World Wrestling Entertainment Is A Short With 35% Downside

World Wrestling Entertainment, Inc (WWE) has been a big winner this year with the stock up 200% year to date on strong earnings and news of a new distribution agreement with USA Networks and Fox Sports for its professional wrestling media. The company’s own direct-to-consumer, video on demand subscription service ‘WWE Network’ has been a success posting continued growth in number of paid users driving revenue. Separately; the company is making inroads internationally hosting more events outside North America.

Still; I believe the stock is overvalued here at $91 per share and ready for a meaningful pullback. Taking a deep dive into the financials, it appears the bulk of the growth story has already played out and the company will be challenged to incrementally lift revenues beyond market expectations. The recent content distribution deal was a big win for the 66-year-old company, but mask other emerging areas of weakness. The company will increasingly rely on a more uncertain and risky international market for growth. My price target for the stock is $60 representing 35% downside

This article will explore the following five points that make up my short thesis.

  • Mature and saturated North American market
  • Weak live attendance and declining cable tv viewership
  • Unproven international growth opportunities
  • Lack of near-term catalysts
  • Stretched valuation

Background

Figure 1. WWE weekly price stock chart: Source – Finviz.com

The WWE stock chart is a beauty. Congratulations to investors that have been in for the past year where the stock returned 290%. The performance reflects the markets’ recognition of the company’s success in transforming its business model towards a direct-to-consumer based WWE Network website and mobile platform. Annual revenues increased to $801 million in 2017 from $508 million in 2013, the company earned $32.6 million last year or $0.44 per share.

Figure 2: WWE revenue breakdown and 2017 performance figures: Source – World Wrestling Entertainment Inc. Investor Relations Presentation

The company’s revenues are broken down between the media division (67% of revenues), which includes WWE Network, Television licenses, pay-per-view events, and home entertainment like DVDs/ Blue ray. Then there are live events (19% of revenues) which are the pro wrestling performances held at venues in the across North America and the internationally that make up the core product filmed and distributed around the world across platfomrs. In 2017 the company produced 314 events in North America and 70 events internationally. Next; consumer products represent (14% of revenues) which are merchandise like apparel, toys, and video games many produced through licensing agreements.

Figure 3: WWE New US Distribution Agreement highlights: Source – World Wrestling Entertainment Inc. Investor Relations Presentation

The major development this year was in June when the company announced a “landmark agreement with USA Network and Fox Sports for the distribution of WWE’s flagship programs in the U.S. effective October 1, 2019”. The new content deals are back loaded adding about $60 million in revenue in 2019m growing to an additional $200 million in new revenue per year by the year 2021. The corresponding expectation of higher income has pushed the stock up about 50% since June.

The Bear Case for WWE

My bearish case for the stock comes down to a simple question; what’s next? Considering company guidance for the revenue bump coming from the distribution deals, where else will growth come from? My argument is that the core North American market is likely ‘tapped out’, and subscriber growth for the WWE Network is set to slow. If you’re a pro-wrestling fan, you’re likely to already be a subscriber or at least heard about the WWE Network. There is no market white space left for the company in the U.S. in my opinion.

The cash cow for the next three years will be the new television distribution deals and its likely already priced into the stock. What I’m seeing is slowing engagement, soft TV ratings, coupled with weak live attendance.

Slowing Social Media Engagement

Figure 4: WWE Social Media Engagement: Source – World Wrestling Entertainment Inc. Q2 2018 performance indicators. Figure 5: quarter-over-quarter social media followers growth analysis: source – Dan Victor

The company reports quarterly performance indicators showing the evolution of social media followers. For Q2 2018, the company reported 923 million followers between Facebook, Twitter and other platforms. While the number of total followers is up 15.3% year over year, the pace of gains is slowing evident by the chart above with total followers growing at the slowest pace in the two-year period at 2.9% against Q1, down from a near double digit growth on total social media in 2016. This dynamic suggests slowing engagement and more difficulty in subscriber conversion for the paid WWE Network.

In June, Twitter made headlines announcing a purge of users across accounts that were found to either be bots or inactive and I predict this will have an affect on WWE social media reach when the company announces Q3 figures.

Soft TV Ratings

Figure 6: WWE TV Ratings: Source – World Wrestling Entertainment Inc. Q2 2018 performance indicators.

TV ratings for the company’s flagship programs ‘Raw’ and ‘Smackdown’ were flat Q2 2018 compared to last year. Pro wrestling has been a staple of cable TV in the United States for decades and the current numbers just don’t show strong viewership growth. Favorably, the company highlights its media performance as better than the broader trend of declining average viewership in top 25 cable networks (down 4% year over year) . Ratings for ‘Raw’ tracked at 1.77 in 2Q18 compared to an average of 0.66 of the 25 top cable channels.

