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World Wrestling Entertainmenthas been slammed to the mat in the last year,with shares falling by more than 60% from their high. Is this an opportunity for investors to grab some shares at an attractive entry price, or is it better to stay away until it becomes clear the company can turn things around?
Going the way of Netflix
WWE is a company in transition: Management is trying to change the business model from the current pay-per-view model to one that relieson online subscriptions. Early last year, the company launched its WWE Network online video service, which provides access to new programs and a huge library of content for $9.99 a month. This includes pay-per-view content such as the remarkably popular WrestleMania and SummerSlam events.
Management made multiple references toNetflixduring the latest earnings conference call, and the company seems to be borrowing pages from the video streamer's playbook. While new subscribers were originally required to make a six-month commitment, the new policy allows for cancellations anytime, and the company also offered a free month for new subscribers in November.
This strategy is risky, but it offers plenty of upside potential if the company can build a sufficiently large subscriber base. Under the new business model, WWE has more control over its content and distribution as well.
By the numbers
Management estimates that the companyneeds approximately 1 million subscribers to break even on operating income, a considerable increase from the 731,000 subscribers logged at the end of the third quarter. However, profitability should increase substantially as revenue grows. Most of the company's costs are relatively fixed, and adding a new subscriber costs practically nothing to WWE, so incremental revenue should have a big impact on margins.
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Based on WWE estimates, operating income will be between $17 and $37 million if the company reaches 1 million average subscribersin 2015. An increase to 1.5 million average subscribers would bump operating income between$72 and $92 million. With 2 million average subscribers, management believes it could turn an operating profit in the range of $127 million to $147 million.
Can WWE succeed?
WWE Network had a promising start, generating 495,000 net additions during the initial launch period. However, growth has materially slowed since then, down to only 31,000 net new subscribers during the third quarter. At this rate, there is little visibility regarding the company's ability to actually surpass the 1 million mark and reverse its current losses.
Not only is the growth rate disappointing, but the churn rate looks quite worrisome. While the company gained 286,000 subscribers in the third quarter, it also lost 255,000. Management might need to take a deep look at why this is happening and how it can reverse the trend if it wants to accelerate growth in a sustainable fashion.
However, it's not allbad news for the company. WWE benefits from a remarkably loyal fan base, and viewer data is showing some positive engagement trends. According to the company, nearly 90% of subscribers access the WWE Network at least once per week, while 99% access the network no less than once per month.
Management expects a gradual ramp up in subscriber gains as consumer awareness grows, and potential customers become more familiar with the technology. International expansion could also be a major growth driver if the company plays its cards well. The U.S. version of WWE Network is currently available in more than 170 countries, and management plans to localize the product over time.
WWE Network also began including a limited amount of advertising in October, partnering with giants such asPepsiCoandMattel. The company needs to be careful not to detract from the viewing experience, but advertising could be a smart way to generate incremental revenue and higher profitability.
As long as the company keeps losing money and burning cash, WWE is clearly a risky investment proposition. However, there is also solidupside potential if WWE Network can gain traction and accelerate membership growth. WWE looks like a typical high-risk, high-reward situation.
Since profitability depends heavily on WWE Network subscriptions, it might be wise to waitfor a clear sign of accelerating growth before taking a long position in the stock. Even if this means paying a higher entry price, WWE should still have something to offerin a bullish scenario.
The article WWE Slammed by 60%: Buying Opportunity or More Pain Ahead? originally appeared on Fool.com.
Andrs Cardenal owns shares of Netflix. The Motley Fool recommends Mattel, Netflix, and PepsiCo. The Motley Fool owns shares of Netflix and PepsiCo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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