While SFX Entertainment (NASDAQ:SFXE) proclaims itself to be a leader in EDM and house music festivals, we believe that SFXE is actually a house of cards headed towards imminent collapse. Despite owning a portfolio of popular EDM concerts, SFXE is over-levered, unprofitable, and burning through its cash reserves at an alarming rate. All an investor needs to do is connect the dots, focusing on the CEO’s actions, the recent debt offering, and absence of 8-K exhibit filings. Investors do not want to be caught holding SFXE shares when the bass drops.
What happened to Robert Sillerman’s 10b5-1 plan?
On June 11, 2014, SFXE announced that Chairman and CEO Robert Sillerman had instructed his advisors to enter into a Rule 10b5-1 stock purchase plan to purchase up to 2 million shares of SFXE. The release states, “Robert F.X. Sillerman, Chairman and CEO of SFX Entertainment, Inc., today announced that he instructed his advisors to file a stock purchase plan under SEC Rule 10b5-1 promptly following the Company’s release of its second quarter financial results in August 2014. Mr. Sillerman’s plan will have a term of one year and provide for the purchase of a maximum of 2 million shares of SFX Entertainment.”
SFXE shares closed the day at $6.96.
On the August 14, 2014 second quarter 2014 earnings call, Robert Sillerman confirmed the Rule 10b5-1 plan and stated that he thought SFXE shares provided compelling value. In his opening remarks, he said, “I announced a 10b5 program, which will have a term of one year, where I will acquire or seek to acquire up to 2 million additional shares. There’s no greater expression of my confidence in the platform, the people who are achieving this and most importantly the loyalty and affection of our fans; they are here to stay.”
Later in the Q&A section, he added, “I am very comfortable with the QMA position, and I’m demonstrating that by a 10b5 that is put in place, and details of which will be forthcoming.”
On the strength of Robert Sillerman’s comments, shares of SFXE closed at $6.75, up 4% on the day.
Despite two announcements of entering into a 10b5-1 trading plan, Robert Sillerman has not purchased a single share of SFXE stock. Any share purchases by executives, even those executed under a 10b5-1 plan, are required to be filed in a Form 4 within two business days. These requirements are clearly outlined by the SEC in this document. As seen here, purchases by executives under a Rule 10b5-1 plan are not exempt and must be filed in a Form 4. SFXE has not filed a single Form 4 outlining any purchases of stock by Robert Sillerman.
We do not know if the CEO has canceled the plan, but we do know that no insiders have purchased a single share of SFXE in the open market. The share price has fallen by over 33% since the second quarter earnings announcement, which is when the 10b5-1 plan was put in place. The CEO’s 2 million shares would have cost him $13.5 million after the second quarter conference call. They would now only cost him $9 million.
If SFXE shares were so compelling at $6.75, why hasn’t Sillerman purchased any shares as they’ve fallen to $4.49? The shares must look like a veritable bargain now. Assuming Sillerman hasn’t bought any shares, a good assumption given the obligation that he would have to file a Form 4, he has saved himself at least $4.5 million. We believe Sillerman has not purchased any shares because he doesn’t want to throw his money away.
SFXE raised debt because it’s burning so much cash
On September 24, 2014, SFXE raised $85 million of second lien senior secured notes due in 2019. Total debt now stands at $305 million, all due in 2019.
On September 18, 2014, Moody’s rated the notes Caa1. This rating is several notches below investment grade, meaning that Moody’s believes that the notes carry significant default risk. Moody’s defines corporate bonds rated Caa as “to be of poor standing and are subject to very high credit risk,” as seen here.
Historically from 1920 to 2007, corporate bonds rated in SFXE’s range had a cumulative default rate of 42.9% over a five-year period, as seen on page 24 of this Moody’s report. That means that approximately two in every five of these lowly rated companies default during a similar five-year period as these bonds default. This compares to a 1.7% cumulative default rate for Investment Grade bonds and 16.7% for Speculative Grade bonds. Based solely on SFXE’s rating, it’s nearly a coin flip as to whether or not the company defaults.
But the chances of default look much higher when SFXE’s financials are analyzed. SFXE burned through $48 million of cash in the second quarter alone, and finished with $59 million of cash and $162 million of net debt. This is significant financial deterioration from the end of the first quarter 2014 when SFXE had $106 million of cash and $124 million of net debt.
These EDM festivals, despite being popular, aren’t nearly profitable enough to finance SFXE’s operations much less service its debt or fund its acquisition spree. In the first half of 2014, SFXE reported an operating loss of $79 million and a net loss of $107 million. EBITDA in 1H 2014 was negative $32 million, which is a loose proxy for cash flow. Even on an adjusted EBITDA basis, which is the most favorable way for SFXE to report its financials, it lost $22 million in the first half of 2014.
Without its recent capital raise, if SFXE had continued its current cash burn rate, it would be out of cash by the end of the year. We believe this is why SFXE rushed to raise additional debt despite having to increase the consent fee by 400% from $2.50 per $1,000 to $10.00 per $1,000 principal amount. It is also most likely why Robert Sillerman has refused to purchase any SFXE shares.
While Sillerman has not purchased any stock, we do acknowledge that Robert Sillerman did purchase $10.0 million of the 2019 notes in a private placementon September 18, 2014. Presented with the choice of equity or debt, Robert Sillerman chose to invest in the debt of SFXE, which is structurally senior, rather than to purchase equity and align himself with suffering shareholders. We believe this is a clear signal of his views regarding SFXE’s equity value…
Additional red flags and who is the CFO?
There are additional red flags that we have observed with SFXE. First, despite claiming that SFXE has signed $50 million to $60 million in Qualified Marketing Agreements (QMAs), SFXE has not filed any of these agreements as exhibits to its financial reports. The SEC requires “material definitive agreements” to be filed as an 8-K and included as an exhibit in the next registration statement (SEC Disclosure Requirements).
These QMAs are supposedly significant for SFXE and the company claims they will contribute meaningfully to profits and cash flows. We question how material they actually are when the company refuses to file these agreements as exhibits. Either the agreements are material and the company violated securities laws or the agreements are immaterial and the company misled investors. Frankly, both possibilities should trouble investors.
Lastly, we ask, “Who is in charge of these loose financial controls?” We’ll note that the CFO Richard Rosenstein (bio here) doesn’t have a CPA or CFA and has no prior training as a CFO in any capacity, at either a private or public company. He does, however, have experience as a stock analyst and previously worked at Keel Capital Management LLC, a failed hedge fund thatclosed in 2007.
Conclusion: SFXE price target of $0
We believe that SFXE will go bankrupt and that the equity is worthless. We have set a mid-term price target of $0. There is simply too much debt at the company. Cash burn is high and net debt levels have been increasing. We believe the risk of default is high and increasing by the day. In addition, we believe SFXE is trying to hide the truth from investors. Despite touting the significance of its QMAs, SFXE has refused to file the QMAs as financial exhibits, which means that they must not be material agreements. The SEC has clear rules for materiality and required filings.
Lastly, Chairman and CEO Robert Sillerman has not purchased stock in SFXE despite multiple statements regarding an 10b5-1 plan. We believe this is the clearest message possible that even SFXE doesn’t believe its equity is worth investing in.
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