shawn O’Malley: Though there are the rare expansion teams that can be added to the NBA and NHL once every decade or so, it’s definitely uncommon. The total number of billionaires in the U. S. alone has risen 88 percent in the last 4 years, and there are now something like 740 billionaires in the country, with combined net worths of over 5.5 trillion dollars. That is a lot of pent up money to bid on a fixed supply of teams, and it’s little surprise then that Forbes estimated valuation of the Knicks Has grown from 800 million in 2012 to 7.5 billion today. And if you’re keeping track at home, that is a compound annual growth rate of 19%. And we’ll get into this more later, but at that estimated valuation, given the current market cap of MSGS, you’re essentially getting the entire New York Rangers for free and only paying a small portion of that toward the Knicks, which is why I find this story so interesting.

[00:05:21] Shawn O’Malley: Like I said, there’s a real non-economic component to sports franchises that extends beyond the economics of how much money they can make, and that’s definitely being baked into the estimates from Forbes. There’s a real emotional value to owning sports teams. There’s a lot of intangible value overlaid too.

[00:05:37] Shawn O’Malley: A Yankee sad is one of the most widely recognized fashion symbols on the planet. And the Phoenix suns as even just a smaller market team sold for a whopping 4 billion in 2022. And obviously, like I said, Phoenix is a much, much smaller market than New York. The Phoenix metro area has around 5 million people, whereas New York’s metropolitan area has a population of over 20 million.

[00:06:00] Shawn O’Malley: And even if half that market is split between New York’s other pro basketball team, the Nets, The divided market is still twice the size of Phoenix. Add to this the fact that New York teams are far more recognizable on a global stage and have longer histories of success, which has cultivated a culture and fan base that is just ravenously devoted to their teams through thick and thin.

[00:06:22] Shawn O’Malley: And you can definitely see why New York sports franchises tend to be even more valuable than their counterparts and other major cities. In terms of the uniqueness of being able to invest in the Knicks and Rangers, there are only a few other notable sports franchises that trade publicly. Major League Baseball’s Atlanta Braves trade publicly with a 2.5 billion valuation under the ticker BATRK, while Manchester United trades with a 2.7 billion valuation under the ticker MANU on the New York Stock Exchange. And then there’s the Liberty Media Corp, which owns the rights to F1 racing and trades under the ticker FWONK. Funny enough, in November of last year, Warren Buffett’s Berkshire Hathaway actually purchased a very small stake in the Atlanta Braves.

[00:07:06] Shawn O’Malley: The trick of valuing MSGS is that the estimated price that the Knicks and Rangers could be sold for is around double the current market value of the company. Yet, the teams would have to actually be sold for that difference to be realized. And obviously the market is skeptical of that happening anytime soon, given that the Dolan family maintains control over the company and teams.

[00:07:27] Shawn O’Malley: There are actually two share classes and the Dolans own the B shares that give them something like 70 percent of the company’s voting power. That alone is a major red flag that gives me pause for consideration. On the one hand, you have the private market value estimated at one price and a completely different value being implied by the stock market where investors are much less patient about waiting indefinitely for that differential to disappear.

[00:07:54] Shawn O’Malley: That said, before we go any further, let’s take a step back and learn a little bit more about how MSGS is structured and how it came to be publicly traded. Let me begin by clarifying that, despite the name, the company does not own the famous Madison Square Garden Arena. The arena itself, aka the garden, is owned by a sister company called Madison Square Garden Entertainment.

[00:08:17] Shawn O’Malley: But of course, this is where the Knicks and Rangers play, and MSGS has long term contracts in place to essentially lease the arena, and they have first priority in doing so for everything from preseason to postseason games. This means that if Drake is scheduled to perform at the Garden, and the Knicks have a playoff game scheduled on that day, Drake gets booted.

[00:08:38] Shawn O’Malley: With the physical capital of an arena owned in another vehicle, MSGS’s core assets are more intangible. Merchandising, ticketing, media rights, that sort of stuff. Being asset light in that way, I think is structurally a significant advantage for MSGS. It’s somewhat similar to how there’s the Coca Cola company everyone knows about that owns the intellectual property around the Coke brand versus a company like Coca Cola bottling, which runs a very resource intensive business and clearly isn’t nearly as valuable or attractive.

[00:09:09] Shawn O’Malley: On top of the Knicks and Rangers, MSGS does also own the rights to two developmental teams, the Westchester Knicks of the NBA G League and the Hartford Wolfpack of the American Hockey League. There’s not really much information available about the business behind these teams, but I’m pretty confident they are definitely money losers.

[00:09:28] Shawn O’Malley: They’re almost like sunk costs though that must be invested in to maintain the quality of the major league teams. So they’re not contributing much to revenue or profit margins, but they are sort of a cost of doing business for owning the major league franchises. MSGS also owns and operates a 114, 000 square foot training center for its team, and has a minority stake in the esports company NRG Sports.

[00:09:52] Shawn O’Malley: Really though, this is all pretty inconsequential for MSGS, and I don’t want to miss the forest for the trees, since this story here centers on its ownership of the Knicks and Rangers specifically. On top of owning controlling stakes in Madison Square Garden sports, the Dolan family controls Sphere Entertainment and Madison Square Garden Entertainment.