Declining tv viewership is a larger trend facing media companies and could be a headwind for WWE growth, but helps explain the lucrative distribution deal with Fox Sports which paid a premium to secure a program bringing in a relatively stable audience. Still, in the future we could look back at the distribution deal as a mistake for Fox Sports and USA Networks if the audience for ‘Raw’ and ‘Smackdown’ doesn’t migrate or declines more noticeably.

Weak Live Attendance

Figure 7: WWE Live Attendance Figures: Source – World Wrestling Entertainment Inc. Q2 2018 performance indicators.

Live event average attendance has tracked lower in each of the last two years. The average show in Q2 had a live attendance public of 5,900 people compared to 6,600 in 2016. The company holds a couple of major events per year including its flagship ‘Wrestlemania’ which drew a 78,133 at the Mercedes-Benz Superdome in Atlanta in April but the majority of shows are at smaller venues. The company has balanced this trend with slightly higher ticket prices; but again, as with ratings and social media engagement the numbers just down show strong ‘organic’ growth. In 2017 WWE produced 384 events globally up from 344 in 2016 (an increase of 12%) while total revenues for the segment increased less at 5% to $151.7 million. For the six months ended June 30th, the live events revenue was reported at $83 million compared to $85 million in 2017 (down 2.5% y/y).

What’s the Bullish Case?

The bullish case for WWE assumes that getting onto USA Networks and Fox Sports in October 2019 will lead to a sudden renaissance for pro-wrestling in America turning everybody and their second-cousin into a new fan presumably leading to a surge of subscribers for the WWE Network and live event attendance. That’s a stretch and I’m not buying it. Excluding the new tv deals, ‘organic growth’ for the company is set to be lower in the medium term which represents the mispricing opportunity making shares of WWE overvalued.

Figure 8: WWE International Growth Strategy: Source – World Wrestling Entertainment Inc. Investor Relation Presentation

The company is looking at the international market for growth for which I’m skeptical. Management includes the statement in the most current investor presentation stating, “Growth will be driven by closing the 75%-25% gap between engagement and revenue”. To me this sounds similar to the current challenge of some social media companies like Snap, Inc. (SNAP) and Twitter (TWTR) attempting to convert users into revenue. WWE is looking to translate ‘likes’ from its videos on ad supported media on platforms like Youtube and Snapchat into more paid WWE Network subscribers.

The company is investing in localized talent which means training local pro-wrestlers and producing unique content for international markets. My view is that any potential distribution deal in an emerging market is likely to be incrementally small in terms of bottom line impact compared the major agreements in North America. It seems every company these days lists China potential market, but for WWE there’s no guarantee it can enter and become a significant player.

Valuation Matters

Shares of WWE look stretched here with a market cap of 7.1 billion, trailing P/E of 115x, and forward P/E 67x. The company earned $0.42 per share in 2017, which is forecast to grow to 0.82 per share for the fiscal year 2018 and 1.34 for 2019. By my estimates, going out through 2021, nearly 90% of the earnings boost is coming from the TV deals. My model considers EPS $1.54 in 2020, and $1.62 in 2021 roughly tracking the revenue guidance bump in those years and slowing to the low single digits beyond that. This means the stock is currently trading at 55x 2021 earnings. There is little to suggest the growth will continue at the current rate. Other metrics including price-per-sales at 6x 2022 revenues are also expensive over my forecast horizon. The main risk for the stock is that WWE Network subscriber growth slows in the near term as I believe will play out as the company has already captured the low handing fruit over the past three years.

Figure 9: WWE Revenue Forecast. Source – Private analysis Dan Victor

My DCF model built with some generous assumptions finds a fair value for the stock at $60 per share implying 35% downside from the current price. The model sees free cash flow expanding from about $110 million in 2018 to $300 million by 2021 but nevertheless the stock is overvalued. At $60 per share, WWE would be trading at a more normalized 45x 2019 earnings and give the company room to prove me wrong on the future of its WWE Network. The market is overly optimistic on growth prospects extrapolating the company’s success of recent years into the distant future. Investors getting in at current levels need a global wave of pro wrestling enthusiasm and perfect management execution which I would not bet on.

Superficially, its easy to look at consensus 2019 EPS and assume there is a larger story at play here than the TV deal. I think a dynamic at play here is the possibility of investors that have an affinity for pro-wrestling becoming emotionally attached to exuberant growth prospects. We’ll see.

Conclusion

WWE is set to report Q3 earnings October 25. Weak performance figures including my expectation of a drop in social media engagement given the Twitter user purge, lack of near-term catalysts in a slow quarter for pro-wrestling events, and elevated valuations make the stock a candidate to short in the near term. WWE has been holding up among the broader stock plunge this month but could be ready for a bodyslam – pun intended.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in WWE over 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.

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