On December 9, 2010, Tim Cummins and Jeff Phillips of SRR joined Richard Brand of Arent Fox and Rich Walden of JPMorgan to discuss the latest financial trends affecting the business and valuation of sports.
Jeff Phillips:
While the overall economy affects all businesses, many have historically perceived sports as immune to macroeconomic factors. How do you see the economy impacting professional sports generally?
Rich Walden:
Overall, the economy has had a negative impact on sports. It has tested the creativity of the owners in ticket pricing and packages. Organizations have also become more creative cross marketing with their sponsors. Despite this, revenue has held up fairly well – there are still fans – and a lot teams have even shown attendance increases. So while impacted, sports possesses a degree of resistance.
Rich Brand:
The fact is that everybody is impacted negatively. And I think you are right that there is resistance to the depressed economy – but there are limits to this resistance. There are fewer naming rights agreements. There are fewer sponsorships agreements. And for smaller fees. But I am also finding that deals for naming rights agreements are now a lot more creative. On the financing side, you see a lot more people trying to figure out ways that they can get more security and have more downside protection. So I agree, there is a negative impact, but players are still playing and fans are still watching and businesses are still making loans and buying sponsorships.
Tim Cummins:
I do not disagree with anything you guys have said. To specifically address naming rights, several new stadiums exist without a primary sponsor, but not for lack of trying. It is just that their ask is pretty aggressive and they are willing to be patient in terms of getting the right deal. But five to six years ago, they would not have been sitting there without a naming rights sponsor. So there has definitely been an impact there. Despite the economy, however, winning still cures a lot of ills. The Blackhawks, in my hometown of Chicago, are a prime example. Here is a franchise that was near the bottom of the league and from a revenue standpoint four to five years ago. And last year going to the Stanley Cup finals they could not have had a better year in terms of revenue generation. It still did not translate into extreme profitability, but the fan base returned and bought everything available. So winning cures a lot of ills, it is just a matter of how sustainable that is. And in sports, not everyone can be a winner.
Jeff Phillips:
Rich, what have you seen from the banking side? What is the appetite for lending to sports franchises?
Rich Walden:
The banks that are active in the sports market have stepped up to do larger shares in deals that are still pretty sizeable. I have not seen a real turn back in the financing market. The people who are sports financing lenders are committed to it. Pricing has gone up, so there is no easy money, but the money is still there.
Rich Brand:
Lenders like to make loans and in fact need to make loans because that is what they do. I think the banks are saying, “Well it is not a good overall lending environment right now, but I need to make loans to make money, and if I am going to make loans, I would much rather make it to an NBA or NFL team or league and get my money out to those borrowers, than to take my chances on some other types of loans, such as real estate or development loans, which are somewhat more risky.”
Rich Walden:
For the most part, that is true, but on the execution side, there is a lot more attention paid to collateral value, additional collateral, other assets, support from guarantors, etc. So even though somebody may believe in the value of a franchise, that second way out, that ownership support agreement, that straight up guarantee from the owner or pledge of other assets is suddenly part of the mix where it wasn’t even on the table before. And I think that is what is a little bit more difficult for the client and has made the market a little bit tougher. But if someone’s willing to step up to those things, the money is there.
Jeff Phillips:
You know, historically collective bargaining agreements (“CBAs”) have impacted transaction valuations because they can certainly create stability if you are at the front end of an agreement. Now as we sit here today all four major sports are coming up in the near term with new CBAs. How are you seeing that affecting some of the discussions between buyers and sellers?
Rich Walden:
If anything it has had an impact on valuation and liquidity (it is an owner’s ability to put a team on the market). You either have buyers saying, “I want to wait for what comes of it” or you have buyers offering a low ball bid thinking it is an opportunity to finally get a sports team for less than full value.
Jeff Phillips:
Exactly. I have always viewed CBAs as creating that valuation gap – the CBA is going to improve the economics of the new deal so every team is going to be worth more. Accordingly, a seller wants that price and the buyers are coming in and saying “Well, you guys are in lock-out for six months and I’m going to lose all this money so I want this price.” You come to a standstill and no deal gets done.
Rich Walden:
And if the deal gets done in this scenario, it affects the purchase price. The announced purchase price may be X dollars, but if you really dig into the deal it will say that the seller is going to carry X amount of losses for X period of time. So the announced value includes whatever the true cost is plus loss carry – and this was never the case in the past.