[00:10:11] Shawn O’Malley: Sphere Entertainment, for the record, is exactly the Sphere you’re probably thinking of. They own the Las Vegas Sphere, which has just become something of a viral sensation in recent months. If you haven’t seen it, all I can say is just Google it. It’s definitely unlike any other arena in the world. Sphere Entertainment also owns MSG Networks, a media business that owns the local media rights to the Knicks and Rangers games.

[00:10:34] Shawn O’Malley: And as I said, Madison Square Entertainment is the company that owns the Garden Arena, not MSGS. The names get a little confusing, but you’ll just have to bear with me. These were actually all part of the same company at one point. In 2020, MSGS spun off its non-sports team assets into MSG Entertainment.

[00:10:54] Shawn O’Malley: And then in 2023, Sphere Entertainment was spun off from MSG Entertainment, but they all traced their roots to the same organization. The takeaway though is that the more capital intensive and lower quality assets were spun off from MSGS into separate companies, leaving MSGS as a fundamentally more attractive company today than it was a few years ago before the spinoffs.

[00:11:16] Shawn O’Malley: That does make it trickier to assess MSGS’s performance over time since it’s not an apples to apples comparison to look at MSGS today versus its results in 2018 when it owned local meteorites and the garden. And so the Dolan family sits at the intersection of these companies since they controlled the original parent company with 69 year old James Dolan serving as the CEO and executive chairman of MSGS, MSGE, and Sphere.

[00:11:43] Shawn O’Malley: As MSGS’s CEO, he recently signed a contract extension through 2027 that’s paying him at least 1. 6 million per year with a target annual bonus of 200 percent of his salary. Thank you for listening. He’s also eligible for a long term incentive plan that could pay him another few million dollars. Clearly, the family patriarch and controlling stakeholder in the company has not shied away from compensating himself generously.

[00:12:07] Shawn O’Malley: On top of this, as mentioned, James Dolan is the CEO of Sphere Entertainment, which owns MSG Networks and licenses the local media rights for the Knicks and Rangers, while also serving as the CEO of MSG Entertainment. Which again, owns the garden. It’s pretty unorthodox, but James Dolan is the CEO of three companies with multiple layers of interdependency between each other.

[00:12:31] Shawn O’Malley: Throughout his life, James Dolan has battled with drugs and alcohol. And in 1993, he checked into rehab. He’s also been a defendant in several sexual harassment lawsuits over the years as well. In 2007, there was an 11 million sexual harassment settlement. And more recently, in January 2024, a massage therapist filed a lawsuit against Dolan, who allegedly set her up to be abused by Harvey Weinstein in 2014.

[00:12:57] Shawn O’Malley: So obviously it’s an understatement to say that he is really not the ideal person to be leading MSGS from a shareholder’s perspective, given this backdrop and the precedent for owners like Donald Sterling and Dan Snyder being forced to sell their teams amid their own controversies, there is a real chance that the NBA and or NHL could force Dolan to sell after owning the teams for almost 30 years now.

[00:13:23] Shawn O’Malley: What it’s worth, fans certainly want him gone after enduring long spans of disappointment over the years. There’s been enough misery for Rangers and Knicks fans at the New York Post as the teams are afflicted by a quote unquote Dolan family curse. And to fans further chagrin, Dolan said last year that he has no plans to retire or sell the team, so he will have to be forced out, and he expects it to remain with the family whenever he does step down.

[00:13:49] Shawn O’Malley: There’s really been no shortage of controversies with James Dolan, obviously, though, from accusations of spying on workers, to allegedly implementing camera software to identify and turn away lawyers at games who worked for firms opposing him in legal battles. So it’s hard to imagine the ownership situation being any worse.

[00:14:08] Shawn O’Malley: And I tend to generally think that as scandals, controversies, and fan resentment stack up, it becomes more and more likely that eventually the Dolan family will have to sell the teams at the right price. And I say all this because it is important to the thesis here, as we’ve talked about earlier, and that there is this difference between the valuation on Forbes.

[00:14:28] Shawn O’Malley: That can only be realized if the teams are sold, but that could be two years from now or 15 when they sell. And there’s really no way of knowing when as a fan of the NFL’s Washington commanders, I know a thing or two about terrible ownership, unfortunately, and Dan Snyder being forced out. Gives me some reason to think it’s a matter of if, not when, the Dolans sell the Knicks and Rangers.

[00:14:52] Shawn O’Malley: For years, Dan Snyder’s misdoings added up until it hit a breaking point, where a toxic work environment, harassment accusations, fan protests, pressure from other owners in the league, and underperformance on the field all made it untenable for him to continue owning the team. I remember hearing throughout my childhood and college years that everyone knew the problems in the organization all came back to Dan Snyder as the owner, and yet as fans we were doomed to indefinite misery because he could never be forced to sell, or at least as it seemed.

[00:15:23] Shawn O’Malley: And as painful of a battle as it was, he did of course finally sell the team to Josh Harris for a whopping 6 billion dollars in 2023. So maybe I’m naive, but having lived through that experience gives me hope as a potential investor in MSGS that a similar victory for fans and investors could finally be won one day.

