Wednesday, June 17, 2015

On BTIG Research initiating BUY/$25 price target for $WWE (analysis)

On Wednesday, 6/17/15, BTIG Research announced that they were "initiating coverage for World Wrestling Entertainment (WWE) with a BUY rating and a $25 price target".

The key element of their analysis is that WWE OIBDA in 2015 would be $77MM and rise to $121MM in 2016.

WWE has noted that, "The rate of WWE Network subscriber adoption is a critical determinant of the Company’s projected future financial performance."
According to WWE's 2015 Business Outlook (published 2/12/15), to achieve $77M OIBDA, the WWE Network would need to average between 1,109,000 and 1,291,000 paid subscribers in 2015. (Depends on whether you're looking at the low or high ranges of estimate.) That middle point is right at 1,200,000 paid subscribers for the year (which is likely how the company arrived at their estimate.)

The key word is "paid subscribers". While WWE has shown the ability to grow the WWE Network (up to 1,327,000 as of 3/31/15), it's important to note that the first quarter average of paid subscribers was only 927,000. To achieve the 1.2M paid subscriber annual average, WWE would need to average 1.291M subscribers for April-December.

Interestingly, BTIG Research admits that at the end of Q2 they "expect to only have 1.18M subscribers". It does not qualify whether this number is paid subscribers, but we'll assume that it is. That would indicate that WWE would have lost about 147,000 subscribers from 3/31 to 6/30. That would put the midpoint for Q2 at 1,253,500 subscribers but only if you assume that the subscriber attrition actually would happen in the middle of April, as opposed to immediately following WrestleMania.

If we assume that Q1 is 927k paid and Q2 is at 1.2535M paid, that would still infer that WWE would need to average 1,309,750 paid subscribers for the second half of 2015 which is lofty target. Do we really believe that in the non-WrestleMania time-period, the service will be able to move back up to the WrestleMania level

Indeed, no one really knows what the post-WrestleMania subscriber slide will look like. WWE has adopted a continuous "free month" model and seems to be trying to "sweeten the pot" by adding WWE Network exclusive shows that are of PPV-caliber (Elimination Chamber). By timing the event on the last day of the month, was WWE successful in rolling over free subscribers to paid status? After more than twenty years, has the company successful reprogrammed casual WWE fans to invest and follow the product throughout the year instead of seasonal Royal Rumble to WrestleMania activity?

I think BTIG is taking WWE's talking points a little too literally and not digging deep enough to test the validity. (It's the same trap that many Wall Street firms fell prey to during the last round of television negotiations.)

For instance, BTIG believes that there's a lot more potential WWE Network growth in international markets. While this may be true, I don't believe it's right to just assume that "China, Germany, Italy, Thailand, Malaysia" are on their way (they forgot to list Japan) nor is it correct to assume that "it's relatively early in some of the markets such as the UK". Doing so demonstrates ignorance of both the high number of fans who are likely accessing the WWE Network using US accounts (explaining the vast difference between the historical int'l PPV percentage and the OTT int'l percentage) and the complex relationship between the media conglomerates in many marketplaces (India, Italy, Germany) and WWE. Furthermore, explicitly laying out the plan to enter the Chinese market and how their product would comply with the regime's censorship. Meanwhile, in the UK, the flood of new subscribers that arrived in January added a much needed subscriber boost. The reality was that hardcore fans were already early adopters and that it's clear that the second-wave of fans that joined during the official launch (nearly a year after the service originally debuted) represented the lion's share of willing subscribers left in the UK.

BTIG mentions they would, "like to see the company exit the movie business." While complaints about the WWE Studios model have abounded for years, it seems highly unlikely that WWE is going to be pulling the plug on the venture any time soon. First of all, the business has settled into a relative malaise. Without the massive financial drains, it remains an unimpressive, but relatively benign segment on the WWE's books. Second of all, WWE just completed $35 million credit facility with BOA/ML for the WWE Studios. Lastly, when you look at activities such as the 2015 Business Partner Summit, it's very clear that WWE values their ability to partner with Lion's Gate, Warner Bros. and Fox. Indeed, to truly understand WWE in 2015, one must realize that the company sees themselves as an "integrated media organization and recognized leader in global entertainment". While the world still sees WWE as a "pro-wrestling empire", initiatives such as the studios segment allows the company to operate in a completely different space.

