TKO Group: Redefining The Arena (NYSE:TKO)

Company Overview

TKO Group Holdings (NYSE:TKO) operates in the sports and entertainment industry, involving two major sports: The Ultimate Fighting Championship (UFC) and World Wrestling Entertainment (WWE). These segments position TKO as a predominant leader in mixed martial arts and wrestling promotions, respectively. The genesis of TKO was marked by a strategic merger between UFC and WWE, announced on April 2, 2023, and began trading on September 18, 2023. This merger, facilitated by Endeavor Group Holdings (EDR) and WWE, resulted in a shareholder distribution of ownership, with EDR and WWE shareholders owning 51% and 49%, respectively.

Endeavor plays a pivotal role in driving TKO, holding influential Class B shares that grant one vote per share, thus exerting substantial control over the company’s operations and strategic direction. Key leadership positions within TKO include Vince McMahon, formerly the Chairman and CEO of WWE, who now serves as the Executive Chairman. Additionally, Ari Emanuel holds a dual role, serving as the CEO of both EDR and TKO.

UFC

UFC is one of the premier sports organizations globally, boasting an impressive fan base exceeding 700 million, characterized by a young and diverse demographic. As a testament to its immense popularity and reach, UFC has cultivated a substantial online presence with 228 million followers on various social media platforms. The organization’s content enjoys extensive broadcast coverage, reaching over 900 million TV households in more than 170 countries worldwide. UFC holds 42 fight nights per year, primarily monetized through media rights.

UFC generates revenue via domestic and international media, sponsorships, live events, and consumer products. In the fiscal year 2022, the UFC generated a total revenue of $1.1B, with the majority stemming from media, which accounted for a significant 71%. Sponsorships also played a notable role, contributing 13% to the overall revenue. Live events were another source, bringing in 11%, while consumer products, although essential, made up the smallest portion at 5%.

A pivotal agreement was forged with ESPN in May 2018, making them the exclusive domestic distributor of all UFC events. This relationship with ESPN gave them the rights to around 20 fight nights on ESPN+ and 10 fight nights on ESPN’s networks. ESPN+ is a platform for various types of content, such as pre-shows, post-shows, and archive for highlights. This agreement is structured in five-year terms and expires in 2025. Before this agreement, UFC’s content was distributed via cable and satellite networks.

WWE

WWE has established itself as a powerhouse in sports entertainment, commanding a global fan base of over 627 million. Its robust online presence is reflected in a remarkable 1.2 billion social media followers, incorporating talent pages. WWE’s YouTube channel is exceptionally popular, with over 96 million subscribers, ranking it among the most viewed channels globally. The brand’s programming is accessible in over 1 billion TV households, spanning across more than 180 countries. Additionally, WWE hosts over 350 major live events annually, attracting over a million attendees, underscoring its comprehensive global content distribution strategy.

Like the UFC, WWE monetizes its media and content properties through four principal activities: Media and Content, which constitutes a dominant 75% of their FY2022 revenue; Live Events, which accounts for 10%; Sponsorship, making up 5%; and Consumer Products Licensing, also contributing 10%. The total revenue for WWE in FY2022 was $1.3B.

In the media segment (75% of revenues), The WWE Network monetizes predominantly through licensing revenues generated from NBCUniversal and Fox Network. NBCUniversal carries RAW and NXT through its cable networks. In the U.S., the WWE Network is distributed exclusively via Peacock, and Fox Network has a license to WWE SmackDown. RAW, SmackDown, and NXT account for a significant portion of its media segment revenues and profitability.

In addition to media licensing revenues, the segment also collects advertising revenue streams primarily from digital marketing, site fees from live events, film production, and appearance fees.

The live events segment (10% of revenues) was the fastest growing segment, with 48% growth through Q2 2023 from the prior period. The principal revenue in this category emanates from ticket sales, with WWE having conducted 218 events in North America and 13 internationally in 2022.

The Consumer Products segment (10% of revenues) consists of royalty fees from licensed WWE products, online merchandise sales from strategic partnerships with Fanatics, and in-venue merchandise sales.

Merger Creates Synergies and New Opportunities

The UFC and WWE are a perfect match, showcased by their impressive alignment in key attributes highlighted in the table below. The two sports exhibit high engagement, demonstrate considerable global growth, and appeal to a young and diverse audience. Additionally, they hold control over all rights, avoiding the complexities associated with teams or team owners, and consistently deliver year-round content.

The merger of the two sports under TKO’s umbrella has put them in a position to benefit from a complementary set of strengths that cater to a modern audience’s demands and needs in the ever-evolving sports entertainment industry. TKO stands to benefit from $50-100m in long-term annualized run-rate net operating synergies.

Moreover, TKO’s structure facilitates significant revenue and cost benefits from the merger. The goal is to incorporate WWE into the Endeavor ‘flywheel’ distribution model, which creates multiple additional avenues for future growth by selling more profitable agreements for WWE internationally.

From a promotional standpoint, TKO can combine content by scheduling UFC and WWE events on the same weekend, which could lead to cross-promotion between the fan bases. Management also foresees potential savings through optimized production methods and a more extensive use of Endeavor’s foundational support and resources. Overall, the synergies enhance content development, production, distribution, licensing, and sponsorships.

In the short term, the primary focus will be on executing revenue and cost synergies. Over the long term, there’s a potential for TKO to expand into other sports. There is a limited number of opportunities in this realm, and I see the most logical next step being boxing, given the combat sports similarities.