[00:15:43] Shawn O’Malley: When I look at the Dolans, the fact that the Rangers and Knicks have been performing better of late buys some time for them, but I’ve also learned that these kinds of things can fall apart quickly, too, if the teams start to flounder or a new scandal emerges. The sooner that happens and the Dolans sell either or both of the teams, the sooner the gap between Forbes estimated value for the two teams is reconciled.

[00:16:06] Shawn O’Malley: With the current stock market value for the teams, and MSGS’s stock would promptly double. Of course, there’s nothing sacred about the estimates that Forbes makes. I’ll cover it more later in the episode, but it’s just that Forbes has a decent track record in estimating the price that major sports franchises will ultimately be sold in part or full for.

[00:16:25] Shawn O’Malley: Most of what they’re doing, though, is just going off of precedent. Forbes has models valuing various sports teams, and they might estimate that, say, a major market NBA team is worth 8 times its revenues over the last 12 months. And then if a similar team sells for 10 times revenues, they’ll update their models to revise the next valuation as a multiple of 10 of its revenues.

[00:16:46] Shawn O’Malley: Overnight, that would raise the estimated valuation of the NICS by 25%. And this is what has happened year in and year out to help the estimated value of the NICS and range risk compound over time. But this is all on paper and derived from guesses about what people might be willing to pay for something.

[00:17:03] Shawn O’Malley: Before I get too far ahead of myself, let’s go ahead now and talk about the business underlying MSGS and the economics of owning pro sports teams like the Knicks and Rangers. The company’s primary strategic goal unsurprisingly is to develop championship caliber teams, which enables higher ticket revenue during the regular season as well as additional revenue from playoff games.

[00:17:23] Shawn O’Malley: Tickets for the Knicks and Rangers are sold on a single game basis, group sales and membership plans for the entire season or just part of it. Single game tickets are naturally the most dynamically priced in order to respond to demand. The better either team is doing, the more that can be charged for tickets and the higher attendance will be at games.

[00:17:43] Shawn O’Malley: Ticketing is pretty intuitive though. Where things get messier is with media rights, which is the fastest growing revenue source for just about all professional sports franchises and leagues. In October 2015, the Knicks and Rangers entered into 20 year local media rights agreements with MSG Networks, which makes home and away games available to fans across regional television networks and a streaming platform called MSG Plus.

[00:18:06] Shawn O’Malley: But MSG Networks is on very shaky financial footing, and probably too close to comfort to insolvency, which would jeopardize this revenue stream for MSGS if MSG Networks is unable to pay in full or at all for ongoing local media rights. MSG Networks went into default on some of its debts in October, and leaders temporarily agreed to hold off on taking any action against the company in hopes of a refinancing being secured.

[00:18:34] Shawn O’Malley: Just to clarify again, this is MSG Networks that’s in default, which is the company paying for the local media rights to the Knicks and Rangers, not MSGS, which owns the teams. But naturally for MSGS, having one of their biggest broadcasting partners in default puts a big question mark around the 180 million in revenue that MSGS is supposed to earn from their existing contracts together.

[00:18:56] Shawn O’Malley: On top of those local media rights, MSG also gets a pro rata share of fees from the NBA and NHL’s national and international media agreements. So basically this is a pot of revenue that the league earns for licensing media rights, which ends up getting split evenly amongst the teams. And the NBA in particular has done very well at expanding internationally in recent years, which in part explains why the Knicks have grown in value faster than the Rangers.

[00:19:22] Shawn O’Malley: I expect a growing international audience for NBA games to increasingly add to the value of media rights and the pot of revenues that the league distributes to teams. Compared to the NFL, where most media rights revenues come from national contracts, the NHL and NBA also rely more heavily on local media rights, which is why there can be huge fluctuations in valuations for teams in these leagues depending on where they play.

[00:19:45] Shawn O’Malley: For example, the Knicks are estimated to be worth about twice as much as the Phoenix Suns as we talked about a bit earlier. For the NHL, its national media agreements with Disney and WarnerMedia expire in 2028, whereas the NBA’s agreements expired in July 2024, and were replaced with a new 11 year, 76 billion agreement with Disney, NBCUniversal, and Amazon.

[00:20:08] Shawn O’Malley: Giving them the rights to certain NBA games. And then also worth mentioning is that MSGS has revenue share agreements in place with MSG entertainment, which is the company again, that owns the MSG arena. The garden as it’s known has 22 event level suites, 48 Lexus level suites. 18 info system level suites, the Madison club and the hub loft.

[00:20:31] Shawn O’Malley: These suites and clubs are private areas with first class amenities that are primarily licensed to corporations and multiyear agreements. So there’s live entertainment, media rights, and hospitality all wrapped together at the core of MSGS business model. As well as merchandising and sponsorships like promotional signage throughout the arena for Knicks and Rangers games that MSGS gets a cut for.

[00:20:55] Shawn O’Malley: That all sounds good, but I have to mention that the NBA and NHL set many of the rules and regulations limiting how the Knicks and Rangers can run their businesses. For example, both leagues have collective bargaining agreements with players that determine the financial landscape for teams. Part of the NBA’s focus has been to create as much of a level playing field as possible, ensuring that every team in every market can compete for championships.

