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SFX Entertainment Dances to IPO Bubble Beat

NEW YORK ( TheStreet) -- The $260 million initial public offering of electronic music festival producer SFX Entertainment (SFXE) signals that not only is the music playing in IPO markets, you've got to get up and dance.

But this offering could also indicate a bubble-like mentality spreading in IPO's, as investors and bankers try to launch the next billion-dollar business on public stock markets. If the company's primary business is putting on electronic dance festivals, investors would do well to question whether they are arriving late to the party.

SFX Entertainment is a deeply unprofitable business that faces large competitive and legal risks. Nevertheless, the company is selling shares in an unusual IPO at a price that gives the firm a valuation of over $1 billion.

The company's founder Robert F.X. Sillerman, however, has a significant track record in the concert and promotion industry after creating LiveNation (LYV - Get Report), a company he sold to Clear Channel for over $4 billion dollars, and CKX, Inc., a vehicle he used to acquire rights to Elvis Presley's Graceland estate and the hit TV show American Idol. Sillerman sold CKX to Apollo Management in 2011.

With SFX Entertainment, Sillerman is seeking to grow the electronic dance music [EDM] industry, what used to be known as raves, into bigger venues and new markets through an ambitious slate of acquisitions and international expansion. The company's IPO also comes at one of the busiest times for share listings since the financial crisis five years ago, and at a time when stock investors have bid up the valuations of recent high profile listings, including Tesla (TSLA), Zillow (Z), Trulia (TRLA), Facebook (FB) and Angies List (ANGI).

It may be time for some investors to slow down.

SFX Entertainment's risks include steep losses, competitive pressure, high debts and restrictive covenants, admittedly weak accounting controls and a business model that faces significant legal liability.

In its IPO documents, SFX notes that drug use at the company's electronic music festivals makes it vulnerable to litigation and injunctions from local authorities that could effectively throw a wench in its business. Two people died at Electric Zoo, a festival SFX is seeking to take control of, this past Labor Day as a result of drug overdoses.

SFX Entertainment's IPO is unusual from the start.

The business model, while already posting severe losses, is untested and will fundamentally change after the company's share offering. In addition, SFX was incorporated on June 5, 2012. Its predecessor entity was started in July of 2011, making the billion dollar company just over two years old.

SFX is planning to use over half of the proceeds of its offering to exercise previously agreed upon joint venture acquisitions, with the remainder going to working capital and other corporate purposes.

Of the $260 million SFX offered in its listing, the company will use about $150 million on acquisitions of joint venture stakes in competing concert promoters ID&T, i-Motion GmbH Events, Totem Onelove Group, Made Event and EZ Festivals, in an international expansion of its concert venues.

Those acquisitions are targeted at firms that produce some of the most prominent electric music festivals in the world, including Electric Zoo, Tomorrowland, and Nature One in Germany. While the venues may be increasingly popular and are generally growing in audience by over 20% a year, they are also going to put SFX in a very stressed financial condition.

Will Losses Dry up a Debt Punch Bowl?

On a pro forma basis including SFX's planned acquisitions, the company would post revenue of $92.3 million and negative $15 million in adjusted EBITDA, and a net loss of $71.3 million for the first six months of 2013. That contrasts with SFX's 2012 revenue of $238.6 million, adjusted EBITDA of $14.6 million, and net loss of $67.4 million.

As part of the acquisition agreements, which contained a set of stipulations that hinged on SFX's eventual IPO, the company is planning a major increase in its debt.
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