Today, I'm taking a look at one of the more unusual investing plays out there today -- the business of Formula One racing.

Formula One racing has been around for a century, but the popularity of the sport has ebbed and flowed. Recently, it's seen a boost in interest stemming from the wildly successful Netflix series, 'Formula One: Drive to Survive'.

It's rare that investors get the chance to participate in such a differentiated pure play. There's nothing really else there in the world of racing like Formula One. Its closest rival, NASCAR, hasn't managed to generate much interest outside North America. This is in an era where other American sports like American football and basketball have successfully found followings abroad. 

However, an investment in Formula One isn't quite as straightforward as buying a few shares of Apple (AAPL). In fact, it's about as complex as a Formula One car. 

So first big question...what are we actually investing in here?

Tracking Stock

As we pointed out in a blog post earlier this year, Formula One Group has three different stock classes.

The ones readily available to retail investors are their Class A shares (FWONA) and their Class C shares (FWONK). Class A shares come with one voting right per share, while Class C has no voting rights. 

However, that's not where the complexity ends. 

Formula One Group was purchased by John C. Malone's Liberty Media in 2017. Formula One was then designated as one of three major divisions within Liberty Media and tracking stocks were issued. That is what investors are buying. 

A tracking stock is a special type of stock that is issued by a company, representing a particular division of its business. It allows investors to participate in particular segments of a larger business and on different terms.

So, rather than investing in all of Liberty Media, for example, investors can invest in the Formula One segment. It also means that management can retain control of the company without spinning it out into a separate entity. One major drawback of this arrangement, though, is that management is able to shuffle around what's actually in the segment with little shareholder oversight, and they could reabsorb the tracking stocks into the main stock at a price that may not suit investors. 

Not confused enough? Let's keep going.

The Formula One Group actually has a host of assets under management that has nothing to do with Formula One. That includes part ownership in the Braves Group (which owns the Atlanta Braves), a drone racing league, an investment fund focused on Israeli technology companies, and a digital media company focused on food and lifestyle. 

We're definitely not going to get around to all of this in a First Look, so let's try focusing on the Formula One bit. 

The Formula One Bit

It's important to understand that Formula One Group doesn't own any of the teams in the sports, nor the tracks, nor is it the regulatory body of the sport. Formula One Group controls the commercial and promotional rights of the FIA Formula One World Championship Series until 2110. The company's primary role is to work with the teams and the regulatory body (the FIA) and other partners to develop and promote the sport. 

The primary revenue is derived from television fees, sponsorship and advertising fees, and hosting fees from race promoters. The company also generates 'Other F1 Revenue' from freight and hospitality. 

From the company's 2021 annual report:

Beginning January 1, 2021, F1 began reclassifying certain components previously reported in Other F1 revenue into Primary F1 revenue to better align with the way it currently evaluates the business. In addition, broadcasting revenue was renamed media rights revenue. The more significant components that were reclassified into Primary F1 revenue include fees for F1 TV subscriptions, fees for licensing commercial rights for Formula 2 and Formula 3 races, fees for the origination and support of program footage, fees for broadcast rights for Formula 2 and Formula 3 races and fees for advertising rights on Formula 1's digital platforms. Following the reclassification, Other F1 revenue is primarily comprised of freight and hospitality revenue. 

How does that revenue break down? In the most recent quarter, the company saw a 35% increase in Primary Formula 1 revenue to $628 million. Other revenues skyrocketed 214% to $116 million. However, because of the disturbances with COVID-19 last year and a huge increase in freight revenue, these growth numbers aren't really telling us much. 

From the most recent earnings report: 

Other F1 revenue increased in the second quarter primarily due to an increase in freight revenue driven by the increased number of events held outside of Europe and inflation in underlying costs, as well as higher hospitality revenue generated from the Paddock Club, which F1 operated at 5 races in the second quarter of 2022 but was unable to operate in the prior year period.

We do know that the company operates a very capital-light model. The company's biggest expense is essentially passing on a percentage of the revenue it makes to teams in the form of prizes for their final position in the league, as well as fixed payments to certain teams. Team payments came to over $1 billion last year -- representing 57.7% of Primary F1 revenue. Other costs exceed other revenues. So, while the company may be able to grow revenue, it has limited scope in turning that revenue into margin expansion further down the line. The company produced over 20% in EBITDA margin in 2021. 

Drive to Survive

I think it's fair to say that Liberty Media has executed extremely well in its role as the promoter of Formula One to date. That's been led by the launch and continued success of the Netflix docu-series, 'Drive to Survive'. 

The show, which debuted in 2018 and is now entering its fourth season, gives fans a look behind the scenes of this technically obtuse sport. It's a show in which bitter rivalries (often between teammates) erupt and billionaire financiers secure driving seats for their playboy sons. The actual racing element is most definitely secondary. 

The show has helped launch Formula One to a new audience, particularly in the United States. 

From The Guardian:

On the opening weekend of this season the Bahrain GP was held on the same day as Nascar Cup and IndyCar races. Adam Stern of the Sports Business Journal kept track of the viewing figures. Nascar picked up just over 4m viewers, F1 1.3m and Indycar 954,000.

The sport is broadcast by ESPN in the US and this was F1's second-highest audience figures on cable TV after the 1995 Brazilian GP. It was up by almost 400,000 on the 2021 season opener.

ESPN has enjoyed increasing ratings since it took over broadcasting F1 in 2018 moving from an average of 554,000 that year to 927,000 in 2021, yearly rises tallying with the growth in popularity of each subsequent series of 'Drive to Survive'.

This year, the sport had two Grand Prix in the United States (one in Miami and one in Austin). Next year, Las Vegas will host one. The company has also expanded its racing lineup outside the traditional European enclaves of motor racing, to places like Saudi Arabia and Azerbaijan -- where they will no doubt excel in high-priced exclusive accommodations. 

It's a compelling growth narrative, but for now, one that I think there are far too many questions surrounding. The explosive growth in popularity could wane and the sport has struggled throughout its history to attract interest from younger viewers. There's also a huge host of environmental concerns regarding the business, which, given its worldwide expansion, is only getting worse. 

That, combined with a convoluted ownership structure and a lack of data on the company's financials, has me backing away from this investment for now.