[00:21:20] Shawn O’Malley: And since 2019, that has worked pretty well with six different teams winning championships in the last six seasons. Accordingly, the NBA operates with a salary cap, which limits how much teams can spend on payroll costs for players. In the 2024 2025 season, the salary cap is 140M. Unlike the NHL though, which is a hard cap that cannot be exceeded under any scenario, the NBA has a soft cap.

[00:21:46] Shawn O’Malley: NBA teams like the Knicks can go over the salary cap with exceptions, as outlined in the collective bargaining agreement, but this can also expose them to what’s called a luxury tax. At a certain point above the salary cap, teams must pay 1.50 to the league for every dollar they exceed the threshold, with even higher taxes on teams that have exceeded the salary cap in multiple seasons.

[00:22:08] Shawn O’Malley: Some teams pay pretty whopping luxury taxes, like the Golden State Warriors, which racked up a 177 million luxury tax bill last year. There are other restrictions too. For teams exceeding the salary cap by 17. 5 million or more, the newest collective bargaining arrangement puts restrictions on how they can build their roster, like not being able to sign players whose contracts were bought out by their former teams.

[00:22:33] Shawn O’Malley: There are really just a ton of seemingly arbitrary rules governing how contracts can be structured, which players can and can’t be signed or traded for, how much rookies can be paid, and more stuff like that. If you thought the iris tax code was dense, the NBA’s salary cap rules and collective bargaining agreement would make your head spin probably just as much, and a large chunk of players’ salaries on court and on ice are partially or fully guaranteed, meaning that not only could serious injuries derail how the teams perform over the course of a season, But the franchise and MSGS shareholders have to eat those costs even if players never play again.

[00:23:11] Shawn O’Malley: I was surprised to learn though that the teams do hedge some of this risk with insurance contracts that pay out if key players are injured. It makes perfect business sense why they would do that. It’s not something as a lifelong sports fan I would have ever thought about, really, without digging into the business of sports franchises though from an owner’s perspective.

[00:23:30] Shawn O’Malley: There’s always the risk too that players go on strike if they’re not satisfied with their collective bargaining arrangements. In 2012, the NHL season was shortened by 34 games due to lockouts, and that of course ripples across ticket sales and media rights. The point of mentioning this all, though, is to show that franchises do not have unlimited discretion.

[00:23:49] Shawn O’Malley: They are ultimately at the whim of randomness and freak injuries, while also being bound by a strict set of rules, which set the tone for how their teams are structured, and the media and entertainment businesses built around those teams. The rules governing what MSGS can do competitively are far more explicitly defined and enforced than those that govern most other types of companies, Amazon has to adhere to the US legal system, but it’s not like it and all its e retailer competitors are organized in a league structure that very specifically outlines how they can and can’t compete with each other.

[00:24:23] Shawn O’Malley: The leagues really have a considerable amount of power over individual franchises like the Knicks and Rangers. And while the league should be acting in everyone’s best interest, they can hold teams accountable for violations with sizable fines or even by removing their draft picks, hurting their ability to build their rosters.

[00:24:39] Shawn O’Malley: So from an investor’s perspective, there’s always a risk that the Knicks or Rangers could be adversely affected by decisions made by the league commissioners of either the NBA or the NHL. In terms of competitors, MSGS ultimately competes in the attention economy, and while it’s most direct competitors are the other franchises and the NBA and NHL, it’s vying for attention and fan interest in one of the busiest cities in the world.

[00:25:04] Shawn O’Malley: New York is also home to the Yankees, Mets, Giants, Jets, Islanders and the Brooklyn nets. So there are a number of pro teams across the NHL, NBA, MLB, and NFL anchored in the area, meaning there’s strong competition for the dollars and eyeballs of New York’s fan base. And of course, people in New York have plenty of entertainment alternatives besides sporting events too.

[00:25:28] Shawn O’Malley: From just a simple numbers perspective, there’s competition for media rights dollars as well, which can always be diluted by new expansion teams since media rights agreements for the NHL and NBA are equally divided across the number of teams. This isn’t something that happens super often, but it does happen and could materially reduce the Nixon Ranger’s share of revenue from licensing league media rights.

[00:25:51] Shawn O’Malley: The NHLs last expansion team was the Seattle Kraken in 2021, and the NBA’s most recent new team was in 2004 with the Charlotte Hornets, formerly known as the Charlotte Bobcats. But there’s a decent bit of speculation that Seattle and Las Vegas could soon get new NBA teams too. It’s also worth mentioning that sports entertainment is a cyclical business.

[00:26:12] Shawn O’Malley: The media rights component of it may be more durable, because I think cable packages or certain streaming subscriptions are stickier, but in an economic downturn, when there’s less discretionary money floating around, people are certainly less inclined to buy tickets for Nyx games, pay 90 for a branded hoodie, or drop 20 on nachos at the garden.

[00:26:33] Shawn O’Malley: Ticket prices in particular are the biggest and also most volatile component of MSGS’s different revenue streams, They can fluctuate pretty dramatically on a nightly basis depending on how good the rangers and knicks are, but also who they’re playing against, whether key players are injured, and on what day of the week the game is.

[00:26:50] Shawn O’Malley: But for season ticket packages, at least, the knicks have an impressive 97 percent renewal rate, which definitely helps smooth out ticket sales from year to year. And the Knicks and Rangers also receive about 50 percent of the net profits from food and beverage sales during their games at the Garden. So about half of MSGS’s revenues come from event related sources, which include ticket, food, and beverage sales, and about a third comes from media rights, and the rest comes from sponsorships and distributions from the NBA and NHL.

