Efficient Scale and Intangible Assets Support International Speedway's Narrow Moat

 International Speedway's narrow economic moat remains intact, extending from efficient scale and intangible assets. Efficient scale is relevant when a product is offered to a limited-size market and the operator can efficiently serve the end users, keeping competitors away. We think this holds true for International Speedway, as the need for more than one track in any major metropolitan area would be unlikely, given high costs associated with such a project coupled with the likelihood of weaker returns for all track operators in the location. We doubt NASCAR would sanction another race in the same geographic location and find it unlikely that another racing organization could enter a market and have clout with track operators, given NASCAR's established credibility.

We believe the fact that all parties (sponsors, drivers, teams, and track owners) can be financially motivated to reach common goals helps foster a powerful intangible asset competitive advantage. Drivers are encouraged to participate to get paid purse monies and accumulate points, which satisfies sponsors and track operators that depend on driver appearances to increase brand loyalty and ticket sales. This intricate financial model, developed over the history of stock car racing, has generated some of the most lucrative sponsorship and licensing relationships across the major sport categories. While admissions and concessions have declined over the past five years, NASCAR recently secured a 10-year $8.2 billion contract, representing a 46% increase in annual rights fees over the prior contract. We believe this development indicates that stock car racing and the NASCAR brand still carry influence with sports fans (and sponsors), and we think declining attendance is a cyclical rather than secular phenomenon. This intangible asset has allowed International Speedway to increase motorsports-related revenue steadily and stay profitable over time.

Efficient Scale Provides Foundation for International Speedway's Moat
We think International Speedway benefits from efficient scale, as the need for more than one track in any major metropolitan area would be unlikely. In our opinion, a competitor opening a track in an already occupied market would have negative implications on returns on invested capital for both track operators, affecting profit potential for each and discouraging such a project during feasibility analysis. Between International Speedway and its nearest competitor, Speedway Motorsports , nearly half of the top 20 media markets already have an existing speedway, and a number of the remaining cities have scarce land resources for a new track (New York and Boston, for example), rendering them an unlikely choice for the development of a new track. We would be concerned that top unoccupied markets would either be prohibitively costly to build in (which would change the economics of the business) or the location would be too far removed from the masses for enough of the population to reach easily.

There has not been a major raceway constructed in more than a decade, but we would expect the construction of a new track would be at least incrementally more expensive than some of the more recent tracks that have been built, like Chicagoland (estimated cost of $130 million), Kentucky ($153 million), Fontana ($100 million), and Texas ($250 million), deterring such a project. As Kentucky Speedway's original owners learned the hard way, when you build a new track, there is no guarantee that NASCAR will award the track a race date--and without a Sprint Cup race and the corresponding broadcasting revenue, the payback period on such an investment can become very lengthy; it took Kentucky 10 years and a new owner to get a Sprint Cup race date. With a finite number of races for NASCAR to sanction between February and November, owners of new locations are better positioned to purchase an old track with an allocated race date and try to have the date transferred to the new track, but there's no guarantee. Again, a new track would have to be in a market that doesn't already have one but is close enough (within a few hours' drive) to attract masses of fans, and most markets are already served.

International Speedway's competitive position could be threatened if another race-sanctioning body were to organize, but we deem this highly unlikely for numerous reasons. First, NASCAR has been the leading authority for more than 60 years, creating the industry rules and regulations that are in place and accepted. Second, NASCAR has long-term relationships with numerous sponsors and licensees, which would be difficult to replicate. Finally, the France family's ties with NASCAR would probably create a roadblock to any other organization accessing the demand from International Speedway's popular facilities.

