CALDWELL'S TAKE VIP - CALDWELL PERSPECTIVE: Analysis of WWE's 17 Business Risk Factors Mar 13, 2008 - 1:50:03 PM

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The following is a free preview of today's Caldwell's Perspective newsletter column analyzing WWE's 17 Risk Factors as named by WWE in its annual yearly earnings report.

WWE issued its yearly earnings report on Friday, March 7 to highlight key financial items from WWE's core business in the fiscal year 2007. One of the sections in the annual report is WWE management's consensus on certain risks the company faces going forward.

The company identified 17 "risks" they face going forward. Despite having record financials in the 2007 fiscal year, WWE still faces significant risks that could greatly affect its business. Following are the risks identified in WWE's report and James Caldwell's analysis of the risks.

(1) Our failure to maintain or renew key agreements could adversely affect our ability to distribute television and pay-per-view programming.

JC: A common theme I'm going to explore in this risk analysis is WWE's dependence on the international market for growth. 25 percent of WWE's business is dependent on international revenue streams, so a significant portion of this risk evaluation will involve WWE's business in foreign markets.

In the area of television programming and distribution deals, I believe WWE is secure domestically on their TV and PPV deals. They have a long-term deal with USA Network for Raw and they just signed a long-term deal with MyNetworkTV for Smackdown. ECW has been extended until December on Sci-Fi, so barring a breach of the contract, WWE is secure for another 10 months. For domestic PPV, as long as buyrates remain steady and the cable/satellite providers are happy receiving their 50 percent cut of WWE's PPV revenue, there shouldn't be any issues.

Internationally, WWE is still cultivating the PPV market. They were previously offering PPV for free in certain markets, and now they are charging an "introductory rate" to international PPV customers. Securing revenue from the international distributors is a significant risk with business being done differently from country to country. From WWE's report: "Failure to maintain or renew arrangements with these distributors or the failure of the distributors to continue to provide services to us could adversely affect our operating results."

(2) Our failure to continue to develop creative and entertaining programs and events would likely lead to a decline in the popularity of our brand of entertainment.

JC: This is interesting, because I think of TNA having terrible television that doesn't sell PPVs, but it actually sells house shows because fans get a chance to see in-person what they're not allowed to see on TV. WWE, though, recognizes the importance of the TV product to sell all segments of their business, especially live events and PPV, which they cal the "core of our business". Often times they struggle to build up PPVs, but WWE recognized change was necessary in the second quarter of 2007 and reported that they were not happy with the hype for PPVs. From the report: "Our failure to continue to create popular live events and televised programming would likely lead to a decline in our television ratings and attendance at our live events, which would adversely affect our operating results."

(3) Our failure to retain or continue to recruit key performers could lead to a decline in the appeal of our storylines and the popularity of our brand of entertainment.

JC: I immediately thought of Jeff Hardy's Wellness suspension when I read this risk item. WWE apparently didn't, though. I've included the full text of WWE's description of this risk factor below, but they do not identify suspensions for Wellness violations as an issue that falls under the category of the product declining if they lose the services of wrestlers.

The report does include a reference to premature death, retirement, or untimely injury having the potential to affect WWE's business. This would have been the opportunity for WWE to magnanimously promote its Wellness Policy as a tool the company utilizes to maintain the health of its performers to maintain their longevity, even if they run the risk of being forced to terminate a wrestler's contract due to multiple violations.

From the report: "Our success depends, in large part, upon our ability to recruit, train and retain athletic performers who have the physical presence, acting ability, and charisma to portray characters in our live events and televised programming. We cannot assure you that we will be able to continue to identify, train, and retain these performers in the future. Additionally, we cannot assure you that we will be able to retain our current performers during the terms of their contracts or when their contracts expire.

"Our failure to attract and retain key performers, or a serious or untimely injury to, or the death of, or unexpected or premature loss or retirement for any reason of any of our key performers, could lead to a decline in the appeal of our storylines and the popularity of our brand of entertainment, which could adversely affect our operating results."

(4) The loss of the creative services of Vincent K. McMahon could adversely affect our ability to create popular characters and creative storylines.

JC: This portion of the "Vince McMahon" risk is related to his creative input, which the report indicates WWE depends heavily on for guiding the creative team. An interesting note here: "The loss of Mr. McMahon due to unexpected retirement, disability or death or other unexpected termination for any reason could have a material adverse effect on our ability to create popular characters and creative storylines, which could adversely affect our operating results."

This could be looked at one of two ways. One way is a message to the creative team to take more responsibility and ownership over the ideas that make TV. Vince McMahon won't be around forever to guide the creative team. Also, depending on whether Stephanie and Shane McMahon read the annual report, it could be a message to them to step up in their creative input as the successors to Vince's position of leadership in the company.

(5) A decline in general economic conditions could adversely affect our business.

JC: There were several reports that came out from financial websites after WWE's strong fourth quarter earnings report that declared WWE has shown they are not affected by economic fluctuations. Again, looking at this from the perspective of the international market, if there are significant changes in the global economy, WWE could be affected if past customers are no longer able to spend money on WWE's product.

From the report: "The demand for entertainment and leisure activities tends to be highly sensitive to the level of consumers' disposable income. Unless the U.S. economy experiences a significant recession period or the U.S. housing market takes a very significant tumble, WWE's business shouldn't be affected by changes in the U.S. market, thanks to strong diversification of its core business segments.

(6) A decline in the popularity of our brand of sports entertainment, including as a result of changes in the social and political climate, could adversely affect our business.

(7) Changes in the regulatory atmosphere and related private-sector initiatives could adversely affect our business.

JC: These items identify that WWE's business always runs the risk of taking a hit if the wrestling cycle swings downward again, such as when the Attitude era boom period ended after the WCW acquisition. Looking at this internationally, WWE has to work within the political climate of each county they have a presence. As an example, there were newspaper articles in Spain recently that called for the end of WWE programming due to the content.

WWE identifies that in a broader perspective: "Our operations are affected by consumer tastes and entertainment trends, which are unpredictable and subject to change and may be affected by changes in the social and political climate". If WWE loses a foothold in these international markets that make up 25 percent of their business, other countries could follow suit like dominoes and force WWE to work harder to secure those lucrative markets.

From the report: "A number of domestic and foreign governmental and private-sector initiatives relating to the content of media programming have been announced in recent years. Changes in these governmental policies and private-sector perceptions could further restrict our program content and adversely affect our levels of viewership and operating results."

(8) The markets in which we operate are highly competitive, rapidly changing and increasingly fragmented, and we may not be able to compete effectively, especially against competitors with greater financial resources or marketplace presence.

JC: There are two parts to this one from WWE's description of the risk. It's important to establish context that WWE might be the fish in the wrestling pond, but they are a small fish in a huge financial market pond. WWE is a mid-sized company and they identify their key competitors are professional and college sports organizations, which have monopoly protection from the U.S. government, and the ability to command advertising dollars, and grab precious time away from potential WWE consumers.

There is a touch of woe-is-us in the report, as they claim other companies have greater financial resources. From the report: "Our failure to compete effectively could result in a significant loss of viewers, venues, distribution channels or performers and fewer entertainment and advertising dollars spent on our form of sports entertainment, any of which could adversely affect our operating results."

The second part to this is identifying the other "pro wrestling" competition WWE recognizes. WWE does not identify any other companies by name, but simply recognizes those promotions as competitors "from other forms of live and televised entertainment and other leisure activities in a rapidly changing and increasingly fragmented marketplace."

It's interesting WWE has this note because they have said in previous conference calls with investors that they don't consider......

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