[00:27:19] Shawn O’Malley: In terms of costs, player and personnel salaries are naturally the biggest expense for MSGS as a sports franchise holding company. On top of travel costs, player insurance costs, and a 6 percent fee to the NBA for regular season ticket sales for the Knicks. Across all major U. S. sports, more than 50 percent of revenues go to player compensation, which is just a huge and actually growing cost.

[00:27:43] Shawn O’Malley: We’ve already talked about the luxury tax in the NBA, but there’s also an escrow system for the NBA and NHL, too. In aggregate, players are supposed to be earning roughly half of league wide revenues, and thus the leagues hold a portion of players’ salaries in escrow throughout the year that’s deducted from their paychecks.

[00:28:01] Shawn O’Malley: Which can be distributed in case players’ salaries fall short of their target percentages by the end of the season. In effect, players are guaranteed to receive roughly half of the league’s revenues each year, and if players receive more than 50%, money is instead paid to team owners out of escrow to balance things out.

[00:28:19] Shawn O’Malley: Additionally, both the NHL and NBA have a revenue sharing plan that tries to even out what franchises across their leagues can earn, So, the top earning teams may have to make contributions to the teams that generate the least revenue. Last year, the Knicks actually paid about 23 million dollars to essentially subsidize the NBA’s least profitable teams.

[00:28:39] Shawn O’Malley: So, we’ve got an idea of the business model generally and the biggest costs for the Knicks and Rangers. Let’s just quickly touch on MSGS’s financials. Revenues rose 16 percent last year to just over 1 billion, while operating income almost doubled to 146 million. After stripping out interest on debt and taxes, the net income available to shareholders was about 58 million, which is not a huge profit margin on a billion dollars in revenue.

[00:29:08] Shawn O’Malley: The rise in revenue was primarily attributed to more playoff games for the Knicks and Rangers, Higher ticket prices during the regular season, and distributions from the NBA and NHL as league wide revenues rose. And then the biggest cost increases came from paying players, incentive bonuses for helping both the Knicks and Rangers make playoff runs, as well as higher escrow costs.

[00:29:29] Shawn O’Malley: Because the Knicks didn’t pay any luxury tax in the last two seasons, they were actually rewarded and paid a share of luxury tax receipts from the teams that did exceed the salary cap. Looking at the financials in the past two years for MSGS is a bit misleading because everything gets thrown out of whack from 2020 and 2021 with the pandemic, but also because financials before 2020 reflect how the company did when it was a combined entity before it spun off MSG Entertainment and MSG Networks.

[00:29:57] Shawn O’Malley: Over the past three years, both the Rangers and Knicks have done pretty well, but any downturn in their performance on the court and on the ice would probably be a severe blow to the recent upward trend in revenues. An interesting wrinkle of the business model for professional sports teams is a tax strategy known as roster depreciation allowance, Basically, because teams put so much time, effort, and money into developing their athletes, they effectively treat their rosters as intangible assets.

[00:30:25] Shawn O’Malley: When the Knicks or Rangers acquire or assign players, the costs are capitalized on MSGS’s balance sheet, creating a player roster asset. And then these player assets can be amortized over time, which shows up as an expense on the income statement. This reduces taxable income, and the goal is to reflect that as players age, their value fades away and depreciates, much like any other type of physical asset.

[00:30:50] Shawn O’Malley: There’s essentially a double tax benefit here though, where not only can MSGS deduct the actual salary costs from its income, but it can also depreciate its intangible roster assets, further reducing the income that’s reported to the IRS and saving the company on further taxes. The double benefit arises because under the roster depreciation allowance, owners amortize the purchase price of the team, player contracts, and other intangible assets like tv contracts and franchise rights over a 15 year span on top of actual payroll expenses.

[00:31:24] Shawn O’Malley: This partially explains why sports franchises are so attractive to billionaires. They can effectively be used as a tax shelter, where teams may be profitable in terms of cash flows, but can report considerable paper losses that reduce tax liabilities. For example, when David Tepper paid 2. 3 billion for the Carolina Panthers, that produced amortization expenses of around 140 million per year.

[00:31:48] Shawn O’Malley: More than wiping out any Panthers profits reported for tax purposes. Depreciating the purchase price of a team is the main benefit of the RDA, which isn’t applicable to MSGS since the Dolan family has owned the team for 30 years now, but it does help on the margins with capitalizing player contracts, and it’s definitely a compelling factor that could support higher sales prices for the teams if the Dolans are ever forced to sell them.

[00:32:13] Shawn O’Malley: Crazy enough, there’s actually an incentive and a way to pay a bunch of money up front to buy sports franchises so that you can amortize more of that cost over time to reduce taxes. When evaluating any company, it’s of course important to consider the bear case, too, and try to see what could go wrong. I think this boils down to a few straightforward points.

[00:32:33] Shawn O’Malley: Firstly, the company’s assets are obviously highly liquid. Sports teams are not sold often, and it’s not easy to sell them. For years, MSGS has sold at a large discount to the sum of its parts valuation, and it’s not obvious why that would change anytime soon. As sports franchises get more and more expensive, there are also fewer and fewer buyers who can easily participate in those deals.

