Zuffa Maintains “BB” Credit Rating, “Stable” is Key
November 3, 2011
Standard and Poor’s has maintained Zuffa’s credit rating at “BB” based on the belief that the company’s strong EBITDA margin and healthy cash flow are sustainable over the “near-to-intermediate term” as Zuffa continues to grow and benefit from it’s well-recognized (UFC) brand and dominant market position.
On the other hand, the following S&P concerns kept Zuffa’s credit rating from being upgraded:
- Risk of revenue and EBITDA volatility given the company’s primarily event-driven business model
- Vulnerability to changing consumer preferences and susceptibility to variability in discretionary spending
- Management’s aggressive financial policy
- Although the UFC has a strong fan-base, in order to maintain their advantage, they need to continue to develop fighters that appeal to the 18-34 demographic.
- Preserve current regulatory acceptance of the sport. Fatal injury or change to the rules and regulations governing the sport and legal status could have meaningful impact to the company’s business model and long-term viability.
- UFC’s seven year TV deal with Fox Sports Media Group, replacing Zuffa’s current deals with Spike TV and Versus, offers more stable and favorable economics over the term of the TV deal in hope of potentially reducing Zuffa’s dependency on the more-volatile event based revenue.
- Zuffa should be able to deliver more content and potentially expand it’s audience through the vast distribution FOX provides, thus exposing content to a higher potential viewership base.
- During the first half of 2011, revenue and EBITDA were down against the comparable period in 2010. Reasons given: One less PPV event, as well as significant fighter injuries which contributed to lower PPV buys.
- Despite a weak first half of 2011, the report expects Zuffa’s total debt to EBITDA and coverage measures to remain in line with the rating over the term.
- It is expected that Zuffa owners will continue to pursue moderate distributions over time as the company continues to grow, which will likely preclude any meaningful sustained improvement to Zuffa’s financial risk profile.
- Nearly 75% of Zuffa’s total revenue is event based. The majority is composed of PPV buys and ticket sales. Remaining 25% revenue is composed of live and taped television broadcasts, sponsorship, merchandising, licensing, and content distribution deals.
- Due to the FOX television deal, it is anticipated that TV broadcasting may become a larger source of revenue, as they see this revenue stream as less volatile than event based revenue.
- Zuffa has been successful in expanding sponsorships and merchandising, which improves stability and strengthens their business model.
- Zuffa’s expansion plans are seen as a positive due to the potential of growing revenue from a more diversified fan base and broadening the acceptance of MMA.
- UFC expansion into the UK several years ago was extremely volatile, and they have since taken a more cautious and measured approach in international expansion.
- Interestingly enough, the report points out that Zuffa could face increased labor costs in the future if fighters organize (union) and seek a higher share of revenue, which is the case for most major sports in the U.S.
- The acquisition of Strikeforce (along with the WEC) is believed to have strengthened the UFCs already dominant market position, as it continues to increase the number of fighters and title fights under the promotion.
- Liquidity: Zuffa has adequate sources to cover its needs over the next 12 to 18 months. Sources include cash flow generated from strong operations and it’s revolving credit.
- Uses of liquidity include minimal capital spending needs, modest amortization, acquisitions, and distributions.
- Debt: Zuffa had only $1 million of availability under its $50 million revolving credit facility as of June 30, 2011, which expires in 2012. $425 million term loan due in 2015.
- Payments for taxes are primarily distributed directly to the owners and additional dividend payments are limited by a restricted payment basket under the credit facilities.
- The expectation is that owners will likely continue to pursue max allowable distributions under the credit agreement.
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
August 2011 – Zuffa Maintains “BB” Credit Rating
Typically, a rating of “BB” implies that Zuffa is less vulnerable in the near term, although it faces major ongoing uncertainties and exposure to adverse business, financial, or economic conditions, which can result in failure to meet its financial commitments. On the other hand, it’s a credit rating of “stable”, which is not a bad place to be for a company who’s core business model is so volatile and can be affected by many market variables.
