Endeavor Group (EDR) acquired small competitors at more than 2.4x sales and expected to sell shares at 1.95x. We see a buying opportunity at that mark. The company’s financial risk explains the low valuation. With that, in our view, once the company reduces its debt, its EV/Sales should increase significantly. This name is not risk-free. Notice that it is a controlled entity, and the Board of Directors may not be independent.
Founded in 1898 as The William Morris, Endeavor Group was once the largest-running talent agency in the world having clients like Charlie Chaplin, Marilyn Monroe, or Elvis Presley. Check below some of the company’s stars:
Source: Endeavorco’s Website
Endeavor adapted well to the new entertainment industry by acquiring IMG in 2014, which owned a leading business model in sports. IMG was the creator of the World Match Play, had agreements with well-known golf players and organized part of the New York Fashion Week. See some of the milestones of IMG in the image below:
Most growth investors will also appreciate that the company received financing from Sequoia Capital, Tencent, and affiliates of Fountainvest Partners in 2016. With capital from well-known investors, Endeavor also bought UFC, the martial arts organization, and Frieze, an arts media company. The image below shows the last steps of Endeavor:
Source: Endeavorco’s Website
According to PwC, the global entertainment and media market was equal to $2.1 trillion in 2018. Analysts of the same firm believe that it will grow at a CAGR of 4% from 2018 to 2023.
With that, the celebrity and sports agency market in the US appears to be a bit smaller. In 2019, total revenue was equal to $11 billion, and annual growth is expected to be 4%. The image below offers further information on the matter:
Good Revenue Growth, But Without Positive FCF
Endeavor Group reports impressive revenue growth. In 2017 and 2018, sales growth was equal to 27% and 19% respectively. The company’s total operating expenses increased at a more significant pace than revenue, which made operating income decline from $2.8 million in 2016 to $107 million in 2018. The losses are not significant. We don’t expect growth investors to care a lot about the operating losses. They will care about the company’s revenue growth. See the top of the income statement in the image below:
In the six months ended June 30, 2019, revenue growth was equal to 36%, which is again quite impressive. Notice that the company reported $548 million more in the six months ended June 30, 2019 than that in the same period in 2018. We are not talking about a company that makes a small amount of revenue. That’s why sales growth of 36% is really remarkable. The image below offers further information on the matter:
In 2018, the company’s cash flow from operations increased as compared to that of 2016. The CFO was equal to -$37 million, $216 million, and $121 million in 2016, 2017, and 2018 respectively. With that, the company is making significant capital expenditures, which made the FCF negative (-$66 million) in 2018.
See the top of the cash flow statement in the image below. Notice that the equity-based compensation expenses were significant in the last three years. In 2018 and 2017, they were equal to $149 million and $153 million respectively. Investors will most likely not appreciate that Endeavor is making extensive use of its stock.
Assets And Companies Acquired By Endeavor
Endeavor Group organized its IPO with a significant amount of cash, which investors will appreciate. They are usually more willing to give money to a company that has already cash.
In June 2019, intangible assets and goodwill comprised of 55% of the total amount of assets. With this in mind, we believe that investors will appreciate getting to know about the companies acquired by Endeavor.
As shown in the lines below, in 2018, Endeavor Group bought NeuLion for $248.9 million and One Sixty Over Ninety for $249.3 million. It is very positive that the company acquired these companies using cash and not stock. As mentioned above, market participants don’t appreciate companies that issue stock. Stock dilution risk is one of the largest fears of growth investors.
As shown in the lines below, NeuLion was acquired at 2.4x sales. This information will be relevant for assessing the valuation of the Endeavor Group.