[00:32:57] Shawn O’Malley: How many billionaires besides Elon Musk and Jeff Bezos could comfortably write an 8 billion check for the Knicks? On that point, you have to wonder whether there’s something of a bubble in prices for sports franchises that’s not sustainable, especially since the underlying economics for these teams really isn’t that compelling.

[00:33:14] Shawn O’Malley: The valuations for these assets are inflated relative to how much cash the Nicks and Rangers can actually produce and the consistency with which they can produce that cash, so the business models are just not nearly as good as you’d think, or at least as I would’ve thought when I first started researching this company.

[00:33:30] Shawn O’Malley: Players have a lot of leverage over teams and as such they command huge salaries that are a considerable chunk of total revenues and that’s definitely not changing anytime soon. If anything players are getting paid dramatically more each year and depending on how the teams are performing there will be good years and bad years for the business.

[00:33:50] Shawn O’Malley: And any legal changes to how teams can implement the roster depreciation allowance I covered a moment ago could also seriously impact the estimated valuation of the Knicks and Rangers too by removing an incentive for paying a larger upfront price to buy the teams. MSGS is also not the epitome of a fortress balance sheet either, it’s financial position doesn’t inspire a ton of confidence because there’s just not that much cash on hand to cushion shareholders from financial ruin.

[00:34:17] Shawn O’Malley: MSGS has a bit less than 90 million dollars of cash on hand against over 300 million dollars of debt, which alone isn’t bad. But there’s also a considerable amount of fixed obligations that MSGS has that aren’t technically debt, yet pretty closely resemble it. Like 30 years of payments on long term leases for the garden and off balance sheet contracts with players with guaranteed money for them that must be paid even if they’re released or injured.

[00:34:41] Shawn O’Malley: This isn’t my biggest point of concern, but you know, it does matter. I’m not saying MSGS is on the verge of bankruptcy by any means, but they do have pretty large liabilities that aren’t captured by basic measures of debt. With an indefinite waiting period for MSGS’s market value to reflect the true value of the Knicks and Rangers, plus a volatile business and potentially vulnerable financial position, it’s not surprising to me at all that the company trades at such a discounted price.

[00:35:07] Shawn O’Malley: And then on top of all this, you have family risk too. If you’ve seen the show Succession, you’ll know how messy things can get when families vie for control over publicly traded companies. Sibling rivalries, inheritance feuds, and nepotism can all derail returns for shareholders, I’m certain that the company could be more efficiently run if it weren’t controlled by the Dolans.

[00:35:28] Shawn O’Malley: All you have to do is look at the board of directors to see this in action. With 18 members, the board that’s supposed to be holding the CEO accountable and representing shareholders is massive with 18 members, of which many are family. Worse is that they’re sitting around collecting 250, 000 per year simply for being board members.

[00:35:46] Shawn O’Malley: If that isn’t concerning enough, just consider that this sort of misuse of shareholder wealth is what they’re willing to disclose publicly. I wouldn’t be surprised if no penny of shareholder money is spared on lavish amenities for the Dolan family and their friends. So the company’s management and governance is not ideal, to understate things, but it is fair to say that the quality of MSGS’s assets are so good that it might more than make up for this.

[00:36:11] Shawn O’Malley: People were attending events at Madison Square Garden almost a hundred years ago and they probably will still be doing so a hundred years from now. The bear case, in short, is that MSGS reeks of a value trap. There is a discount to intrinsic value that will surely lure investors in, but that discount may persist for years, burning investors who don’t have the patience to potentially wait decades, if ever, for the Knicks and or Rangers to be sold.

[00:36:35] Shawn O’Malley: Fans have demanded for the teams to be sold for years, and James Dolan’s response has been just too slowly withdraw from the operations of the company to take the spotlight off of him. But there doesn’t seem like there’s enough pressure to force him to sell, at least not in this moment. And There’s also a question of opportunity costs.

[00:36:51] Shawn O’Malley: If you’re going to treat an investment in MSGS stock as a private investment that you hold for the long term, since you might be confident in the value you’re getting, even if it’s not reflected in the stock price, there are certainly companies with better business models who will be superior compounders to own over time, especially if you don’t see any specific catalysts on the horizon that would drive a sale of the two teams.

[00:37:12] Shawn O’Malley: That is in a nutshell, the bear case. Still, I’m here to estimate the intrinsic value of MSGS. Price is what you pay, value is what you get, and there’s clearly a favorable difference between price and value in this case, even if there are good reasons for that to be true. For what it’s worth, MSGS has made moves to try to enclose the discount that its stock trades at and compensate shareholders, but they’ve been limited.

[00:37:38] Shawn O’Malley: There was a special discount in October, 2022 of 7 per share. And over the last decade, management has repurchased around 400 million worth of the company’s outstanding stock with over a hundred million dollars of authorized buybacks still remaining that they can choose to implement. I would prefer to see them ramp up buybacks more aggressively and expand the buyback program, which effectively reduces the number of shares outstanding and bids the stock price higher.

