Zuffa Credit Rating Upgraded to BB

December 22, 2010

Standard and Poor’s have upgraded Zuffa’s credit rating from “BB-” to “BB” on the strength of the UFC’s strong operating trends, improved profitability internationally, and good credit measures.

Report Summary

  • Zuffa has increased profitability in large part due to holding its events in more profitable domestic venues or international markets that facilitate live PPV broadcasting to the domestic market.
  • Specific mention is made of the UFC-WEC merger as potential source of incremental ticket and ppv sales growth.
  • The volatility of consumer tastes and preferences continues to be a slight concern as these may impact PPV revenues, but the report also cites the development of new fighter talent and regulatory acceptance as additional risk factors.
  • However, the company’s strong EBITDA margin and healthy cash flow conversion rate are reportedly sustainable over the near to intermediate term and partially off-set concern over volatility in PPV earnings and risk factors mentioned above.
  • The report reinforces that 75% revenues are event-related; PPV buys account for nearly 60% of all PPV event revenue while gate and sponsorships account for the rest.
  • The remaining 25% of revenue comes from live and taped broadcasts on SpikeTV, merchandise, and digital media revenue; much of that is broadcast revenue, but an emerging portion is merchandise and digital media.
  • EBITDA margins are expected to track within a consistent range in the future, even with expansion into new markets like Brazil.
  • Liquidity remains strong due largely to limited capital spending requirements.
  • Debt: $50 million credit facility expiring in 2012; $425 million term loan due in 2015.

Zuffa Credit History

November 2007 – S&P Cuts Zuffa Rating, BB to BB-
July 2008 – Zuffa Rating Goes Negative to Stable
July 2009 – Cuban Now a Zuffa Bond Holder
October 2009 – S&P Re-Affirm BB-, Slide Recovery Rating Down
December 2010 – S&P Raises Zuffa Rating, BB- to BB

Payout Perspective

Zuffa has invested a great deal of time, effort, and money to diversify its revenue sources over the last few years. I expected this focus on merchandising and digital media revenue generation to increase non-event-related revenues as a percentage of overall revenues, but Zuffa has matched this revenue growth with substantial growth in the PPV domain. Thus, there remains a 75-25 split between event and non-event related revenues.

Overall, the raised rating is not surprising. Zuffa has had another excellent year, breaking its PPV and live gate marks for the third consecutive time. I suspect it may break the record again in 2011 with the addition of the WEC roster that now gives them two more titles to use in its event scheduling rotation.

There’s been a lot of talk lately about the UFC peaking, but I don’t think this is the absolute top of the mountain. Sure, the company is going to have its ups and downs – we can’t expect straight line 20% growth in perpetuity – but I do think there remains a host of growth potential both on the event-related side and the ancillary side. Its best chance for growth is to gain exposure domestically with a new television deal (somebody other than Spike). However, it may also achieve growth in other ways:

  • The UFC Gyms model
  • The continued development of its merchandising business
  • An aggressive digital media expansion to reach new audiences
  • Investing in a strong integrated marketing campaign (something they’ve yet to really do) to work on converting awareness to interest and beyond

UFC Gyms are perhaps the most exciting opportunity that has yet to be fully explored. I’m not sure they’ll provide material revenues (either in operation or through licensing fee), but the potential is there to leverage these gyms as first a means to greater exposure and then as a teaching tool. This seems to be even more crucial in MMA than other sports; it’s something that people don’t think much about trying, but upon doing so often realize the many health and fitness benefits to the training. These workouts often provide enough new perspective and appreciation for the sport that a new fan is born.

There are many things the people of this industry have yet to discover (myself included, certainly). However, one I feel quite strongly about is the notion that a.) while everyone may “get” MMA, not everyone is going to like it, and b.) not all those that like it, come to like it in the same way or for the same reasons. MMA has to learn to be flexible and accommodating to all sorts of people that like the sport for various reasons or get into the sport in various ways. The UFC Gym idea is something that helps in this regard.

12 Responses to “Zuffa Credit Rating Upgraded to BB”

  1. mmaguru on December 22nd, 2010 5:26 AM

    Hi Kelsey,

    Nice write up, but I’ll have to disagree on the future viability of the UFC Gyms model.

    Although I feel strongly that the UFC has peaked domestically, there is a lot of potential for growth internationally. With big events scheduled in 2011 in Toronto and Sydney, I believe we will see some big gate numbers in 2011 if they continue to put on events abroad.

    Also as you mentioned the WEC merger will help with PPV sales. At least keeping the numbers stable.

