By Francesco Maulini
Many readers have passed through the turnstiles at their stadium if only at least once. In many cities, it’s a rite of passage for anyone seeking to call him or herself “a local” and many engage in this ritual week in and week out. However, few contemplate the broader industry surrounding the sporting events that they spectate and fewer still understand the size and nature of the business of sports.
Professional sports franchises are a category within sports entertainment (comprising of athletic clubs, sports media/broadcasting and sports betting), a sub-segment of the media industry. In its entirety (including sporting goods and infrastructure) the sports industry is worth up to an estimated $620B globally. Of this total, the NFL and EPL contributed approx. $13B and $5.3B respectively in 2016 while the most valuable club is the Dallas Cowboys at approx. $5B, edging out Manchester United, Barcelona and the Yankees. Professional sports have been in operation since the 1920s and observed consistent growth in popularity ever since. Yet when it comes to investing, the analyses and forecasts for assets in this area are typically oblique relative to other market sectors. This is due to the fact that the sports segment possesses unique features both in its operations and its balance sheet. In turn, it is difficult to apply to professional sports teams the same investing criteria and managerial practices that are commonly utilized for other investments.
Sports Entertainment Overview
Professional sports have recently become a multi-billion-dollar commercial enterprise; but big gains come with big risks. In many respects, sport businesses represent some of the riskiest investments available at the moment. In fact, many organizations, particularly those unconstrained by salary caps, run massive deficits by financing player trades and other operating activities with debt (see the 2011 Dodgers). Revenues are also cyclical and subject to the unconventional demand for sports entertainment. Franchises exhibit a wide customer base with robust brand loyalty yet strongly dictated by on-field performance. Hence, media coverage and annual TV rights top the list of primary revenue streams, while sponsor endorsements take silver and the merchandising of jerseys, branded apparel, memorabilia and the like place third on the podium. These means of turnover are extremely vaporous as relegation can expunge any and all three streams.
Consumer volatility is also an evident factor differentiating professional sports from other more sheltered investment landscapes. There is an irrational passion imbued in both the sports fanatic and the club shareholder. In this way, success depends on audience reception and level of fan engagement a team is able to generate – investors and managers alike must understand how to bridle this passion and monetize it. Unfortunately, success in the sports industry is not directly related to revenue growth and capital structure because sports teams have multiple goals (no pun intended); this is the most prominent area of scission between ordinary industries and sports. Because of brand value, winning championships and being successful on the pitch, rink or court are higher priorities than being sound from a financial point of view. Furthermore, the relationship between competitors also differs. If the ultimate goal of an ordinary firm is to become a monopolist by outperforming the field, the objective of a sports franchise is the opposite, viz. maintaining a winning streak while hoping that the competition elevates their game. Strong rivalries promote sports and history has continually proved this. Think back to the boom in popularity in Formula 1 during the years of Senna-Prost clashes or the decade in which tennis courts where dominated by Borg and McEnroe.
Although a subsector of the media industry, another singularity of professional sports is the fact that there is a significant real estate component linked to the business. The usual infrastructure includes training facilities, medical clinics and, of course, an arena. As for the accounting, stadiums are either leased from the local municipality, or owned directly by the team itself. Home matches represent an advantage both on and off the pitch because a significant portion of a team’s revenues comes from ticketing. Therefore, a brand-new amenity may motivate fans to attend matches, however it is a significant capital expenditure. Yet more teams are taking on the investment. Notable cases include AS Roma blueprinting an innovative €1B stadium in Rome and the construction of a $4B behemoth for the displaced LA NFL teams. Moreover, new facilities evince convertibility and the arena itself can be used for a plurality of purposes. Consequently, the construction must keep up with evolving requests. Take Tottenham’s new £1B stadium; heated seats and prawn cocktails are only two examples of the amenities that one may find in the renovated White Hart Lane.
Taking all these considerations into account, it is readily apparent that the professional sports sector is incredibly convoluted, which is exactly what makes it all the more curious. Furthermore, because the sports business is so globally widespread and because its product sits at the hearts of many, it is appropriate to investigate whether an allocation into a sports club could be profitable for an investor.
Buy Side Activity
Sports investing is long-term. Major leagues are enforcing strict controls over ownership changes in order to avoid frequent turnovers and prevent short holding periods. For instance, the NFL bars any group greater than 24 persons or any publicly listed company, financial or otherwise, to acquire a franchise. These restrictions are made in an effort to allow teams to develop and solidify under stable management. For these reasons, it’s largely difficult for private equity funds to invest in individual teams.