[00:38:04] Shawn O’Malley: And I think that special dividend would have gone much further as a buyback in signaling to markets that management is serious about closing the valuation gap, or even if the Dolans don’t sell their controlling stakes in the Knicks and Rangers, selling minority stakes in the company to, to say private equity firms could be enough to at least meaningfully close the gap between what Forbes estimates the two teams to be worth and the market cap of MSGS.

[00:38:28] Shawn O’Malley: But let’s look at this supposed valuation gap more closely. There are two general approaches to valuation that investors can rely on. We can take a discounted cashflow perspective and map out the cash available to shareholders. We think a company will produce over the next decade or so, and then reduce that back to a present value.

[00:38:46] Shawn O’Malley: Or we can take a pricing approach where we value assets based on what similar assets have sold for. For MSGS, I think the latter makes more sense, at least in my opinion, because we can’t map out the company’s profits without implicitly anticipating how the Knicks and Rangers will perform, which is not something you can predict with any real confidence.

[00:39:04] Shawn O’Malley: And as we’ve talked about a bit, sports teams aren’t solely economic transactions, there are non-economic factors baked into the prices of sports teams, from billionaires egos to tax sheltering. So taking a pricing approach, I found a list from Morgan Stanley with details on all sales of major US sports franchises from 2021 to 2023.

[00:39:24] Shawn O’Malley: This includes sales of minority and majority stakes in teams like the Dallas Mavericks, Charlotte Hornets, Washington Commanders, Los Angeles Lakers, Golden State Warriors, Tampa Bay Lightning, and nine others. These teams in America’s four major sports leagues sold at an average 17 percent premium to their valuation, as estimated by Forbes.

[00:39:43] Shawn O’Malley: At an average 10 times multiple of revenue. If we were to assume no premium to the Forbes estimate of the Rangers and Knicks value, the combined value of those two teams is about 10 billion. If we tack on the average 17 percent premium to what Forbes estimates, then the combined value is closer to 12 billion.

[00:40:02] Shawn O’Malley: Meanwhile, the company’s enterprise valuation is roughly half that, which reflects the actual costs to acquire MSGS, including not just the market value of its equity, but also its outstanding debt. In other words, MSGS is currently valued at around 50 percent of the current value of its two main assets, the Nicks and Rangers, even after you subtract out the company’s debt and long term lease commitments.

[00:40:25] Shawn O’Malley: As we look forward from there, the Knicks have compounded their Forbes valuation at 17 percent per year for the last 15 years, while the Rangers have compounded their Forbes valuation at about 9 percent per year over that same period. I don’t think it’s crazy then to say that over the next decade or so, the combined estimated value of the teams will probably continue to grow by at least 10 percent per year, but this is speculative because while I think it’s plausible, the number isn’t necessarily in line with how the business will perform going forward.

[00:40:53] Shawn O’Malley: To help me grasp the thesis and valuation for MSGS, I spoke with Vince Pagano, who specializes in value investing and special situations. His basic approach to the valuation is to add up the Forbes estimates for the Knicks and Rangers, subtract MSGS’s net debt, and then divide that number by the number of outstanding shares, and that gives you a rough proxy of value per share.

[00:41:14] Shawn O’Malley: The numbers fluctuate depending on what you count as debt and whether you add a premium to the Forbes valuation, but for the sake of conservatism, I added no premium and used the largest calculation of debt, including long term lease contracts for the Garden. On top of that, Pagano recommended to me that I add in another 15 percent discount to that value to reflect the fact that the valuation gap may never fully close.

[00:41:38] Shawn O’Malley: So at 85 percent of the estimated net asset value of MSGS, I get around 350 per share. Over a three year period, this implies a compound annual return of as much as 16 percent per year from current prices. For the valuation gap to narrow like that, MSGS would have to get more aggressive about share buybacks, or sell a sizable minority stake in the company, or even better, if the Dolan family is forced out completely, the returns could be much higher.

[00:42:07] Shawn O’Malley: This also doesn’t account for the fact that over the next few years, if the past 15 have been any guide, the combined estimated values for the Nyx and Rangers will probably continue to compound at double digit rates, adding to possible returns. I do have some mild concerns though about the Knicks and their valuation and whether it can persist because there have been a ton of reports lately about how viewership for the NBA has fallen off and it’s not nearly what it was a decade ago and how ratings may be down even as much as 20 percent year over year.

[00:42:35] Shawn O’Malley: I’m not sure what really to make of that though and overall I do feel pretty good that the NBA is in safe hands and any short term headwinds can probably be rectified down the road. And I also know that I’d be buying in at a hefty discount to current estimates of the team’s valuations. That said, I could easily imagine that a bad season for the Knicks could derail MSGS’s operating results and further expand the discount between the stock’s implied valuation for the two teams and what Forbes estimates.

[00:43:02] Shawn O’Malley: So I am conflicted. I feel like I’m biased by the fact that I think it would be objectively cool to call myself an owner of the Knicks and Rangers, but I can buy into the story here too, though. In all honesty, it is a pretty straightforward thesis. Forbes has a very good track record of estimating team values relative to what they end up selling for.