Source: Devoncrof’s Website
The goodwill registered in the transactions comprised of approximately 65% and 62% of the total amount of net assets acquired. It is not that significant. With this in mind, we believe that the company does not expect massive revenue growth from NeuLion and One Sixty Over Ninety. The image below offers further information on the matter:
In 2016, Endeavor Group acquired two companies and registered a significant amount of goodwill. In the acquisition of Zuffa, goodwill represented 224% of the total amount paid. Savvy individuals would be wondering whether Endeavor expected more revenue growth in 2016 than that in 2018. Information obtained from Reuters and Sports Pro Media reveals that the company was sold close to EV/Sales ratio of 5.7x. The lines below offer further information on the matter:
Source: Sports Pro Media
Liabilities And Contractual Obligations
Endeavor Group reports debt worth $4.49 billion, which investors will not appreciate. It is by far the most significant liability. Long-term debt comprises of 62% of the total amount of liabilities. Market participants will appreciate further research on the company’s debt and contractual obligations. The image below offers additional details about the liabilities of Endeavor:
The company’s contractual obligations are a bit worrying. As of December 31, 2018, the contractual obligations are equal to $11.29 billion with purchase obligations worth $4.13 billion. In 2019, the company has to pay $1.174 billion, and in 2020 and 2021, the obligations are worth $2.83 billion. Given the company’s FCF and the current amount of cash, it is obvious that the company needs financing to continue its operations. The image below provides the company’s contractual obligations:
The company expects to use $568 million from the IPO to acquire equity from Endeavor Manager, one of the existing shareholders. Besides, Endeavor expects to pay ~$546.8 million to settle a loan that matures in 2025. Investors may not appreciate the use of proceeds. However, the company needs to pay the debt. We don’t see any right solution. The lines below offer further information on the matter:
The company competes with a long list of companies, but many of them are not public. It is not ideal since they will not serve to assess the valuation of Endeavor Group. The image below offers further information on the company’s peers:
Creative Artists Agency
United Talent Agency
With 129 million Class A shares, 127 million Class X shares and 176 million class Y shares, in our view, the total share count equals 129 million. Note that shares of the company’s class Y common stock and class X common stock do not have economic rights.
Assuming an IPO price of $31, the market capitalization will equal ~$4 billion. As shown in the table below, after the IPO, cash in hand will equal $739 million, and debt will approximate to $4.56 billion. With these figures, we get an enterprise value of ~$7.8 billion.
With $2.048 billion in the first part of 2019 and 36% revenue growth, we believe that forward sales of $4 billion represent a conservative figure. Thus, the EV/Sales would be close to 1.95x, which is not at all a high ratio. Notice that Zuffa was said to be acquired for more than 5x, and NeuLion was acquired for 2.4x sales.
In our view, once the IPO goes live, investors will push the share price up. A valuation of 2.5x-3x is much more appropriate for a company that reports revenue growth of more than 36%. Underwriters had to sell the shares at a low price because the company’s financial risk is significant. However, once the company pays its debt, we believe that the EV/Sales ratio will increase from 1.95x.
Risk: This Is A Controlled Entity
Silver Lake Equity and directors of the company control more than 50% of the total amount of shares outstanding. As a result, the Board of Directors may be non-independent. It means that the protection of minority shareholders may not be that significant. Directors may make decisions to benefit the largest shareholder, which may be detrimental to the interests of minority stockholders. The lines below offer further information on the matter:
We have applied to list the shares of Class A common stock offered hereby on the Exchange. Because Messrs. Emanuel and Whitesell, Executive Holdcos and the Silver Lake Equity holders will control, as a group, more than 50% of our combined voting power upon the completion of this offering, we will be considered a “controlled company” for the purposes of the Exchange’s rules and corporate governance standards. As a “controlled company,” we will be permitted to, and we intend to, elect not to comply with certain corporate governance requirements of the Exchange, including those that would otherwise require our board of directors to have a majority of independent directors.
Endeavor Group should sell shares at more than 1.95x sales. The current share price represents a buying opportunity. Keep in mind that the company acquired businesses at 2.4x sales and even at more than 5x. In our opinion, these purchased businesses should help Endeavor Group reach enough revenue growth to justify a ratio of 2.5x-3x sales. Yes, the company has a financial risk. Underwriters had to sell shares at a low valuation. However, once part of the debt is paid, we believe that the valuation will go to more decent marks.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.