As a follow-up to Robert Joyner’s solid analysis of Standard & Poor’s latest credit rating report on Zuffa LLC., I have been tasked with piecing together an overall assessment of past and present reports in order to create a picture of Zuffa’s current and future financial position.
Current Picture
Perhaps the most common metric for valuing a company’s profitability is the use of EBITDA and the EBITDA margin. Standard and Poor’s revealed the company’s margin for the year ending 2006 was nearly 40% – a substantial increase from the mid-teens in 2005. However, Zuffa failed to meet creditor expectations in 2007 as its margin dropped “meaningfully.” The reports attribute the fall in margin to “lower top-line growth and higher operating costs,” which eventually resulted in the downgrade and negative outlook placed upon Zuffa’s debt at the end of last year. S&P also notes that the company is unlikely to regain the 40% margin that it once enjoyed, because of increasing fighter expenses and rising domestic production costs.
Looking back at the year of 2007, it’s clear that the UFC wasn’t able to continue the financial momentum it was riding as the result of mega PPVs like UFC 61 (Ortiz vs. Shamrock) and UFC 66 (Liddell vs. Ortiz). They also made aggressive forays into the UK (nearly doubling their operating expenses from the previous year) that didn’t exactly pay immediate dividends – the much-maligned UFC 72 being most notable.
Yet, despite Zuffa’s failure to meet creditor expectations, I am inclined to believe that EBITDA, alone, cannot paint the entire picture. After all, a company can have a solid EBITDA and still be without the cash to pay its bills. The phrase “Cash is King” is very relevant to a growing industry like MMA and in this regard, Zuffa seems to be on solid footing.
Overall, the company exhibits good operating cash flows and low capital expenditures – a combination that amounts to a strong free cash flow. Free cash flow represents the amount of cash that can be reinvested into the firm. In other words, it’s the money used to make new acquisitions, hire lobbying groups, sign marketing firms, or reduce the company’s debt. Standard and Poor’s recognition of Zuffa’s free cash flow as “strong” bodes well for the future of the company and the expectations for continued growth.
It’s important to emphasize that a strong free cash flow gives Zuffa the ability to repay its debt. As Zuffa plans to grow and expand, their corresponding need for leverage will also increase. The result of negative revisions to their credit rating directly translates into greater borrowing costs in the future. Thus, the recent recovery to “adequate” debt coverage ratios – both debt-to-EBITDA and EBITDA coverage of interest – and a strong free cash flow are quite meaningful indicators of the company’s strength and ability to rebound from a difficult year.
The fact that Zuffa’s operations are characterized by revenue and expense streams that are heavily event-driven causes a great deal of volatility in the quarterly and yearly earnings of the company. Based on this volatility and the company’s relatively short operating history, S&P is probably more stringent on Zuffa than they would be for a more established company, competing in a proven industry.
I’d like to remind the MMA community that volatile earnings come part and parcel with competing in many growth industries. A growing business whose operations are largely event-driven is going to experience setbacks in revenue generation or unforeseen cash outlays that will punish its bottom line. Zuffa is only 3-4 years into profitability and while the expectation is for more consistent earnings moving forward, they’re also likely to experience more hiccups along the way.
Future Outlook
Zuffa’s ability to meet future expectations for consistent earnings and growth will largely depend upon the firm’s ability to become less dependent on event-related revenues. I believe this is a strong possibility based on upcoming non-event related revenue streams that are beginning to take shape for Zuffa. The company continues to secure numerous blue chip sponsors like Bud Light; has established several licensing and merchandising deals including the most recent with Jakks Pacific; is working with software developer THQ to produce a UFC video game penciled for a Spring 2009 release; and Zuffa may possibly be on the verge of a national network television deal with FOX or ABC.
However, as S&P reports, consistency (and another positive ratings revision) may also be found with the implementation of a more aggressive financial policy focused on cost control. Recent staff layoffs at the Las Vegas-based corporate headquarters in combination with roster cuts signal that Zuffa is listening closely.
An aggressive financial policy also highlights the need for prioritization in Zuffa’s quest to expand the UFC and WEC internationally. Zuffa needs to be smart about where and how it spends its money in order to provide for maximum growth while also not committing too much of its cash and sacrificing its ability to cover its debt.
While MMA has the ability to transcend all barriers, that doesn’t mean MMA should transcend all barriers. Not everyone is going into India or Vietnam or China – certainly not companies that are going to spend millions of dollars only to possibly recover it 20-30 years down the road. As others have mentioned, anything more than a grassroots campaign would be ill-advised considering the company’s current financial picture.
Fourth Quarter Predictions
I feel confident in predicting a solid to strong 4th quarter for Zuffa, based on the following series of live events and television programming set for the fall:
- SpikeTV will air UFC 89 from the UK on tape delay while also running the eigth season of The Ultimate Fighter reality TV series and its Ultimate Fighter Finale.
- The UFC will be hosting its first events in freshly sanctioned Illinois and Massachusetts. Chicago and Boston are very much sport and media hotbeds in addition to being MMA-starved markets.
- The quarter will then be anchored by the New Year’s Eve event in Las Vegas; an event that could possibly feature the UFC’s best PPV draw Chuck Liddell or extremely marketable young stars like Georges St. Pierre, Anderson Silva, and BJ Penn.