Despite Attendance Decline, Racing Still Captures Significant Gains in Media Rights
Attendance and spending at tracks has declined consistently over recent years, and we harbor concerns about when consumers will return to the track and whether the operators will be able to pass price increases through at previous rates. We view stock car racing as an entertainment prospect rather than just a motorsports offering, and we remain concerned that it must compete for consumers' discretionary dollars, which can be spent on other sports, vacations, or hobbies. This clouds our comfort with International Speedway's ability to generate excess economic returns over an extended horizon and ultimately prevents the company from capturing a wide moat. Track-generated revenue (admissions and concessions) has ticked down approximately 45% from peak levels in 2007, and we think it could take a considerable amount of time to bring these revenue streams back to historical levels; we don't have the company reaching peak levels again throughout our 10-year forecast. With admission and concession growth of 2%-3% annually over the next decade, we think the segments could deliver approximately $225 million in revenue by 2022, versus $338 million in 2007 at the peak of consumer confidence (it was $182 million in 2012).

While entertainment and leisure spending has begun to resume, we believe the category strength is coming from high-end consumers. Nearly half of NASCAR fans earn less than $50,000 per year, a demographic segment that was disproportionately affected by the last recession. Extended unemployment, stagnant wages, and high ticket prices could deter ticket sales from rising rapidly across this core consumer base.

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We still think the NASCAR brand resonates with consumers, which is one of the key components of the intangible asset source for our narrow moat rating. Despite historical declines in attendance, the sport continues to generate interest among fans, which has led to healthy increases in media rights over the last decade (across NASCAR and all major sports categories). While the broadcasting contract represents an important percentage of locked-in revenue, we don't consider it alone in assessing the strength of International Speedway's moat. However, we view the value and duration of the broadcast contract as an indirect indication of NASCAR's brand strength and interest by fans. Without fan interest, sponsors would not pay for advertising, ultimately leading to lower broadcast rights. Over the last three contract cycles, we have seen massive increases in media rights, which indicates to us that interested parties believe the sport will have a valuable fan base through at least 2024, when the new broadcast contract is set to expire. The broadcast contract that NASCAR announced with Fox and NBC this summer is expected to generate revenue of $8.2 billion over 10 years (2014-24), which represents $820 million per year, a 46% annual increase over the $560 million per year average the current contract is earning for the sport.

Without this contracted revenue, we would be significantly more negative about International Speedway's moat, as the business' financial stability would become more precarious. During periods of economic calm, ticket and concession revenue tends to increase, allowing the company to turn a healthy profit solely from operating the tracks. However, during periods of economic duress, admissions and concession revenue can slip consistently (it fell at a double-digit pace annually between 2009 and 2011), making broadcast revenue a more important stream of income that ultimately helps track operators turn a profit; it contributed 46% of total revenue in 2012. Throughout the most recent economic downturn, the operating income from media rights has exceeded the company's total operating income, indicating that if the tracks were standing alone, they would probably be operating at a loss. However, the sport is built on a particularly symbiotic relationship among broadcasters, sponsors, drivers, teams, and tracks, where none can exist without the other. This keeps us reassured that the financial stability of the sport will remain and profitable track operations will resume as fans return.

Creative Opportunities Offer Upside to Revenue Potential
We contend that meaningful earnings growth can come from adding new revenue-generating streams to the existing infrastructure, primarily by adding entertainment or destination aspects to the business. The least capital-intensive way to do this is to host additional events outside racing at current track locations. During 2013, tracks have hosted multiple music events at different locations, adding to total revenue on nonrace weekends. While concert promoters run these shows and capture the majority of the profits, we view positively any incremental profit from a track that would otherwise remain idle, as long as the crowds maintain the infrastructure.

It was recently announced that Bristol Motor Speedway would be hosting a Virginia Tech-Tennessee football game in 2016--another area to which motorsports facilities could feasibly cater. International Speedway doesn't offer information on the profitability of these events, but competitor Dover Motorsports disclosed that a three-day festival earned approximately $570,000 in fees. We think after deducting moderate expenses for an event, a dozen events in total would add approximately $0.07 per share to earnings each year and over the next decade would tick our fair value estimate up by almost $2.