  2. Kelsey Philpott on December 22nd, 2010 9:01 AM

    Guru,

    I’d love to hear your thoughts on the UFC Gyms model. Please share when you get a moment to compose things!

    KP

  3. Fightlinker on December 22nd, 2010 10:12 AM

    MMA Gyms > digital media expansion? Whatchoo smoking, Philpott!?!?! Great breakdown otherwise

  4. Kelsey Philpott on December 22nd, 2010 9:12 PM

    I want to be clear in stating it’s not the most exciting opportunity per se. Rather it’s the most exciting of those that has really yet to be explored. There’s a difference.

    Still, I’d encourage everyone to think about it. What’s the greatest impediment to the UFC’s success? Social acceptance. It’s a great product bounded only by its antiquated reputation fed by a high degree of misinformation and the perpetuation of false stereotypes.

    Seeing is believing, and there’s nothing more effective than showing someone what the sport is all about. Let them kick the bag, take a shot, or grab an arm. In combination with a consistent marketing plan across all channels, the expansion of digital content, and development of merchandising, the UFC can continue to grow while it waits to find a good TV deal.

    No smoking here. ;)

  5. rick on December 24th, 2010 12:01 AM

    Gosh, it really is disapointment when peeps keep talking about the UFC/MMA peaking. That talk is so premature its not even funny, UFC/MMA has alot of room to grow in the USA. There is alot of room to grow internationaly. I know sometimes we as individuals sometimes feel like ok…MMA has peaked, doent mean the whole sport has. I myself have felt that sometimes and than here comes the new fan you never thought would watch it and remind you how much MMA is alive!! I have had all kinds of peeps wake me up, from the the floor guy at the hospital, to the Hot ER nurse, hell to even my own brother all of sudden calling me to ask when the next ppv is. This my friends tells me that we havnt even begun to get the casual fan involved!!

  6. mmaguru on December 24th, 2010 6:39 AM

    rick, it’s really hard to say if the UFC has peaked or not, but based on the last couple of years and trends on PER EVENT TV ratings, PPV buys and ticket sales, I would say the writing is on the wall. There appears to have been little or no growth in those areas since UFC 100. It’s one thing to put on more events and to be able to say at the end of the year that you made “X” amount more money or 10% more growth, but if you look at the per event revenues I would guess there is no growth – quite possibly a decline. But to be honest, I don’t follow the numbers to that detail – just observe when I get a chance.

    One reason for the UFC’s aggressive push towards global expansion is likely due to the fact that Zuffa has all but exhausted the market in the U.S. Zuffa’s growth domestically in the coming years will depend on global demand and other streams of revenue as Kelsey wrote about – merchandise, media and other subsidiary ventures such as the UFC Gym.

    Kelsey, the reason I feel that the Gym model will not succeed is the same reason the XFL did not succeed when Vince started it. Basically, you need to stick to your core competency in business. Competing in a established market such as fitness clubs is not the same as competing in a market such as MMA and where your brand has been established for years as being the #1 organization in North America. The foundation of a good business is a good business opportunity and filling a need in the marketplace.

    There certainly is little need for a new fitness club in the current marketplace and there is just way to much competition with MMA training facilities. Any serious athlete wishing to break into MMA would likely join a serious training facility such as AKA, ATT, X-Treme Couture or Jacksons. UFC Gym is a gimmick and I would have little faith in it succeeding. Dana wants to put on the perception that anything he touches turns to gold. It’s one thing to be able to run an established brand and grow it in a marketplace where your organization has been #1 domestically for 20 years, it’s another thing trying to break into an established marketplace that provides little growth opportunities.

    When the press release for the UFC Gym came out back in late 2009 a quote was “envision as many as 400 gyms “across the United States within five years.” Over a year later, we have 3 Gyms.

  7. Steve on December 24th, 2010 7:36 AM

    mmaguru,

    UFC gyms won’t be competing with fight gyms or even designed to produce pro fighters. Their gimmick is MMA, but they have no designs on producing pro fighters, at least not that I have read about. They are looking to be your standard commercial gym, but with MMA as their hook rather than the crossfit, women only, or fatties only hooks used by other commercial gyms.

  8. mmaguru on December 24th, 2010 7:50 AM

    Thanks Steve,
    I am aware of that as well. That’s why I mention “fitness center”. I was trying to point out that they will have trouble in either market.

    What are your thoughts on the UFC Gym model? Success/Unsuccessful?