But private equity moguls, on the other hand, have created an uptick in the acquisition of professional organizations. Pertinent examples include Joshua Harris purchasing the Philadelphia 76ers and New Jersey Devils and Tom Gores acquiring the Detroit Pistons. At a high level, it seems as though there are no profit-based incentives behind such a market move. So what’s causing the sports investment brouhaha?
Considering the high interest expenses and other operating expenditures it appears as though asset valuations, as opposed to cash flows are king. Specifically, investors target franchises which are underperforming or which hold undervalued assets to takeover. Many of the principles that apply to value investing are duly noted by these investors. For instance, capital gains are a key profitability item, and this in terms of players’ stock. When a player is acquired, the cost is capitalized in the balance sheet and amortized over the length of the contract. A capital gain is realized if at any time the transfer fee exceeds the player’s book value. As a result, a keen eye for undervalued talent can offer outstanding financial returns and this has motivated organizations to bankroll their development facilities and scouts. Again, look no further than Tottenham as it became the world’s most profitable football club after making some opportune trades of key players.
Further to the point, the target clubs for private equity experts are those struggling in the win column and which are poorly managed. But nevertheless, to assuage Warren Buffett, fundamentals are still observed as strong brand value is always necessary. Owning a winning team without a fan-base is a lost investment. However, some private equity companies attempt to circumvent the risky selection of undervalued teams altogether by purchasing the entire league instead as testified by Silver Lake, KKR, and MSD’s consortium in UFC and Bain Capital’s attempt to takeover the NHL.
Moreover, it seems that the private equity method has been gaining momentum in sports especially since PE magnate Joshua Harris acquired the Philadelphia 76ers. The deal occurred in 2011, in the wake of the departure of Allen Iverson – the face of the franchise and a player who’s capabilities shaped the NBA on and off the court. Harris, by no means a basketball expert, was handed the reins of the franchise for a cool $280m and quickly appointed many figures which would lead the team to new heights. The Apollo cofounder treated the Sixers like any portfolio company and incorporated the value analysis as briefed above. This private equity style has permeated in the league ever since with teams such as the Boston Celtics, Golden State Warriors and Atlanta Hawks being bought up by PE tycoons.
Even as an observational study, it’s difficult to gauge the performance of sports organizations. This is because few exits by financial investors have transpired within this sector. However, a stellar example is the divestment of Formula 1 by CVC Capital Partners to Liberty Media in 2016. CVC aggressively levered the racing organization in a buyout in 2005 while also pursuing dividend recapitalizations throughout the holding period. The fund ultimately auctioned its controlling stake for approx. $4.5B, roughly a 450% ROI. Earlier, in 2011, another successful venture came from the Ontario Teacher’s Pension Plan which sold its package of the Toronto Maple Leafs and Toronto Raptors to Rogers Communications. The 1.32B CAD exit represented nearly a 4x cash-on-cash multiple after the 17 year holding period.
While trade sales can be lucrative, another divestment channel that financial investors may choose is an IPO. Many European football clubs are now publicly listed including Juventus, Arsenal, and Manchester United among others. In North America, publicly-owned teams are rare with the exception of Madison Square Garden Company’s (New York Knicks and New York Rangers) spinoff from Cablevision which was primarily initiated for investor transparency purposes. Although they are not present across all sports or regions, IPOs still prove to be a reliable exit strategy; take the IPO of Manchester United in 2012 which garnered a $233m investment. Yet opting for this strategy requires a delicate touch. While the opportunity to raise capital directly from supporters may stimulate publicity, fragmented ownership can create issues for a team in terms of consensus and management.
What remains is that the acquisition of sports franchises by PE firms and dignitaries is not a widespread phenomenon and only some prudent individuals and funds are allocating capital into this sector. Essentially, the advantages (and disadvantages) of sports investments vary, from visibility to ROI. On top of requiring heaps of cash, it is also difficult to tick all the boxes for ownership eligibility. However, interest is undoubtedly growing and some financial firms have proven that owning a team is more than a bored billionaire’s novelty, but rather a serious and remunerative investment. However, the buy side should be wary of the peculiarities and idiosyncrasies of sports teams and leagues when evaluating and managing them.
Editor: Eric Peghini
Author: Francesco Maulini