Alpha Exposure

About the Author Alpha Exposure

Alpha Exposure writes about long term fundamental investment ideas, and invests in them as well. This author has substantial investment research experience.

SFX Entertainment Inc (SFXE): The House Of Cards Is Collapsing

In October 2014and November 2014, we wrote up our short case on SFX Entertainment Inc (NASDAQ:SFXE). Our write-ups highlighted SFXE’s over-levered balance sheet and heavy cash burn and warned investors of an upcoming collapse in SFXE’s share price. Since our publications, SFXE shares are down over 70%.

Recent negative developments at the company and continued cash burn make us believe the company is now hurtling towards bankruptcy. We remain short shares of SFXE with a price target of $0.

Robert Sillerman has pulled his bid

We never believed Sillerman’s bid (here) was legitimate. First, Sillerman had no financing in place. Second, Sillerman stated he’d vote for a better deal if it was only 2.5% higher than his bid. We believed this did not indicate firm interest on his part and that it was merely bait as he fished for a buyer. Lastly, it appeared that Sillerman himself had cash issues. His termination fee, should he walk away, was payable in shares of SFXE and not cash. Also, the provision that allowed shareholders to stay in the equity in the private NewCo suggested that Sillerman would prefer to spend less cash in taking the company private.

When Sillerman failed to meet SFXE’s request for financing commitments last week (here), we weren’t surprised. We believe his statements that he is still interested in taking SFXE private, albeit at a lower price, don’t carry much water either. We will explain why below.

It’s easy to see why Sillerman walked away: SFXE is hemorrhaging cash

The cash burn issues that we highlighted previously have only continued at SFXE. It has failed to produce positive CFFO in any single quarter since going public and net leverage has risen every single quarter.

It’s also worth noting that cash flows and net leverage would be even worse if Spotify had not advanced SFXE $10 million for their Content Agreement (see Note 15 in the 2Q 2015 10-Q here). While a $10 million upfront payment is nice, it’s still less than 3 months of cash burn at the company.

Limited liquidity sources remaining

SFXE’s liquidity issues are evident in other ways as well. First, SFXE disclosed in Note 5 of its 1Q 2015 10-Q (See “Credit Facility Second Amendment” here) that Barclays had pulled its credit line and required SFXE to fund 105% of any amount it wishes to borrow on the Revolver. Second, it was reported by Forbes in early August (here) that SFXE had stopped paying distributors and music labels for putting their music on Beatport. While this was resolved shortly thereafter (here), it is not an indication of financial strength at SFXE.

In fact, things have gotten so bad that despite the egregious lending conditions with the Barclays credit line, SFXE withdrew $24.2 million under the Revolver and only had $5.9 million of availability, as of June 30, 2015 (See “Liquidity and Capital Resources” here). In order to collateralize the revolver, SFXE had to borrow money from Sillerman Investment, an entity controlled by Robert Sillerman, and pay a 12% interest rate.

With additional debt availability severely restricted and expensive, any future capital injection would require equity. However, SFXE’s ability to tap the equity markets is effectively shut off after its disastrous share issuance on June 17, 2015 (here). SFXE shares quickly broke the $4.34 issuance price and fell 70%. We don’t believe any shareholders would be interested in another deal.

SFXE itself acknowledges its liquidity issues in its latest 10-Q filing (See “Future capital requirements” here). It noted that it has significant cash needs coming up:

Furthermore, SFXE is not certain it can meet these financial requirements:

The bond market has certainly reacted negatively to the SFXE disclosures and news flow. SFXE bond prices have collapsed in the last three weeks, according to internal runs from Barclays, which underwrote the debt. It appears that debtholders think a default or bankruptcy is highly likely and that SFXE’s equity is worthless.

The signs of the company’s disintegration aren’t limited to the financial markets. A quick review on indicates that SFXE is losing employees (here). One employee wrote on June 2, 2015, “get your money out before you go bankrupt…will probably be this year.”

Other reviews echo similar sentiments:

The average review for SFX Entertainment is 1.9 stars with a deteriorating trend.

Has EDM peaked?

Lastly, it appears that the popularity of EDM music festivals has peaked, or at least the popularity of SFXE’s properties. First, SFXE’s Deferred Revenues balance in 2Q 2015 shows a decline, despite continued acquisitions and a greater number of festivals. Ticket sales collected in advance of an event are recorded as Deferred Revenues by SFXE. If the festivals were growing in attendance and people were purchasing more tickets, we would expect an increase in Deferred Revenues. The opposite is happening for SFXE, which indicates that ticket sales are likely declining.

This is especially alarming because SFXE is hosting more festivals this year in the 3rd quarter than last year, and more festivals are on sale as of the end of the quarter. This is an indication that the festivals are seeing falling ticket sales, which is alarming for SFXE’s future prospects.

The lower attendance trend is evident in other channels as well. If one looks up popular SFXE festivals such as Tomorrowland on Google Trends, you can see that search trends have peaked and are declining.

Mysteryland, a major festival in the Netherlands since the 90s, appears to be in rapid decline.

Life in Color, which helped popularize “paint parties,” appears to have peaked and interest is now waning.

Most shocking, the decline in popularity appears to be global. Stereosonic, a major festival in Australia, has been seeing declining search trends.

Google Trends shows similar declines in other major SFXE properties such as Electric Zoo and Sensation, as well as for the term “Electronic Dance Music.”

Conclusion: SFXE remains a compelling short

We believe SFXE is under significant financial duress. It is quickly burning through cash and has limited financing options. We believe the company is on its way to bankruptcy and that Robert Sillerman’s latest interest in taking the company private carries little weight. While the company and Sillerman have stated that SFXE extended the offer period to October 2, 2015 in order to “allow potential bidders and their financing sources to have visibility into the Company’s performance during its peak festival season,” we believe this is a false statement. Deferred revenues, a proxy for ticket sales, are declining, and SFXE has substantial cash requirements that it says it may not be able to meet. We believe management has stepped away because they can see that SFXE is going to go bankrupt. We share this view and have a price target of $0.

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