[00:43:20] Shawn O’Malley: And if anything, they usually end up being too conservative. And as we’ve covered at length, MSGS trades at a large discount to what Forbes estimates. If I want to put my Ben Graham hat on, then I can really convince myself that I shouldn’t care about market pricing. I want to treat stock investments like any private business I can own and recognize that the stock market can have other reasons for discounting the value of a company like MSGS, but aren’t all that relevant to long term investors who truly like to think like owners of an underlying But buying into a stock long term with such poor corporate governance and a system that’s just really ripe for abuse from management is definitely a big red flag for me.

[00:43:59] Shawn O’Malley: Plus, there’s the fact that the underlying business behind the Knicks and Rangers is not super high quality, meaning that to some extent, the Forbes estimates are premised on billionaires continuing to pay more and more for sports teams at the same pace they have in the past, which is by no means guaranteed.

[00:44:13] Shawn O’Malley: I wouldn’t want to bet on that not happening, but acting on an intrinsic value estimate for MSGS that isn’t primarily based on real cash flows and profitability makes me a bit uneasy too. This is what makes a market, as they say, and this is what makes investing hard. I can see why it will likely work out, with some protection working in my favor via the discount to Forbes valuation, and the potential to quickly double the investment if the Dolan family unexpectedly sells the team.

[00:44:39] Shawn O’Malley: But I can just as easily imagine the stock stagnating for years and the discount widening further if either team doesn’t perform well. Buying a stock at a discount to its sum of the parts valuation without a clear catalyst on the horizon is an infamous mistake investors have made in the past, and that’s what is really giving me second thoughts here.

[00:44:58] Shawn O’Malley: My decision for the intrinsic value portfolio is not to add MSGS because I just don’t feel good enough about the underlying business. If the profit margins on the Knicks and Rangers were higher and the teams kicked off more meaningful free cash flows, I’d have much stronger conviction in the private market value of the teams, but I can’t help but think that the purchase price for sports franchises are pretty far separated from their operating profits and that there may very well be a bubble forming in acquiring sports franchises more generally.

[00:45:26] Shawn O’Malley: At some point we have to hit a ceiling on who can even afford to buy these teams. There are only so many billionaires who could even pony up 8 billion in cash for the Knicks, and even with a consortium of billionaires making a purchase or investment funds getting involved with minority stakes, the momentum in prices paid for sports franchises has to wear out eventually.

[00:45:46] Shawn O’Malley: Your guess is as good as mine, but after 15 years or so of pretty rapid appreciation, we definitely aren’t in the early stages. Like I said, if I felt there was a good economic reason that the Knicks were worth, say, 8 billion, I’d be all over this opportunity. It’s another thing entirely to speculate that they could or should be sold for that much though.

[00:46:07] Shawn O’Malley: It’s like buying a house in a nice neighborhood just to flip it. That might work out for you, or it might not, and there’s a component of random luck involved. The Nix or Ranger’s valuations based strictly off of cash flows would be a fraction of what Forbes estimates, which is something Aswath Damodaran covered generally in a 2023 video I’ll link to in the show notes.

[00:46:26] Shawn O’Malley: And of course, there isn’t a clear catalyst for a sale either. And while MSGS has the opportunity to close the valuation gap with aggressive buybacks, they have yet to really do that. Well, I do think MSGS is probably trading at a discount to its intrinsic value. I think there are likely better opportunities for companies to invest in long term, but if you did want to invest in MSGS, it’s not something I’d recommend making a core portfolio holding.

[00:46:51] Shawn O’Malley: It’s more of a special situation than a true long term compounder, and as such, you’d want to manage your position size accordingly and very cautiously. All it would take is a bad season or two for the Knicks or Rangers to derail MSGS’s financial results and hit the stock hard, but that actually probably wouldn’t weigh on the estimated prices that the teams could sell for, so that would make for a pretty interesting buying opportunity, potentially.

[00:47:15] Shawn O’Malley: Right now, the NYX and Rangers are both expected to continue doing well, and as such, the financial outlook for MSGS is better than it otherwise would be. But as we’ve covered today, MSGS’s financial results could be a short term headwind to the stock, while the value of its assets are not closely tied to their underlying economics.

[00:47:33] Shawn O’Malley: Meaning MSGS will very much continue to be on my watch list. And if for some reason the gap widens further between its stock market valuation and Forbes is estimated value of the Knicks and Rangers, I’d be increasingly interested in it. So that’s it for today, folks. And I hope you enjoyed the first ever episode of the intrinsic value podcast.

[00:47:53] Shawn O’Malley: For more on MSGS and some of the numbers I use and assumptions I made, make sure you’re signed up for the intrinsic value newsletter, which I’ll send out each week to compliment the podcast. You can find the link to sign up in the show notes below next week. I’ll be breaking down another interesting business and investment opportunity for you.

[00:48:11] Shawn O’Malley: And once again, decide whether it should be added to the show’s portfolio. Obviously, I’m still looking for the first stock to add to it, but I know that patients will pay off over time to wrap things up here. Let me leave you with a timely message from the Oracle of Omaha, Warren Buffett. He tells us, quote, I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years. That’s all for today, folks. I’ll see you again next time.

[00:48:40] Outro: Thank you for listening to TIP. Make sure to follow The Intrinsic Value Podcast on your favorite podcast app and never miss out on our episodes. To access our show notes and courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decisions, consult a professional. This show is copyrighted by The Investor’s Podcast Network. Written permissions must be granted before syndication or rebroadcasting.