By Adam Swift | September 30, 2007
As a privately held company, Zuffa is under no public reporting obligations. As a result very little financial information is made public. The numbers that do see the light of day are carefully screened and released only when convenient to tout the growth and success of the UFC brand. As result the company’s financial status and business model are largely left to speculation. But a recent series of reports by Standard & Poor’s, one of the leading financial services companies in the world, have provided a new insight into the finances of the undisputed leader of the MMA world.
The headline was a cut in the company’s credit rating outlook, from stable to negative, but the rest of the report revealed a still growing business. While profit margins are down substantially due to European expansion efforts, pay-per-view, the company’s key revenue source, is actually up 35 percent through the first quarter of the year. Furthermore, despite more than doubling operating costs from a year ago, the company remains profitable.
S&P initiated coverage on May 21 assigning Zuffa a credit rating of BB. A BB rating reflects a company that is less vulnerable in the near term than other lower-rated obligors. However, it indicates that Zuffa faces ongoing uncertainties and exposure to adverse business, financial, or economic conditions which could lead to its inadequate capacity to meet its financial commitments. Bonds rated BB and below are considered junk bonds due the risk of failure associated with the companies that issue them. At the time S&P issued the following outlook:
The stable outlook reflects our belief that Zuffa’s ability to successfully market UFC events will continue to drive strong revenue and cash flow growth through the next few years. We also believe UFC has gained a solid niche following, which will add stability to the company’s financial profile over the intermediate term. A shift in consumer interest away from MMA or a shift to a more aggressive financial policy could lead to downside rating pressure. Conversely, if the company continues to drive increased interest in the sport over the intermediate term while maintaining currently healthy EBITDA margins and free cash flow generation, the outlook could be revised to positive.
According to S&P, roughly 75 percent of the company’s revenues are generated through the production of live events. Pay-per-view buys account for the lion’s share of live event revenue with the gate playing a much smaller role. By way of example, while the average show might generate $2 million at the gate (ticket sales), it generates at minimum roughly $4.8 million in pay-per-view revenue (assuming 300,000 buys and a 60/40 split between Zuffa and the PPV distributor). The company’s contract with Spike TV and assorted sponsorship revenues account for the remaining 25 percent of revenues.
Last year Zuffa experienced what can only be described as explosive growth. In 2006, S&P reports that the average buy rate per event nearly tripled compared with the previous year. As a result the company’s EBITDA margin (EBITDA represents earnings before interest, taxes, depreciation and amortization, an EBITDA margin is akin to a profit margin) more than doubled from the mid-teens in 2005 to more than 40 percent of gross revenues in 2006. It is believed that Zuffa grossed $190 million last year and posted a before tax profit of $76 million.
Entering 2007 Zuffa was expected to post an EBITDA margin of more than 50 percent. Instead, while pay-per-view buys for domestic events have increased 35 percent over the first half of last year, and total revenue growth is up 30 percent, there has still been a more than 50 percent decline in the company’s EBITDA margin due to dramatically increased operating costs. Operating costs have more than doubled thanks to production costs associated with the two events held in the U.K and an aggressive marketing campaign to establish the brand in the U.K., the scale of which was criticized by the company’s financial officers according to Dave Meltzer. As result the company’s EBITDA as a percentage of gross revenues has fallen to roughly 20 percent for the year thus far.
S&P “expect[s] the company to reduce the scale of its international UFC bouts going forward, with the intent to limit potential losses generated by these events and return consolidated cash flow to a level more consistent with 2006 results.” It will be interesting to see if the company can meet this expectation given White’s stated commitment to the European market place and aggressive expansion plans. However, despite this anticipated cost reduction, the company is not expected to return to its previous EBITDA margin of 40 percent because of “increasing fighter costs and production expenses for domestic content.” S&P’s most recent report from September 14, concludes that the UFC’s credit outlook is negative:
Failure to improve the company’s currently depressed margins through more stringent cost controls and continued top line growth or a shift to a more aggressive financial policy over the intermediate term could lead to a downgrade. Conversely, if the company can restore its previously strong credit metrics through cash flow growth and debt repayment, the outlook could be revised to stable.
Credit rating outlook aside, the numbers behind the headline reflect a healthy growing business. While profit margins are down substantially due to European expansion efforts, pay-per-view, the company’s key revenue source, is actually up 35 percent through the half of the year. However, it is important to note that the first half of last year was significantly weaker than the second half of the year, while this year’s first half may end up being the strongest.
Check PAYOUT tomorrow for a UFC Pay-per-view forecast for the rest of the year.