RACE - Formula One Group: The Limits Of Growth

2023-05-31 22:49:42 ET

Summary

• Formula One Group continues to generate significant revenue growth.
• However, it is likely to slow down in the not-so-distant future.
• The current valuation of Formula One Group leaves limited upside, if any, for the stock at its current price.

Since acquiring the Formula One world championship from CVC Capital Partners, Formula One Group ( FWONA ; FWONK ; OTCQB:FWONB ) has almost quadrupled in value. An aggressive expansion of the race calendar and a plethora of new fans reached through new means of communication such as Netflix’s ( NFLX ) hugely popular Drive to Survive show have led to significantly higher revenue. But how long can those growth rates be maintained? In this article I discuss why I believe that there is little room for further upside for the stock of Formula One Group from the current valuation.

A few things to keep in mind upfront: Formula One Group is strictly speaking no legal entity of its own, but a segment of Liberty Media Inc. Another particular feature of the stock is that it should always be analyzed on an annual or YoY basis, due to the seasonal nature of its operations.

Limits of Growth

Right now, revenue growth looks not too bad. Q1 (notably the quarter that has the lowest number of race events, as the season begins in late March) revenue increased 5.1 percent YoY. 2022 full year revenue grew 20.5 percent compared to 2021 figures (which, however, are not entirely comparable due to government imposed Covid-restrictions at several events). But there is the question of sustainability. Growth will slow down eventually in the not-so-distant future.

Formula One relies on three primary sources of revenue: media rights, race promotion fees (= payments made by local promoters in order to secure the event) and sponsorships.

Media companies will increasingly have to keep tighter controls on content spending given high debt levels and slowing streaming growth. Notably, the German free-TV (in Germany, subscription television, while certainly existing, is less common for households than in the US) rights did not find a buyer for the upcoming rights period.

Additionally, there is an inherent conflict between exclusive media rights and sponsorships. Sponsors pay for the exposure, read: eyeballs. Naturally, selling the media rights to an exclusive broadcaster/streamer with a subscription model decreases the number of eyeballs, as not everyone, especially not casual viewers, will be willing to pay for the ability to watch Formula One racing. That, in turn, makes the sport less attractive to sponsors.

Another important balance to keep is that between mass appeal and exclusivity. While premium experiences such as the Paddock Club are a way to earn good profits, the series must at the same time avoid becoming too much of an elitist sport. To their credit, Liberty Media seems to handle this exceptionally well at the moment.

A much greater limiting factor is that the number of races per season cannot grow much farther. Currently, there are 24 races on the calendar (two of which, the Grand Prixs of China and the Emilia Romagna, have already been cancelled due to Covid restrictions and heavy floods respectively). Already, there is no room for rescheduling any events. Given the immense logistical challenges as well as the strain that the constant travel puts on personnel, I believe that 25 races are the absolute maximum. Not being able to further increase the number of events hurts growth prospects threefold: first, depending on the location a race can rake in around 50 million in promoter fees (Middle Eastern monarchies tend to be the highest payers, Monaco is believed to pay the lowest fee). Second, a higher number of races equals more broadcast/streaming content, thus higher media rights revenue. Lastly, any additional race means more eyeballs, making sponsoring more attractive.

Teams May Demand More Money

Even with growing revenue, an important obstacle for higher profits may present itself in the form of teams demanding a bigger piece of the cake. The so-called Concorde Agreement is up for renewal (and renegotiation) in 2025.

There are no more old-school privateer outfits. Instead, teams owners include:

• private equity (Williams, Sauber)
• car manufacturers such as Ferrari ( RACE ), Mercedes-Benz Group AG ( OTCPK:MBGAF ; OTCPK:MBGYY )- who own a minority share alongside team principal Toto Wolff and Ineos, Renault SA’s ( OTCPK:RNSDF ; OTCPK:RNLSY ) Alpine brand and McLaren; Volkswagen AG’s ( OTCPK:VLKAF ; OTCPK:VWAGY ; VWKPF ) Audi will complete their takeover of the Sauber team by 2026
• serious businessmen like Gene Haas (Haas F1), Lawrence Stroll (Aston Martin F1, also a significant shareholder of car manufacturer Aston Martin Lagonda Global Holdings plc ( OTCPK:AMGDF )
• Austrian beverage distributor Red Bull, which owns both the Red Bull Racing and Alpha Tauri teams.

Private equity is inherently for profit. And the higher the profits, the better. Messrs. Haas and Stroll, while clearly in it for emotional reasons, will be interested in earning money with their hobby as well. Car companies certainly like profits, too (at least as a shareholder in two of those companies I would certainly hope so- especially for Ferrari, this may even move the needle some percent, as I have previously explained ). The same is probably true for Red Bull, especially after the death of founder and CEO Dietrich Mateschitz, who was known to have an emotional attachment to the sport beyond pure business considerations. According to rumors, a sale of the Alpha Tauri team may even be explored due to lack of profitability.

