The Value of Scalpers - Why Ticketmaster Has It All Wrong - Part I

Ticket sales agencies, ever protective of their exclusive right to sell (and profit by the sales of) tickets to sporting, cultural and other events, have waged war against "scalpers", i.e. ticket resellers, for years, if not decades. Many states have on the books, either now or at some time in the past, laws against scalping, especially if the resale price is above the ticket's face value. On June 8, 2009, the Wall Street Journal published an article how Ticketmaster is using paperless technology, familiar to many from airline e-tickets to thwart scalpers. The article is available here. It is interesting how a technology designed to simplify the life of purchasers and increase their flexibility is being adopted primarily to constrain those purchasers.

It is the view of this article that Ticketmaster, in waging war against scalpers, is actually hurting itself. Scalping could not exist without demand, in a way similar to how cocaine or marijuana supply could not be lucrative if there were no serious demand for it. As an important aside, this author does not support the usage of drugs, or criticize the efforts of federal and state agencies to remove the scourge of illegal drugs from society. It simply analyzes the impact of such efforts on the market, as a way of understanding the impact of anti-scalping activities. Furthering the analogy, the more Ticketmaster attempts to thwart scalping, similar to governmental efforts to interdict drug flow, the more that the price actually goes up. Using simple supply and demand, assuming demand does not change, then as supply is constricted - either by Ticketmaster using its e-tickets / state laws or the DEA stopping drug flows - the price must rise. As the price of each ticket - or gram of cocaine - rises, the greater the incentive of the holder of product has to perform the blocked activity. Fortunately for Ticketmaster, concerts are not quite as addictive, and thus the price of tickets never rises to such an extent that the Medellin cartel or other violent groups will get involved in scalping, perhaps with the exception of Tupac Shakur concerts.

Leaving narcotics out of the picture (at least for now), let us examine the economics of concerts, and see the impact with and without scalpers.

Ticketmaster had the following sales and profit figures in 2008, 2007 and 2006, as reported in their 2008 annual report.

• 2008: $1.44BN revenue, $526MM (36.5%) gross profit, $954MM loss, mostly due to a major one-time goodwill impairment charge. As such, its recurring operating profit is more on the order of $140MM (9.7%).
• 2007: $1.22BN revenue, $474MM (39%) gross profit, $216MM (18%) operating profit.
• 2006: $1.06BN revenue, $426MM (40%) gross profit, $225MM (21.2%) operating profit.

It is interesting to note that their gross profit has been shrinking as their revenues have increased, mainly due to an increasing cost of sales. If we look at the accounting treatment for Ticketmaster, on page F-9 of their 2008 10K, we will see that Ticketmaster (probably correctly, but I am not a tax attorney) does not recognize the entire face value of the ticket as revenue, and then deduct the payments to the event organizer clients. Rather, Ticketmaster recognizes as revenue the portion of the ticket sale payable to it, primarily fees and perhaps any amounts paid as incentive. For example, if Ticketmaster sells a ticket to the upcoming Connecticut Bruce Springsteen concert for $104 face value, and charges a $5 handling fee, it will recognizes $5 in revenue. Additionally, if Ticketmaster's arrangements with Bruce Springsteen's concert organizer allows it to pay them only $94 for each ticket sold, then Ticketmaster will recognize an additional $10 in revenue ($104-94), for a total revenue of $15.

As such, it is pretty clear that Ticketmaster is not being constrained by increasing ticket price demands or squeezed margins by its clients, event organizers. Ticketmaster's revenues have increased by 15% from 2006 to 2007 and 18% from 2007 to 2008. Clearly, Ticketmaster is selling more tickets, garnering higher fees, or both. However, its gross margins are shrinking as its costs increase. Essentially, its variable costs per dollar of sales are increasing, a bad place to be. Ticketmaster does address these cost increases on page 38 of its 10K, by stating that the increase in 2008 was due to several factors:

1. Ticketing royalties, i.e. commissions paid to event organizers as their clients.
2. Compensation and other employee-related costs
3. Other secondary causes

Interestingly, ticketing royalties increased only in line with the increase in revenues, in other words, neutral or even below the previous year as a percentage of revenue. The biggest line items, however, are the increase in employee compensation due to a 7% increase in staff, and increased royalties due to acquisitions that did not exist in the prior year. Essentially, this tells us two things:

1. Ticketmaster is using its employees less efficiently than before. Its revenue per dollar of labour cost is going down.
2. Ticketmaster has acquired business(es) whose costs of sales are higher than the acquiring unit's, i.e. its gross margins are lower. Essentially, this is the equivalent of saying, "I have $1,000 invested in a stock that returns 20% per year. I now have another $1,000; instead of buying more of the same stock, I will buy a stock that returns only 17% per year." I sincerely hope whoever advises this to you is not your regular investment advisor (at least going forward).

It is clear that Ticketmaster, although reasonably quite profitable in previous years at 20%+/- operating margin, and one bad year due to unusually high operating costs and a one-time impairment event, is on a trend that is slowly but definitely worrisome. The stock, which was at $25 6-8 months ago, is now languishing below $10, for good reason.

What, then, does all this have to do with scalpers? The answer will come in Part II, in the next few days. As a teaser, think of the analogy between music studios, movie studios, the television industry and Ticketmaster, all in the face of more efficient distribution channels.