UFC president Dana White revealed to Sports Business Insider that he plans to launch a boxing promotion within 12 to 24 months. White was also quoted saying, “I don’t know if I can fix the sport, but I think I can put on fights that people want to see, and I can make boxing interesting again and build a brand around it.” Whether any potential plans feature investment or participation with TKO is unclear.

There’s a genuine opportunity for TKO to harness its expertise in managing combat sports events. Ideally, TKO could unify promotion and content distribution, which are currently fragmented in boxing, resulting in inefficiencies. Furthermore, TKO has the potential to rebrand boxing and enhance its appeal, considering modifications like changing the format (comparing boxing’s 12 three-minute rounds to UFC’s five five-minute rounds) or adjusting weight categories (boxing’s 17 versus UFC’s 12). However, recruiting top talent poses hurdles, as professional boxers are accustomed to significantly higher earnings than UFC fighters.

A viable direction for TKO could be delving into amateur boxing, which has seen a surge in popularity on social media. Organizing crossover battles for notable personalities from UFC or WWE could also be appealing, like the iconic Floyd Mayweather vs. Conor McGregor fight. Additionally, UFC’s track record of nurturing amateur fighters through programs like The Ultimate Fighter and Dana White’s Contender Series can be advantageous.

Financial Overview

In TKO’s investor presentation for April 2023, their key financial metrics for FY2022 showcase a desirable financial profile. TKO’s combined portfolio of UFC and WWE segments grew revenues at 10% CAGR since 2019, emphasizing a consistent growth trajectory. TKO has achieved an impressive 61% Free Cash Flow (FCF) conversion rate, highlighting efficient operations and profitability. Additionally, the company’s adjusted EBITDA margin stands at 42% for the fiscal year, indicating solid profitability margins. Lastly, the net leverage ratio of 2.5x provides insight into the company’s healthy balance sheet, allowing for flexibility in its capital allocation policies.

TKO management has yet to provide guidance on capital allocation, given the company’s newness. During its investor presentation, the company stated its capital allocation priorities of organic investments, continued deleveraging, opportunistic capital returns, and disciplined M&A.

TKO is set to unveil its first Q3 2023 Earnings on November 7th. The management will likely offer deeper insights regarding capital direction for 2024 and subsequent years. Operationally, I don’t expect revenue and cost synergies to materialize until mid-2024. Thus, this upcoming earnings presentation aims to acquaint investors with the merger details and clarify the strategy for realizing synergies.

Valuation

TKO stands out as an outlier compared to its peers within the entertainment industry. TKO trades at a forward EBITDA multiple of 8.45x, significantly lower than the peer group median of 18.55x, indicating that TKO is attractively priced. TKO’s gross margins of 71% compared to the peer group median of 42%, suggesting that they are more efficient at managing costs to produce revenues.

If TKO were to trade at its peer group median of 18.55x, its implied enterprise value would be around $20.7 billion. Accounting for cash and short-term investments of $172.8 million and deducting total debt of $2.7 billion, we would be left with an implied equity value of approximately $18.1 billion.

Given that 83 million shares are outstanding, resulting in an implied share price of $217.56. This implies an upside of 62% compared to its current share price of $83.35. While this example is hypothetical, it highlights the tremendous potential if TKO traded in line with the industry.

Risks

TKO faces competition from rivals such as the Professional Fighters League (PFL) in MMA and All Elite Wrestling (AEW) in the wrestling domain. The PFL recently secured a $100m investment from Saudi-backed SRJ, taking a minority ownership. This has caused speculation about whether PFL can compete with attracting elite talent, especially when UFC has been under scrutiny for its fighter compensation and contract stipulations.

PFL has over 70 fighters on its roster and has already poached big names such as former UFC heavyweight champion Francis Ngannou. While acknowledging these competitive threats, drawing parallels with the PGA Tour / LIV Golf might be rash. The UFC has always had competition, like the Bellator backed by Paramount, underscoring that effective implementation and captivating presentation matter more than large financial investments.

The sustained success of WWE, even with AEW’s emergence, suggests ample room in the market for several combat entities to thrive, particularly on a global scale.

In addition to the competitive pressures, there’s an ongoing antitrust lawsuit between WWE and MLW Media. Earlier this year, a complaint was filed against WWE by MLW Media. The discovery process revealed that a WWE executive spoke with a Tubi executive the day before a planned press release announcing a Tubi partnership MLW deal. The deal was terminated after the executives met.

Court Bauer, MLW’s CEO, alleges that WWE pressured Tubi executives to get MLW’s deal thrown out with Tubi—a streaming service owned by Fox, which also airs SmackDown. Bauer also claims foul play regarding MLW’s nixed deal with Reelz, which could not air MLW Underground due to Peacock’s exclusivity deal with WWE.

Final Thoughts

TKO stands out as a promising investment, symbolizing a revolutionary shift in the sports and entertainment industry through the merger of UFC and WWE. Despite the presence of risks such as competitive pressures and legal battles, TKO possesses strong attributes that signal robust potential for growth at an attractive valuation entry point. The combined synergies of UFC and WWE under TKO’s umbrella open doors to enriched content, diversified revenue streams, and a broader, more engaged global audience. Additionally, the approach to exploring opportunities in other sports, particularly boxing, unveils avenues for innovation and market expansion.