Pole Position: Why Formula 1 Looks Attractive

KEY TAKEAWAYS:

• From a viewership perspective, it is equivalent to the Super Bowl over the course of 20+ races
• Growth prospects remain strong as the 2022 season gets started and crowds are welcomed back to the track
• Once Liberty Media spun out the Atlanta Braves and SiriusXM components of the business, the stock became quite attractive

TRANSCRIPT

Race Announcer:

We’re going to have one lap of racing to decide the championship, and we have got 3.2 miles of racing action, all the way to the checkered flag. As the crowd roar the drivers on to the final lap of this race and Verstappen sets after Hamilton, is it going to be a first world championship for Verstappen? Is it going to be an eighth world championship for Lewis Hamilton? He’s going to make the launch down the inside. Hamilton season coming. It’s a late launch by Verstappen who takes the lead of the race. Verstappen now snatches the championship trophy from Lewis Hamilton who’s tried to fight back.

Here comes Lewis Hamilton though, down the back straight. He’s got a slipstream. He almost touches Verstappen. They almost make contact into turn nine. Verstappen stays ahead, of all the drama of all the controversy. In Formula 1 in 2021, it comes down to this and at this moment it looks like it’s going to go the way of Max Verstappen.

Mercedes not happy, Red Bull will be delighted. They have shared a brilliant championship battle, but the championship can only be won by one, and it’s going Dutch in 2021, Max Verstappen for the first time ever is champion of the world.

Host:

Hello and welcome to the QPD Podcast. On today’s show, we’re discussing Formula 1 racing. One of the most talked about sports in the world these days and how the stock looks undervalued.

Formula 1 docu-series, ‘Drive to Survive.’ Now entering season four has been credited with attracting new audiences around the world and providing never before seen insights into the once fledgling sport.

The open-wheel races, which are located in exotic locations around the world and features 20 world-class drivers saw 40% increase in TV viewership for the 2021 season, making it the most watched Formula 1 season in the U.S.

Is this a flash in the pan moment or is this be beginning of a longer-term trajectory for the sport? In the driver’s seat today to discuss this is MM, portfolio manager for the Cambiar International Portfolios, MM has over 22 years of industry experience spending the last five at Cambiar Investors. MM, welcome to the show.

MM:

Thanks Jim.

Host:

To get us started. Tell us what got you interested in the stock originally.

MM:

Yeah, I think it was early on during the pandemic and like everybody, I was looking for content and came across the Drive to Survive Series on Netflix. I’d heard about Formula 1, listened to a couple of different, interesting podcasts. And I remember somebody talking about Formula 1 and how interesting of a company or a sport it was and started watching it.

And I was immediately hooked, I think I binge-watched it and I started on a Friday night after my wife went to bed and the kids were down, and I think I binge-watched it finished the entire series by Saturday night the next day. Went onto the next season and the season after that, and I just completely hooked. The backstory on the drivers is super impressive in the teams, Lewis Hamilton story and Max Verstappen story.

And then the backstory about how Red Bull got into the sport and obviously now they’re dominating, but they were a newcomer and Ferrari and the history, their history with the sport. So the backstory behind the teams and the backstory behind how the sport got started, the history of the sport itself.

The sport was started in the 1930s, really by Maserati, Alfa Romeo, and Ferrari. They were just trying to test the engines on their new cars and they didn’t have test tracks back then. So they just tested them on the roads of Italy and patrons and citizens would come out of their homes in Italy and just watch these cars go flying by remember back then.

I mean, seeing a race car flying down the front of your house was probably pretty cool. And so Ferrari, Alfa Romeo and Maserati, they were testing their cars and then over time, just more and more spectators kept watching the sport, watching these races, and then they formalized the sport in 1970 and then turned it into what we now see as Formula 1.

Host:

Great. Yeah, I’m not as familiar with the sport, but I saw an interesting stat that 108 million viewers tuned into the last Abu Dhabi Grand Prix, to put that in perspective, there are 101 million viewers of this year’s Super Bowl. So I know that 108 million is a global figure, but can you put those numbers into perspective?

