Madison Square Garden Entertainment Q1 Earnings: Stock Getting Crushed (NYSE:MSGE)

Madison Square Garden Entertainment Corp.’s (NYSE:MSGE) share price has taken another big hit after its latest earnings report as higher costs at MSG Networks and Tao Group Hospitality, along with upwardly revised costs at MSG Sphere had a negative impact on earnings.

Since it reached a high of approximately $121 per share on March 8, 2021, the company’s share price has failed to find support. It did go through a period of consolidation where it traded in a range of $62.00 per share to $82.00 per share from mid-August 2021 to early May 2022, before resuming its downward trajectory.

At the time of its earnings report, it was trading at about $45.00 per share, plunged to its 52-week low of $38.89 immediately after the report.

In this article, we’ll look at some of the numbers triggering the sell-off, as well as what to expect from live entertainment and the Sphere going forward.

Latest earnings

For the first fiscal quarter, MSGE generated $401.2 million in revenue, up $106.7 million, or 36 percent year-over-year, beating by $19.43 million.

The company had an operating loss of $44.8 million in the reporting period, a gain of $38.5 million over the first fiscal quarter of 2021, or 46 percent. Weak comps were a major reason for that.

Adjusted operating income in the quarter was $2.8 million, down $7.5 million, or 73 percent year-over-year.

At the end of the quarter, MSGE had about $441 million in cash on hand and held a debt of around $1.76 billion.

MSG Networks adjusted operating income dropped 41 percent to $32.9 million, based on decreasing revenues and an increase in direct operating expenses.

Tao Group Hospitality’s adjusted operating income fell 44 percent to $14.6 million to an increase in SG&A and direct operating expenses. As for MSG Sphere, construction costs through September 30 were close to $1.78 billion, but the company upwardly revised its overall cost estimate for the project from $2 billion to $2.175 billion. With construction materials experiencing a strong inflationary environment, that number is likely to continue to be upwardly revised until the project is completed.

This will without a doubt weigh on the performance of the company. Another headwind that could arise is if the deadline for completion is extended further out – possibly into 2024. The company has stated they believe it’ll open in the latter part of 2023, but investors shouldn’t take that as a guarantee.

Entertainment

One of the areas I wanted to focus on in this article was live entertainment. The reason is because, in the near term, I think that is going to be the segment of the company that will perform the strongest.

Fiscal 2023 first quarter revenue bears that out, as the segment generated revenue of $147.1 million in the quarter, up $112.9 million year-over-year. Again, a lot of that was weak comps, but it was still a decent performance.

While MSG Sports licensing agreements were up $18.3 million, along with licensing fees ($8.4 million) and signage revenues ($3.7 million), I want to focus on revenue associated with events, which was up $80.6 million; I believe that’s going to improve ongoing pent-up demand for experiences that live events provide.

This is confirmed by the latest performance of Live Nation Entertainment (LYV), which delivered huge numbers as people came out in droves to various venues after being locked down for so long.

While MSGE doesn’t have the geographical diversity that Live Nation has, I still believe the same demand will remain in place for live events offered by MSGE; I don’t think the market is close to being assuaged yet for those types of experiences.

Besides the proof companies like Live Nation provide, another reason to think this is how it’s going to work out is how people responded to receiving stimulus checks in America. After receiving the money, people started spending it on products. The reason why was the service industry was shut down, so there was nowhere the money could go but there.

But now that services are open again, the money has rotated from products to services, and live events are part of that category in my opinion, which means MSGE, in this area of its business, should do very well over the next couple of quarters. While economic headwinds could eventually dampen results, I think that’s not likely to happen in the near term because even in difficult economic times so far in 2022, people have continued to prioritize spending on live event entertainment.

Assuming that’s how it plays out, which I believe it will, this should be the major catalyst driving the performance of the company over the next couple of quarters. On the other hand, if there is an underperformance in entertainment, the company will take another huge hit.

MSG Sphere

As mentioned above, costs related to inflation on building materials have caused MSGE to upwardly revise construction costs associated with building the Sphere. Management said the remaining costs will be funded from available cash and cash flow from operations. That includes plans “to reduce or defer certain discretionary capital projects.”

Management is “confident” it will have enough liquidity from cash and cash flow to complete the construction of the Sphere, citing the company being in the middle of the “seasonally strongest point of the fiscal year.” If the company needed to, it could also draw on its credit revolvers.

Another strategy the company is using is to “reduce or defer certain discretionary capital projects as well.” If materials inflation continues in a significant way, it’s going to put pressure on MSGE in regard to rising costs, but another key element to consider is there continue to be supply chain issues that have the potential to delay the project. When combined with materials inflation, that could add a lot more cost to the project.

Another cost headwind has been the company having to refine up to a third of its design plans or adjust certain parts of the construction because of the complexity of the project.

This is why the company raised its estimated costs by another $175 million, from $2 billion to $2.175 billion.

My point in bringing this up is the company has decided to go all-in on this project, being the obvious priority going forward. That said, it’s also tapping into much of the company’s liquidity and transferring it to this project to increase its chance at success. In other words, essentially everything is on the line with the Sphere in regard to the future performance of the company.

I’m not going to get into the bells and whistles that will be part of the Sphere because the company has gone into more detail in past earnings reports. I want to focus more on the implications of the project’s success or failure.

With the spend and expectations associated with the Sphere, it can’t just do okay, it has to minimally meet expectations, and probably exceed them if it’s going to be a success.

Its location is ideal for what it’s being built to do. Another positive is now that we’re in the midst of a recession, even if it does go deeper for longer, the Sphere is scheduled for opening by the latter part of 2023, meaning the bulk of the recession should be over by that time, making it a nice catalyst for the company. As the opening gets closer, management said it will reveal more elements on revenue streams like sponsorship, etc., that will be included in the Sphere, providing more color on what to expect from the project. In one sense, you could say it’ll be like Madison Square Garden on steroids; at least that’s the hope the company has.

In the near term, the company will need to perform well, especially in entertainment, in order to continue to draw from cash flow to pay for construction. Unless the recession deepens quicker and inflation starts to impact consumer decisions on spending for experiences, the company should be able to move forward with the project on the cost side of the equation.

Conclusion

MSGE has come off a disappointing quarter based upon rising costs, and it appears that’s going to be an ongoing issue as it also struggles with materials cost inflation at the Sphere.

The key thing to watch over the next couple of quarters will be the performance of its entertainment business, because that will determine the steps it must take to pay for the construction of the Sphere in the months ahead.

If cash flow underperforms, it’ll have to think in terms of accessing its revolver to pay to keep the project going. That would, in my opinion, be considered a negative catalyst.

MSGE is going to remain under pressure until the final costs of the Sphere are revealed and there is a successful opening. If that occurs, then there will still be a waiting period to see how the Sphere performs.

For now, the company must do very well with its entertainment segment in order to continue underwriting the costs of the project, while keeping the lights on in the rest of the business.

This will of course be a drain on resources as the company prioritizes the completion and opening of the Sphere. For that reason, the next two to three quarters are likely to be challenging for the company.