I agree with BTIG that tiered pricing for the WWE Network would offer greater opportunity. I was critical of the decision to launch the WWE Network at $9.99 (a price which is higher in Canada, UK and Ireland) when it represented such a radical devaluation from the profitable $45+ PPV monthly business. In fact, should WWE move ahead with audacious plans to fill AT&T Stadium in 2016 for WrestleMania 32 with a Brock Lesnar vs Steve Austin main event, the company shouldn't even entertain offering the show as part of the WWE Network package. Indeed, the lessons of Mayweather/Pacquiao demonstrate that with the right program, the "dinosaur" pay-per-view business can be very lucrative.

The challenge with the WWE Network is understanding what content has been truly driving consumers to sign up for the service. While many fans, myself included, would love to see more than fraction of WWE's vast library digitized, organized and accessible, it's also clear that top tier of programming which WWE Network subscribers are watching is new content (live pay-per-views, Network specials and original programming). It's worth noting just how enormous the costs have been for producing original content for the WWE Network. In the first quarter of 2015, WWE amortized $6.8M alone and that's before the new batch of programming has come online. (The decision to carry the new season of Tough Enough on USA Network is a godsend considering that the company had to delay taping the show last year as a cost-cutting initiative when it was scheduled to be a WWE Network program.)

Core interest in the current WWE product remains the number one driver for subscriptions to the WWE Network. That's one reason why healthy relationships with television partners (in particular NBCU) are so critical. While BTIG insists that " In 2014, Raw ratings were up 2% and SmackDown ratings were up 3%." the reality is that Raw ratings have been falling throughout 2015. (For more analysis, see Brandon Howard's "An Investigation into WWE's Slumping Ratings"). WWE's trending schedule reveals that Q1 ratings for Raw and SmackDown both declined in 2015 (-5% and -7% respectively). That's in the most important quarter of the year for WWE interest. While WWE can rely on their guarantee television rights with built-in escalators, it does not bode strongly for future negotiations. Advertisers still remain wary of the WWE's brand despite the large weekly, live sports audience though it's clear the company has made some in-roads through their PG initiatives to appeal to more blue-chip sponsors. Moving SmackDown to USA Network in 2016 will likely boost the ratings of that show, though it remains an open question whether it would be fiscally responsible to move SmackDown to a live show since that incurs higher cost with limited upside.

BTIG notes that "The cost structure also makes us wonder if WWE is ultimately better suited to be part of a larger media company." While this is certainly true, it's also very unlikely to change until after the death of CEO Vince McMahon. WWE has shown a stubborn reliance to "go it alone". With the exception of using the backbone provided by MLBAM (a company whose CEO Robert Bowman used to serve on the WWE Board of Directors), WWE Network remains a service who enormous costs are mostly carried by WWE themselves. There's an opportunity for more partnerships (akin to the Rogers Communications deal in Canada), but WWE is reluctant to give up their crown jewel. After all, how could they go to all of those Telecommunication and Global Media conferences unless they had the WWE Network trump card to tout?
Of course, it's easy for me to play the contrarian when it comes to looking at WWE prospects. I'll maintain that core metrics such as house show attendance and television ratings are going remain very good proxies for the general appetite of casual consumers to subscriber for a OTT service such as WWE Network. And right now? Those aren't moving significantly. Furthermore, I maintain that WWE Network is a niche product and should be priced as such - not as a competitor to general entertainment service such as Netflix or Hulu.

Lastly, WWE is involved in several lawsuits. BTIG wrote, "WWE is a defendant in two lawsuits alleging performers have received traumatic brain injuries and could be liable for significant damages." They're actually defendants in at least three: Haynes III v. World Wrestling Entertainment, Inc., Singleton et al v. World Wrestling Entertainment, Inc and McCullough et al v. World Wrestling Entertainment Inc along with Cassandra Frazier v. World Wrestling Entertainment, Inc. Furthermore, there is the class action complaint for violations of federal securities law (Ganues et al v. World Wrestling Entertainment, Inc et al ) around the disappointing television rights renewal fees and the numerous IP suits involving patent infringement (mostly around digital initiatives, including the website and WWE Network). There also remains the risk that the entire system of independent contractors of WWE Superstars could be blown up, though recent challenges have not been very fruitful.

As always, I'll continue to review the analysis and carefully consider their points. As of this morning, WWE Stock shot up 5% though it's settled down to about 3% up as of this writing.

Chris Harrington
twitter: @mookieghana

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