MM:

Yeah. The viewership numbers are astounding. So cumulatively through every year during the course of one season about 1.5 billion people watch the sport. Now that’s not unique viewers that’s just in total, and so I think unique viewers, they have about four to 500 million worldwide viewers of the sport. Those are people who attend the races or watch the races on TV.

That compares to the NFL, which is the highest grossing league in the world. I could have these numbers wrong, but I believe they do right around 12 billion in revenues as a league.

And, they have a little over 100 million followers. So, you’re talking about a sport that has four times a following of the NFL every season, there are 22 races, each race gets 70 million viewers. And just to get to your point, that compares to the Super Bowl at 100 million viewers, which is the most watched event in America.

So, this is like the equivalent of the Super Bowl, 22 times over the course of a season. It’s really incredible, and then in person attendance, it’s also amazing. I mean, these are huge events for any big city. An average race will attract 200,000 people over the course of three days, which is huge.

I mean, it brings in tourism dollars. You know, these are not cheap races, that average ticket costs $200. I was just looking at the ticket prices for Miami, which is the first year they’re going to host the race in Miami. And they sold out within a few hours. I think tickets in the secondary market right now, on like StubHub, are going for $2,000 apiece. So, the viewership numbers are pretty amazing.

Host:

Interesting. Maybe pivot a little bit and talk about the stock. I think you’ll be the first to agree with me that not every business makes for a great stock. So when you think about Formula 1 from an investment perspective what makes it compelling?

MM:

Yeah. So the background of the sport is really important. So the sport was created in the 1970s by a guy named Bernie Ecclestone and Bernie, he’s hardly a visionary, he’s a British tycoon, entrepreneur.

He’s involved in multiple different businesses and he really just ran Formula 1, as his own little piggy bank, just ran it as a cash cow business. Never really ran it to optimize revenues, never ran it to optimize profits, was never really aligned with the interests of the team and the interest of the sport.

The league traded hands in the early 2000s it was bought by a private equity, and then finally in 2017 Liberty Media bought the company out from private equity. And as a result, kicked out Bernie and introduced their own management team. And John Malone, who’s also on the board also a significant shareholder, in addition to Greg Maffei who’s, chairman of the board and also a significant and shareholder. They’re just visionaries, they know media, they understand media, they own the Atlanta Braves. They own SiriusXM. They own Live Nation.

They’ve just brought a bigger energy to the sport. So since they took the league over in 2017, they have added more sponsorships. They’ve brought the race in the United States, so, obviously they signed Miami. Any day now, I think they are going to sign Las Vegas, they signed the deal with Netflix, which was huge, the Drive to Survive docu-series.

We think they’re going to probably going to add another team here pretty soon, so that there’s so much low-hanging fruit with Formula 1 that just has yet to be extracted. And I think over the next three to five years, especially now that we’re coming out of the pandemic, I think that’s an important point to make. They took over the sport in 2017, they’re doing all these things to reinvigorate the brand and then the pandemic hits, they have to cancel three or four races.

So I think now going forward, you’re really going to finally start to see what the league can do underneath visionary management team. And so I think that’s the underappreciated part of the story is just a lot of low-hanging fruit, both in terms of sponsorship, but also new broadcasting deals.

Host:

MM getting a little bit more specific, and into Cambiar’s quality, price, discipline process. You know, when you think of the company from a characteristic standpoint and the qualities we seek in a business, how does Formula 1 fit within QPD?

MM:

I think this is quintessential QPD, just as a reminder, QPD quality, price, discipline. So quality of the company is outstanding. This is a very scarce asset. It’s a monopoly effectively. There’s only one Formula 1, there’s also NASCAR, but you know, NASCAR’s really largely in the U.S, Formula 1 is a global sport.

We’re not betting on any individual team. We’re really just betting on the sport by owning the league. It’s a lot like if you own the NFL or the MLB, rather than owning the individual teams, this is where we own the league itself. So incredibly scarce asset, it’s a very free cash flow generative business. The company makes 25% operating margins, and because of various accounting rules, they pay very little in taxes.

So 25% operating margins basically trickle down into 25% free cash flow margins. So of every dollar they generate in revenues, 25 cents goes to free cash flow, which is really astounding. That’s as high as a lot of software companies, high variable cost structure. So in the pandemic, even though revenues declined by about a little over 30%, that was because they obviously had fewer races, but also broadcasting revenues were down and ticket revenues were down, race promotion fees were down.

