Sphere Notes

May 13, 2023 Update

Some notes on Sphere (SPHR) from a recent annual letter:

After the quarter’s end, MSGE completed the spin of the MSG arena, a catalyst I had been eagerly
anticipating since it was announced in August 2022. The company separated into a SpinCo consisting of
the MSG Arena and the Rockettes franchise, which assumed the ticker MSGE, and a RemainCo consisting
of the Sphere development and MSG Networks, now renamed SPHR. To avoid confusion, I will refer to
the company prior to the spin as “Original MSGE” and the SpinCo as “MSGE” going forward. As I
anticipated, MSGE’s form-10 included guidance and historical financials which were far above bear
concerns and matched my projected earnings. $40 vodka sodas are indeed profitable. MSGE is now
trading ~$32, yielding an EV of ~$2.3B which implies ~15x 2023 EBIT of $150MM, and ~21x fully taxed
levered FCF/sh. of $1.50. While at first glance the stock appears reasonable yet not exceptionally cheap,
MSGE will pay minimal cash taxes until FY2027, allowing rapid deleveraging and share buybacks, which
along with modest MSD EBIT growth should result in $2.50 in fully taxed FCF/sh. by 2026. Further, MSGE
retains the air rights above the MSG Arena, which I value at $300-$500MM and I believe will be
monetized in the next five years. Given the “hidden assets” and predictability of MSGE’s iconic holdings,
I believe shares could double in the next five years, a strong return given the low-risk nature of these
assets.

However, while the fund maintains a significant investment in the economics of MSGE, I believe SPHR is
the more attractively priced piece. In the spin, SPHR retained a 1/3rd stake in MSGE, resulting in SPHR
owning ~0.5 shares of MSGE for every one share of SPHR. At market prices of $32 for MSGE and $30 for
SPHR, the market is ascribing ~$14/sh. for the remainder of SPHR, or $490MM given 35MM shares
outstanding. For this $490MM investment, we get 1) the Sphere development, 2) the MSG Networks
equity, and 3) an estimated $200MM in cash, net of the recently announced sale of Tao and further
capex and start up costs for the Sphere. Given the $2.2B construction cost for the Sphere, not to
mention opex already spent developing content and the ~$500MM of prime Las Vegas Strip land LVS
contributed to the project, the market is effectively valuing the Sphere at cents on the dollar before it
even opens. I find this even more interesting given the recent string of positive news regarding the
project. Last week, tickets for the Sphere’s opening show with U2 sold out in a matter of days. SPHR and
the band are now set to open the venue in late September with a run of 17 shows for a total of ~340,000
tickets. Further, I believe the shows have an average ticket price close to, if not greater than, $500.
There is an exceptionally wide gulf then between the market, which seems to discount the very viability
of Sphere as anything beyond a spectacular bust, and Sphere customers, who seem excited to pack the
value at prices well ahead of national averages. To size the opportunity, if the Sphere’s Vegas residency
business is consistently booked, say three packed shows a week for 40 weeks a year, combined with just
modest execution on advertising and owned attractions, I believe the Sphere can generate over $1B in
sales and over $200MM in operating profits, which at 15x valuation would yield ~$100/sh. for SPHR
including its MSGE stake. I believe there is room for reasonable upside to both profits and multiple if this
occurs.

However, I want to acknowledge that there are modestly higher risks to SPHR than MSGE: the project
has yet to be opened and the business model is not proven, the MSG Networks term loan must be
renegotiated by fall 2024, there could be cost overruns getting the Sphere ready to open, etc. The
elevated execution risk gives me pause and impacts our sizing, but I believe we are being very well
compensated for taking these risks. Further, I believe we have strong downside protection from our
“cents on the dollar” purchase price for the Sphere and SPHR’s remaining investment in the less risky MSG Arena and Rockettes businesses. I have substantially rotated our position from MSGE to SPHR,
though we retain a large investment in MSGE on a look through basis.