Formula One Stock: Great Entertainment But Expensive Asset (NASDAQ:FWONA)

Carlos & Daniel. Infiniti Red Bull Racing F1 Showrun

Daniel Rodriguez Tirad

Investment Thesis

Liberty Media has successfully reinvented Formula One (NASDAQ:FWONK), (NASDAQ:FWONA) as an attractive content package. The fan base and engagement are increasing, driving revenues and prospects. Nevertheless, financial results are weak and don’t justify the asset’s current price.

Note: throughout this text, I’m only using the ticker FWONK for readability, but it may also apply to FWONA. When FWONK is used, I mean the company. When Formula One is used, I mean the sport or league.

The Liberty Group worked on the reshaping of the Formula One business, since its acquisition in 2017. The strategic focus is directly related to increasing engagement in markets where penetration was low and creating a more entertaining experience both for the live audience, TV, and social media fans. In terms of internationalization, the championship counts 22 events. Among those, Bahrain, Saudi Arabia, Azerbaijan, Singapore, Abu Dhabi, Qatar (2023), and China (2023) depict a focus on growing markets in the east. In addition, after some controversy, Miami’s debut was a success in 2022, Las Vegas will make its first appearance in 2023, and the US will total three races, improving focus on a market where Formula 1 was inexpressive. On the other hand, the league just announced the failure in negotiating with South Africa, granting a spot for the traditional Spa-Francorchamps circuit in Belgium. In general, hosting such kind of event became a source of dispute among cities, as in the case of GP Brazil renewal between Sao Paulo and Rio de Janeiro, raising the ticket for FWONK.

Another important priority is related to fan engagement increase based on the development of greater rivalry, the impact of key brands, and the improvement of the experience. In 2021, the tournament was boosted by the strong dispute between Hamilton and Verstappen, the introduction of different formats such as the sprint races (increasing interest in the whole weekend event), and higher competition in mid-size teams. Besides that, the Formula One experience includes iconic brands like Ferrari, Mercedes, and Aston Martin, among others. Audi just announced it will join the show.

My thesis in companies that generate content is the following: the real competition resides in creating a product interesting enough that people will dedicate part of their scarce free time to it. A winning content experience, in these terms, is the one in which a strong number of people decide to spend, frequently, some hours consuming it, instead of any of the many entertainment products available today. The changes implemented by FWONK effectively raised interest and engagement in the sport. GP attendance is at an all-time high, TV audience skyrocketed to 1.55 billion people (4% increase YoY), and social media engagement has also increased with a special focus on the F1 app and F1 TV subscription.

Before we continue, a Warning: You Are Not Buying a Regular Stock

Investors should be aware that FWONK and FWONA are not regular stocks. These securities are called tracking stocks and represent a business unit within a legal entity. In this way, these securities are not related to a separate legal entity, including its assets, which belong to the Liberty Media legal entity.

Liberty Media segregated its business into three business areas: Sirius SM (LSXMA) (LSXMB), Formula One, and the Braves (BATRA) (OTCQB:BATRB). By holding FWONK or FWONA, investors are entitled to receive claims on the financial performance of this business. The assets related to FWONK and FWONA include Formula One, Drone Racing League, and Meyer Shank Racing, among some more disconnected assets, such as Tastemade.

Company Performance

RoE and DuPont breakdown of results

Figure 1 – Financial Performance Highlights of FWONK (Calculated by the author)

Despite the strong operating performance, FWONK’s financial results are lagging. If, on one hand, the company was heavily impacted by the COVID pandemic when RoE reached its lowest level, as depicted in Figure 1, negative returns were being recorded since 2018. The most important factor in this situation is related to the margin. The company works with relevant operating leverage as virtually all expenses are quasi-fixed. From 2017 to 2021, the annual rate of change for SG&A, Depreciation, and Financial Expenses, combined, was inferior to 2%. In this way, the operation became over-sensitive to increases in revenue, which had occurred but not at the necessary level to stabilize margins on a healthy plane. On Seeking Alpha, the company received a C grade for profitability.

Another important point raised in Figure 1 is related to the debt level. Before the pandemic, FWONK announced a leverage target that had to be reviewed in 2020 as the races were suspended. At the end of 2021, the initial target was recovered as the debt was reduced from US$ 3.5 B to US$ 2.9 B during the year. This point embeds a value problem for investors: more cash needs to be used to reduce leverage further, or the quasi-fixed nature of financial expenses will continue to pressure margins, or additional dilution of capital will be needed.

Company Sustainability

Altman Z-Score and Cash Flow generation

Figure 2 – Company Sustainability Highlights of FWONK (Calculated by the author)

The potential pressure on the cash can be assessed in Figure 2. The company was unable to generate positive Free-Cash-Flow in the pandemic-hit years and a small reversion may be expected for 2022. Again, the focus on revenue increases to dilute expenses, increase margins, and improve cash from operations is crucial going forward.

In terms of the Altman Z-Score, the above-mentioned reduction in leverage enhanced the financial situation of the operation, and the prospect related to the going-concern situation is positive.

Valuation Model

My valuation model consists of a Monte Carlo simulation with a thousand rounds on the FCFF model, where inputs are set for centrality and dispersion. The advantage of this methodology is related to the treatment of the fair price as a probability distribution under normal conditions. Therefore, it can be calculated the probability by which the fair value is above the current price of the price generated by the Dividend Discount Model (when applicable).

Most important assumptions used:

  • NS growth of 6%. This assumption considers the increase compared to pre-pandemic levels, and the indications in audience/attendance increase. Standard Deviation of 2% to allow for more aggressive growth
  • Gross Margin, SG&A, and depreciation of 34%, 9%, and 16% respectively with low volatility, representing a small improvement as revenue increases
  • Beta of 1.0. In line with FWONK projections and also considering comparison with peers, such as WWE (WWE), Live Nation (LYV), or the Braves.

Fair Value of Asset

valuation result

Figure 3 – Valuation Model Result (Calculated by the author)

The fair value of FWONK is US$ 34.88. Moreover, the probability that the fair value is higher than the current price is negligible. The company doesn’t provide dividends, so the return is comprised exclusively of price return. Faster than expected revenue and cash flow increases would be key to unlocking greater value prospects.

Investors may consider FWONK as a sell, despite the recent improvements in the operation. It also may be important to track future revenue increases, as in cases of abnormal growth that may be registered, the dilution effect on the operating leverage may imply that results and cash generation will respond quickly.

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