Without the teams, there is no racing. At the same time, nowadays, all teams and their respective owners could probably even afford a “strike” if necessary. At the end of the day, Formula One needs the teams more than the teams need Liberty Media. The 2009 threat of the Formula One Team Association of setting up a rogue series should serve as a cautionary tale (then CEO of Formula One, Bernie Ecclestone, resolved the crisis by essentially paying off Red Bull and Ferrari – and handsomely at that - to break the ranks). This gives them considerable leverage. Naturally, the more money is paid to the teams, the less profit growth remains for shareholders of the promoter.

Finding the Right Valuation

Direct comparisons for Formula One Group are hard to find, especially listed ones. The likes of LiveNation Entertainment, Inc. (LYV), CTS Eventim AG & Co. KGaA ( OTCPK:CEVMF ; OTCPK:CEVMY ), operate in a vastly different field of entertainment (although they will not seldom be counted among Formula One Group’s peer group). Of all relevant publicly listed companies, World Wrestling Entertainment, Inc. ( WWE ) is the one most comparable to Formula One Group (despite their vastly different core product).

I believe that CVC’s deal with Spain’s LaLiga football (the one actually played with the feet, known as “soccer” to Americans) league a good comparison may be an even better yardstick. CVC paid the then equivalent of about $2.15 billion for 8.2 percent of broadcasting and sponsorships, thus valuing the business at about $26 billion.

LaLiga’s sold its domestic broadcast and streaming rights for a total of about $5.6 billion over three years (= $1.86 billion a year). Additionally, it generates close to €900 million (currently around $965 million) a year in international media rights. So all in all, annual media rights revenue amounts to about $2.8 billion. Add to that about $170 million in sponsoring income.

So, all in all, annual league revenue is close to $3 billion (excluding club revenues).

That in turn translates to a valuation of about 8.66 times core revenue.

If one were to apply the same valuation to Formula One, one arrives at $22.28 billion. That is roughly in the same ballpark as the $20 billion that Saudi PIF was allegedly willing to pay for the series in late 2022 (with Liberty Media reportedly rejecting the offer).

However, football/soccer is still by far the most popular sport in the world. Formula One (as well as the whole of motor sports for that matter) cannot compete in terms of viewership and fan engagement. Also, the CVC deal guarantees access to league cash flows, whereas Formula One Group pays no dividends to its shareholders. Neither should one forget that Formula One Group comes with debt attached (including that of other Liberty Media segments, if they were ever to be unable to service it). The good news first: the debt level of Formula One Group seems absolutely manageable (provided Liberty Media as a whole remains in financially healthy shape). Net debt attributable to Formula One Group is around 2.5 times attributable income. However, this may change somewhat due to the upcoming reclassification of Liberty Media tracking stock classes. Liberty Media reported gross debt of $16.4 billion as of March 31 ^st , $2.95 billion of which were directly attributable to Formula One Group (against $1.58 billion’s worth of cash and equivalents attributable to the segment; $2.23 billion total cash and equivalents).

All those factors strongly suggest that Formula One Group should be valued at a materially lower revenue multiple. 15 Percent would be a rather bullish assumption, but one that may be justifiable given the uniqueness of Formula One. Also, I believe that there should be a substantial discount of at least 10 to 15 percent given due to the complicated structure and the risks associated with tracking stocks compared to separate corporate entities.

When applying an overall discount of about 25 percent to the LaLiga valuation, one arrives at about $16.7 billion - which is not far off Formula One Group’s market capitalization. And, as I said, this reflects rather bullish assumptions.

Trophy Asset Premium Not Warranted

Sports teams are generally considered trophy assets, which justifies a valuation premium. But here we are not talking about a team, but the promoter of a racing series. Formula One Group owns the commercial rights (until December 31 ^st 2110) to the championship, which is licensed and sanctioned by FIA. The individual races on the other hand are organized by local promoters.

The individual teams may be trophy assets. But I do not think that the promoter deserves a trophy asset premium. Notably, when given the chance to buy into the series, only one of the teams and their respective owners, Ferrari, did so. This underlines that the real value is in the teams, not the league.

Conclusion

All in all, I think there is limited if any upside for Formula One Group at the current share price. The reclassification of the tracking stock will not change that. If a full spin-off into a separate corporate entity were to happen, there might be some room for a higher valuation, if the financials continue to improve as fast as they have since the Liberty Media takeover.

For the time being, I rate the stock a hold at best.

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