The international expansion efforts and the seven-year $100 million FOX TV deal help tremendously in bringing more stability into the UFC’s business model, but with that said, it still only accounts for 25% of their total revenue. In this regard, not much has changed since 2010 when Zuffa was able to match the event based revenue growth with the non-event based revenue growth, so we still have a 75-25 split in overall revenue. The hope here is that through the new TV deal, more mainstream exposure can come to the brand by creating more PPV draws, and opening the door for more stable revenue opportunities which can help offset the volatile nature of PPV based core business model.
The report points out that revenue and EBITDA for the first half of 2011 is down compared to the same period in 2010, though one less PPV was accounted for this year. The main reason given for the decline was injuries to UFC stars. The problem with solely blaming injuries and correlating it to revenue is that you hope next year won’t be as bad but as we are starting to see on a year-to-year basis, injuries are part of the sport. Fights and training camps take a toll on the fighters, so having a PPV star such as a GSP or Brock Lesnar can really only give you about 2 fights per year taking all the variables into account. Injuries is an unknown that cannot be controlled or correctly estimated beforehand, so it will be interesting to see how if injuries becomes a hot topic again in 2012, as it has been for the past 2 years.
If injuries is the main component of declining PPV buys, then that brings up another issue. It means that fans are only willing to pay to see fighters that they deem worthy of their hard-earned money. It also shifts the drawing power to the fighters instead of the UFC brand and product they offer. It means MMA may not be enough anymore to get anyone outside of the MMA hardcore fanbase to tune in, and I’m sure that’s something the UFC hopes to address with the exposure the FOX TV deal brings along with its vast distribution platforms.
There has also been a lot of talk this year about the UFC or MMA peaking or plateauing, and pointing out declining PPV buys and TV ratings as a quick and easy measuring stick. Oddly enough during a year when we’ve seen TV ratings decline or hit low points for the UFC and Bellator, both were able to sign TV deals with major media groups. UFC signs a huge TV deal with FOX that not only gets their full support and puts them on FOX, FX, and Fuel TV, but it can now be linked to FOX and become synonymous to other mainstream sports they televise. FOX has been heavily promoting the first UFC on FOX event on all their high viewership sport programming including MLB’s World Series and Sunday NFL games. Bellator was just purchased by Viacom and looks to be moving on to Spike in 2013 after only getting roughly 150-180K viewers on average per event on MTV2. Again, Spike re-iterates that they will be sticking with them even through hard times as they have done with other programming. They find themselves in a similar situation when the WWE left Spike and TNA was picked up as their replacement. After a few up and down years, TNA has been getting great ratings for Spike as of late, a formula they hope to reproduce with Bellator after the UFC leaves at the end of this year.
What we are seeing here is that these media groups believe MMA has a ton of potential left, but at this point, it makes more sense for these media groups to either own or sign a very intimate contract with a promotion rather than having a licensing fee agreement for MMA programming such as Showtime, Spike, Versus, and CBS have done in the past. Is more mainstream MMA content what we need for ratings and PPV buys to kick back up again or will it just add to the ever-growing free MMA content anyone can get from various TV and media channels? Will an adverse effect shift UFC’s business core to be more TV dependent in the next few years? Can you really sustain a PPV core model in the long run? I have a feeling these questions will be answered in the next 5 years, as the FOX and Spike TV deals run their course.
It’s not realistic to expect that the UFC will outdo itself year-after-year, but it will be interesting to see how it can push itself off a potential stagnant stage and onto that next level as they have shown in the past with the Spike TV deal (TUF), the acquisition of PRIDE/WFA/WEC, and now signing the major FOX TV deal.
MMAPAYOUT QUICK THOUGHTS:
- Zuffa has significantly drained their revolver, which makes you wonder what kind of burn rate/overhead they have.
-The other interesting tidbit is Zuffa’s dividend distribution policy. On one hand, some people think its smart/prudent to protect your gains/investment. On the other hand, some people say if you really believe in this company long term and its a business your going to keep, why would you cash out all the money instead of putting it back into the company.