Friday, May 18, 2012

Ariel Funds John Rogers On His Current Holdings

When we invest, we are constantly looking for businesses with wide moats that make it hard for new competition to break in. This is where we get excited since sports are somewhat insulated from the disruptive forces that have made some media cash cows less profitable. In television, the DVR has wreaked havoc on traditional advertising. Instead of watching commercial after commercial during our favorite shows, we fast forward through the ads with remote in hand. This phenomenon does not exist with sports because fans prefer to watch games live. Also, while many turn to the Internet to get free news and entertainment—people are willing to pay for sports. We buy pricey tickets to see games in person and are even willing to pay to watch athletes play on TV. For example, it is hard to see National Hockey League games without a pay television service. Similarly, with Monday Night Football on ESPN, viewers pay a charge on their cable or satellite TV bills. Escalating television sports contracts underscore this point. In December 2011, for instance, the National Football League signed a new 9-year deal with CBS Corp. (CBS), Fox and NBC that represents a 60% revenue increase over the current $4 billion annual take.

Herein lies the opportunity for our portfolios. As seasoned media investors, our deep knowledge of their revenue streams as well as their recent challenges puts us in a unique position to assess the opportunities at hand. This hard-learned media expertise has given us insight into the value of those assets that maintain or increase revenues in a world where the top line is often volatile and sometimes sliding. We are also employing the knowledge we have gained in real estate from companies such as Jones Lang LaSalle Inc. (JLL) and CBRE Group, Inc. (CBG). Real estate is an unusual asset because it can be tricky to estimate its current value, and also because savvy managers can wring far more value out of it than others can.

For all these reasons, we bought shares of one of the world's most famous sports venues last year—Madison Square Garden Co. (MSG). One part of our attraction was the fact that so few realize that it recently became a publicly traded company. Having been spun off from Cablevision Systems Corp. (CVC) in 2010, MSG includes the Garden, two regional sports networks, as well as the New York Knicks, the New York Rangers, and a variety of other venues and businesses. One of the main overhangs on the stock is the admittedly huge cost related to a massive upgrade of Madison Square Garden itself. With estimates running as high as $1 billion, the market is skeptical, but a tour of the under-construction facilities more than convinced us the dollars represent money well spent. The facilities will be spectacular when all is said and done. We are further reassured about the expense when one considers that even in the worst economic downturn, fans continued to pay for premium tickets to live sporting events. Additionally, there is no better moat since the scale of the Garden simply cannot be duplicated in Manhattan today. Even though it gained nearly +20% in the past quarter, we think it still trades at a 21% discount to intrinsic value today. 

CBS and Gannett Co., Inc. (GCI) represent more of a back-door sports play. CBS, a holding in Ariel Appreciation Fund, currently has five of the top-10 rated shows in the country, the most of any network—as well as a topnotch sports franchise. Among other offerings, it currently hosts the NFL, PGA golf, the NCAA basketball tournament, and SEC (Southeastern Conference) college football. Moreover, the network has successfully made itself synonymous with watching these premier events on television. Even though it has gained more than 25% in the last quarter, we estimate it still trades at a double-digit discount to intrinsic value. While many continue to think Gannett, a holding in Ariel Fund and Ariel Appreciation Fund, is limited to USA Today, it is truly a diversified media company. A few of us recently attended their analyst day, where their small-town papers got a lot of play because Americans love their small-town sports and read the local paper to get the best coverage of these events. Additionally, the company's 23 television stations carry live sports. As a forward-thinking company, Gannett is working hard to monetize other parts of the sports craze. For instance, it recently devoted a chunk of its free cash flow to buy, a fantasy sports website. Gannett trades at just 7x consensus 2012 earnings, which we think remains quite a bargain.

For us, the sports theme feels like a triple-play: the trend is clear in the social and entertainment world, remains unappreciated—and thus undervalued—in the investing world, and falls right in the center of our circle of competence.

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