The company was still free cash flow break-even. So we liked that about the business leverage they have also de-levered the balance sheet. They bought the company in 2017, as I mentioned earlier. And they’ve since de-levered the balance sheet quite a bit, both because free cash flow has grown, but also because they’ve reduced debt, they’ve also cleaned up the corporate structure quite a bit.

And as of the summer of last year, Formula 1 also held stakes in the Atlanta Braves and Sirius and Liberty, spun them out as separate companies. So now what you own, or what we own is purely Formula 1, which means they can engage in buybacks, which is something that Liberty is known for. And then on price, we were buying it on depressed earnings. So, coming out of the pandemic, we’re buying it at what looked like about 20 times free cash flow.

We think on normalized free cash flow, this is more like 12 to 15 times free cash flow, which if you consider commensurate assets and there really are no peer groups here. But if you just look at where the Atlanta Braves trade or Man United trades, or where Juventus trades or private multiples for different sports teams, this is in compelling valuation.

And in terms of discipline again, we had been looking at it for some time and definitely piqued my interest, but it wasn’t until the summer when they spun out serious and they spun out the Braves and we had that clean corporate structure where we employed that disciplined approach and took a stake. So I think this is quintessential QPD for us.

Host:

Sounds good. So thinking about risk management’s a big part of Cambiar’s process. So when you think about the potential concerns and maybe in racing terms, some yellow flags that exist with this business, what concerns you the most with respect to potential downside?

MM:

Yeah. So, obviously, another pandemic would be bad. Race promotion fees are a big part of the revenue stream as our broadcast and rights. So if we get another wave, something out of left field that would hurt, they did have a race in St. Petersburg that they now are suspending as a result of the issues going on in the Ukraine.

So that’s one race, but they’ll probably replace that race. And they’ll announce something here pretty soon so that’s another thing that’s worth flagging. I think also it is still a show-me story. This is a company that’s only really been in the hands of Liberty Global for about a little under five years now, and then two of those years was during a pandemic.

So we’re really going to see what Liberty can do with this company. So there’s some execution risks. If viewership numbers start to decline, if the interest in the sports starts to wean, all those things are potential risks, but everything we’ve seen so far, the surveys suggest that social media engagement, especially by the kind of 16 to 35 year old, 40 year old cohort is off the charts. As you know, the championship race between Max Verstappen and Lewis Hamilton late last year was watched by over 100 million people in real time, amazing awareness and engagement on social media.

So everything we could see is that the interest in the sport is only continuing to grow the Drive to Survive season 4 comes out today. The new season starts next Friday, and we’ll get better reads on how engagement looks, but everything suggests so far that things look really solid.

Host:

Great. You mentioned Ukraine and obviously maybe a bigger picture question to wrap up our discussion today, but the recent pullback due to the volatility there, just the conflict across Europe any comments with respect to just the broader portfolio and the international strategy is with respect to what’s gone on in Europe and the Ukraine conflict?

MM:

Yeah, I think what all of this volatility, what it forces us to focus on is really investing in what we call ‘scarce assets’. These are businesses that have significant pricing power. These are businesses that sit in these oligopolistic, duopolistic, competitive positions, definitely businesses that generate a lot of free cash.

You definitely want businesses that don’t have a lot of leverage in this market environment. And whether it’s a company like Formula 1, which as we know, there’s only one of, and they have tremendous pricing power or TSMC, which is the largest dominant global foundry on the planet, and they’re raising wafer prices as we speak.

Or whether it’s Canadian National Rail, which is a duopolistic railroad provider that moves, everything from grain to fertilizer, to potash, to alumina, to aluminum all things that the world is going to need more of because of trying to cut off Russia. That I think that’s really our North Star right now is just focusing on companies that are truly scarce assets.

Host:

Great. That makes sense. Thanks for your time today, MM. I like many am excited for the upcoming season of Formula 1, and I’m looking forward to seeing how the story plays out for the stock as well. To all of our listeners, thank you for tuning in. If you’re looking for more information about the International Portfolio mentioned today, please visit cambiar.com. 

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