  9. Kelsey Philpott on December 24th, 2010 8:46 AM

    Guru,

    I think that’s the problem. People just take a quick glance at some of the figures and make general assessments without really diving deeper. They see that the average television ratings are declining and they panic because the sport is relatively new and still considered to be on the “fad threshold”.

    However, the larger body of evidence paints a different picture. There is still a strong demand for the UFC’s product and they’ve yet to meet all of that demand. The UFC is still adding shows and still increasing revenues. The growth will stop when it can no longer add shows without taking away from its overall revenue generation (or profitability).

    I understand that averages are easy to look at and make for simple comparisons; certainly it’s an obvious indicator of growth when your aggregates and your averages are both increasing. Unfortunately, averages never tell the whole story and that can negatively influence your assessment of a situation. Here is an example:

    The 2010 PPV average was 570,000, roughly 40,000 buys less than the 2009 average of 610,000. You could look at that and say, “hey, the UFC isn’t growing” but a closer look at the situation and the numbers reveals something else.

    The UFC had an awful injury streak in the latter part of 2009 and early 2010, which royally screwed up their PPV scheduling rotation. It made the poor choice of running three shows (UFC 108, 109, and 110) with no title belts and few notable headliners in the span of six weeks between January 1 and February 20th. The average PPV buyrate of these three events was 263,000. However, the average PPV buyrate for the rest of the year was 706,000 (in which the UFC strung together a record 8 events in a row with more than 500,000 PPV buys each).

    In the end, the UFC still generated over 9 million PPV buys this year, which is a 16% increase over 2009. It also generated approximately $51 million in live gate revenue this year, which is $10 million more than last year. What business wouldn’t want to increase the number of its shows to find out that averages are holding and revenues are increasing?

    Is the UFC’s growth slowing? Sure. That’s inevitable. Its PPV buys have grown at 23% and 25% over the last two years. No company can sustain that type of growth, especially in a down economy.

    None of that means the UFC has “peaked” however.

    ———-

    The UFC isn’t going to run these gyms. It’s going to license its brand name and a standard set of operating requirements to a local entrepreneur that has experience in the fitness industry.

    How is it any different than the UFC licensing out its name to THQ in order to produce a video game. It will give the gyms the same type of support it gave the video game and will use the gyms to a.) generate awareness, b.) convert awareness to interest, and c.) generate revenue from licensing fees and increased revenues across the board as the result in an expansion of the fan base. It’s no different than the video game.

    I hear your point about competencies. The UFC will remain a promoter. It’s not going to be operating 300-400 gyms (or even 10 gyms) on its own.

    And I mean, you’ve got to have some patience. The end goal is to have 300 gyms, but that’s not going to happen over night. Three UFC Gyms is a start and if they can get to 10 by the end of 2012, I think that’s a success.

    Kelsey

  10. Random Dude on December 27th, 2010 8:11 AM

    Gym franchises are a bust. Most franchisees of 24/7 Fitness, Snap Fitness, and a bunch of others are basically burning tons of money each month. A UFC gym is going to require bigger loans and bigger monthly costs than the other failing fitness center franchises. I don’t see this working out in the long run. They will get a couple of suckers, but not as many as they are thinking.

  11. mmaguru on December 28th, 2010 7:49 PM

    Nice writeup Kelsey, but I think I’ll have to agree with “Random Dude”. It’s a bust market at the best of times and the cost to run Gyms is quite high. Quality equipment does not run cheap and require constant maintenance. I’m also concerned by the fact that Zuffa is not in there running it as you stated. I’m not sure that Zuffa “subletting” their brand to some local fitness businessmen is a good idea. Short term gain for some bad publicity down the line.

  12. Kelsey Philpott on December 29th, 2010 4:09 PM

    I think you two raise some great points. There are certainly risks here. It’s a very competitive market with relatively high initial investment costs. Given the small margins the typical gym runs, there’s also usually a long time to investment recovery.

    However, I think those risks are largely mitigated by a differentiated product that affords the gym an opportunity to provide credibly unique services that not only increase foot traffic but boost margins.

    It all comes down to execution here. Yes, if the UFC just “sublets” out its brand and doesn’t fully support these gyms, they’ll fail. But how likely do you think that is? The UFC has proven to be tremendously protective of its brand. I believe these gyms will be no different. It’s not like supporting these gyms are going to cost a lot, either; some merchandise, fighter appearances, and even the use of social media marketing like #Hunt4UFC to drive awareness and interest.

    This is one of those cases where I truly believe there is no such thing as bad strategy, just bad execution.

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