SFX Entertainment (SFXE) dropped to all-time lows yesterday after reporting earnings that the Street took in a bearish light. After reading through the report, I believe this stock is actually progressing faster than anyone suspects and remains deeply misunderstood as it begins to build its growth story. That’s why I recommend using this weakness as a buying opportunity. Let’s take a closer at why I still believe in SFXE.
The mixed blessing of investing in any underfollowed stock is that there is no strong consensus to establish fair value, much less the finer points of modeling the balance sheet or determining how far management is advancing on its growth plans. Without that consensus, there is substantial room for a difference of opinion, which can drag share prices far short of underlying fair value and subject it to volatile swings.
Conviction is what keeps an investor grounded through the swings. I have high conviction that CEO Bob Sillerman really is putting together a new media powerhouse and that he will not settle for anything less. As long as he is involved with SFXE, I’m confident that he will move it forward.
In that light, I wasn’t as concerned about SFXE’s net loss per share as some investors were. Burning $40 million in cash over the recent quarter is not what any shareholder ever wants to see, especially when the company only reported $17 million in cash three months ago. If we were looking at a traditional start-up, that burn rate would be not only unsustainable, but apocalyptic. It would be time to think about pulling the plug on a failed experiment.
However, SFXE is not a traditional start-up. Sillerman’s mergers and acquisition (M&A) activity has been so aggressive that the company is already big enough to live with the losses as long as it needs to do it. Management said yesterday that it is generating $84 million in revenue in a good quarter, and $19 million of that is gross profit. SGA (selling, general and administrative) expenses are substantial, but the number doesn’t represent much in the way of internal consolidation yet. As management integrates its new acquisitions, we are already starting to see efficiencies of scale and even the often-elusive “synergies” of scope push the margin in the right direction.
Meanwhile, Sillerman can still open his wallet to keep the company liquid in an extreme situation. He has already seen his own stake in SFXE cut in half, losing a staggering $100 million in paper value in the process. From everything I’ve seen about the way he operates, he is not going to let a billion dollar project starve for want of a few tens of millions of dollars pulled from his personal balance sheet.
SFXE also has access to about $150 million in untapped credit and has until 2019 to pay the $70 million in debt it has already accrued in buying so many electronic music promoters, websites and management groups. Even if the company defaults after that point, I suspect we will be looking at a very different SFXE five years from now. A fresh $30 million revolver should smooth the path in the meantime.
The scale of the net losses in the fourth quarter also speaks to the speed at which Sillerman has rolled up this segment of the music industry. It takes scale to generate $80 million in revenue across any three-month period and it also takes scale to spend $120 million in order to do it. SFXE may swim in a world of youth culture that most investors consider peripheral, but from the billboards in Las Vegas I can tell you that electronic dance acts like Tiesto are actually in the mainstream for young American and global consumers.
And if SFXE has scale in that world, it can pivot at any time to slow its acquisitions and cut costs on the new house Sillerman has built. The numbers may get a little worse from here, but the odds are stronger that they actually get better.
Believing that the numbers get better is a statement of high conviction in management’s ability to execute on a valid business proposition. Again, Las Vegas shows me that there is a lot of money in electronic dance music, and $80 million in revenue in the recent quarter indicates that SFXE is earning its share of that money.
Cut direct costs and SGA by a mere 2%-3% and boost event attendance near the 35% rate SFXE enjoyed in 2013, and the implied operating burn drops to barely $10 million. If Sillerman keeps bringing new sponsors to the table, this company could easily become sustainably profitable in a very short period of time.
That sets us up for significant profits ahead, which is why I think this stock is an opportunity and continue recommend SFXE as a buy below $9. However, I urge only those with a high risk tolerance to invest in the name, as we could see some further volatility ahead while we wait for the market to catch up on the stock’s potential.