Additionally, we think the joint venture with Penn Gaming to add the Hollywood Casino at Kansas Speedway was smart and could be replicated with similar partners at other racetrack locations. While these projects require a commitment of capital (the Kansas location cost $380 million shared between partners), the company operates in at least a few markets that legally allow some form of gaming--notably Florida, Michigan, and Arizona. We perceive state legislation as the biggest threat to successful expansion in this category, but contend that additional job growth and potential state revenue tied to a new casino could be factors that could help sway lawmakers if presented properly. Management forecasts the Hollywood Casino at Kansas to deliver $8 million in income during 2013 (its first full year of operation), which we think can grow about 65% over the next decade as consumer spending strengthens in a stabilizing economy.

If the company can duplicate this at two additional locations that could come on line by 2018, it could add at least an incremental $0.35 per share to earnings in the casinos' first year of operation and another $8 to our fair value estimate (if we assume equity income from the new locations grows at just 3% per year perpetually). We think this could be more meaningful if these casinos grow on a trajectory similar to Kansas.

The company recently announced the revival of its Daytona One project alongside its Daytona Rising project. This project, which is expected to cost approximately $400 million, will revamp the front stretch of the storied Daytona International Speedway and develop a mixed-use entertainment-oriented destination slated to include shopping, dining, theater, and hotel facilities. As a 50/50 joint venture with the developer, International Speedway doesn't carry the full risk a sole developer would, and we expect this will allow the company to keep its investment-grade status, unless it has underestimated the true cost of the project, which could cause it to draw on its revolver for an extended period. Projects that create a destination generate incremental revenue on race weekends but provide year-round income for the business during quieter periods, helping the track become better at self-funding renovations from working capital. The wild card with this specific project is that management doesn't see it becoming accretive to earnings until three years after completion (although it will be accretive to EBITDA immediately), a time frame (2019) we see with very opaque transparency due to limited visibility on economic conditions that far out.

The aforementioned projects require finite amounts of capital, something that we would prefer for an already capital-intensive business. In the past, allocation of capital has been spotty across the industry as opportunities are scarce, leading to either the acceptance of bad projects or overpayment for properties. For example, International Speedway recently sold its Staten Island property, which had originally had been purchased for a new track because of its proximity New York City. However, the company couldn't garner the political support for approval to land use changes, and a feasibility analysis no longer indicated a reasonable outcome--both issues we think should have been resolved before the company purchased the property in 2004. We don't believe this means International Speedway is a frivolous capital allocator; instead, we think it has more to do with the timing and lack of visibility management had about the oncoming recession than lack of due diligence. We believe management now takes a significantly more prudent stance on projects, with ticket and concession revenue still materially depressed from peak levels.

Shares Positioned for Upside When Consumer Spending Trends Improve
We believe shares are about fairly valued, though asset utilization opportunities could offer upside potential. Our $33 fair value estimate includes expectations that interest in the sport remains stable or improves, which will allow International Speedway to pass along steady, minimal ticket price increases to the end user. Over the next decade, we forecast admissions revenue will rise in the low single digits on average (after a 2% decline in 2013), with food, beverage, and merchandise growing at a similar pace. Our forecast includes operating margin expansion to 26% as attendance resumes a healthier and more normalized growth path if the economy continues to improve.

We deem International Speedway's valuation as fair based on the company's current opportunities, despite its protected competitive position. However, we believe there could be meaningful multiple expansion if the company takes on new projects (for example, casinos) or the state of the consumer improves faster than we currently anticipate. We would look to sustained consumer confidence metrics to lead an upswing in earnings potential and indicate an interesting entry point for investors. Longer term, we think significant infrastructure improvements are unlikely at many of the tracks, as numerous changes have already been undertaken during the past five years. We would still wait for a pullback before investing. In our opinion, investors could overreact to spending on the Daytona Rising project or weaker-than-expected early indications of ticket interest, providing a buying opportunity.