Rich Brand:
Before even considering the effect of CBAs on valuation, I think it is just as important to consider the effect of leverage and demand. This still controls valuation. If you have a highly competitive process and a lot of people want to buy a team, then leverage and competition are going to make the ultimate buyer pay more than he or she normally would want to pay. This is where a to be determined CBA can affect the valuation. The sellers will say what an incredible opportunity you have here because of the fact that we are going to get a ridiculously good CBA. The buyers say, “How do I even know there’s ever going to be a new CBA or that the new CBA will be more favorable?”
Tim Cummins:
The CBA issues are certainly very interesting at this point in time for all four leagues, but especially with the NBA. With the NBA, you also have within ownership a controversy about revenue and how it gets distributed between major market teams and the rest of the league. So you could envision a situation where certain franchises benefit tremendously if they are able to negotiate what the majority of owners want with the players, but for the major market franchises the CBA may ultimately be a wash because they end up giving more to the rest of the league just to keep it viable.
Rich Brand:
That is an interesting complexity. The CBA also creates a challenge for the buyers and the people putting the transactions together behind the scenes. When they come to you, Rich, and say we need projections for the next three years, how do you know what the team will make in the next three years when you do not know when the season is going to start – or if it is going to start and what the new CBA will even look like? So they want more information from you and you have less information and certainty to base your valuations on.
Rich Walden:
And in sports, you never have a lot of certainty anyway. But with CBA issues it just means more scenarios, and I think it gives the buyer a little bit of an advantage. That is, if you have a team that needs capital and you are an existing owner with a tighter financing environment, then unless you have the pockets to throw in more money, you may have to sell the team for at least a little bit less. So there is a slight advantage to the buyer because you are getting pressure from me as the lender as I want to see those losses covered. The leagues are doing the same thing.
Jeff Phillips:
How do lockouts impact debt covenants?
Rich Walden:
Typically in today’s structure the covenants are waived or suspended during a lock-out in exchange for a payment reserve that is established. The issue is always not during the lockout, but more so after players return. Can you then be compliant with covenants? And there will be a hangover. How long will it take for fans to come back? Is there a ramp up to get back to even on some of the sponsorship deals? Or if you happen to be in a cycle where you are renewing X percent of your suites, are you going to get hammered?
Jeff Phillips:
If you look at the leagues, you might argue that with the length of the NHL lockout, they may have learned their lessons and they probably won’t go down that path again. But if you were handicapping the various leagues and advising your clients, are there certain leagues where you would say, “Oh that’s just posturing, and there will be a deal so don’t worry about it.” Or are there other leagues where you are genuinely concerned that there will be a stoppage?
Rich Walden:
I think that for MLB, things look pretty good. In the NBA, certainly there are some financial issues when you look globally at the league, and I think there are going to have to be some real negotiations and therefore a pretty strong likelihood that some games will be lost. Same thing in the NFL. Whether it is a couple of games, a season, I do not know. With the NHL, I agree with you. But at the end of the day, I certainly believe that all four of these leagues will come to some sort of resolution. I cannot believe that anyone is going to want to kill the golden goose.
Tim Cummins:
I agree with your comment. I do not think they are going to kill the golden goose, but I do think there are definitely going to be some feathers lost. Speaking of both the NBA and NFL, the situation gets complicated because it is more than just a bilateral negotiation – particularly in the case of the NBA. Within the players’ union, you are going to have negotiations with the rookies’ salaries – that is, how much gets devoted to rookie salaries versus veteran salaries. And the same thing with the NFL so that you are not spending half your payroll on someone who has never played a down in the league. So you have competing factions within the players side and within ownership, so it is a very complicated process. And I think it is very hard to tell where it will shake out.
Rich Walden:
In some ways it is pretty simple from that of a league-wide economic standpoint. In the NHL and the NBA, if you look at total league revenue versus league expenses, they are losing money so it has to be fixed. And their payroll is the largest single component of anyone’s expenses. I do not know what the right balance is, but clearly the present situation does not work. With the NFL, revenue sharing is a hot button because there are some people on each side of the issue who put a lot of time, money, value, and risk signing deals and putting up a lot of assets to build stadiums. And they are not going to give that away easily.
Rich Brand:
The other thing is that regardless of where you end up in a final CBA, there is always a question about how you calculate expenses and what elements will be considered in coming up with the bottom line numbers.
Tim Cummins:
Well besides the overall financial situation, the dynamics of the negotiation is interesting. On the owners’ side, there are relatively few of them and they are not expanding significantly. But on the player’s side, you have a bunch of individuals who, for the most part, have very few career alternatives. And these players on average have a career length that is two to four years. Which means a lockout may cost a player half of their earning potential. Are the players really willing to give up 25% to 33% of their career for the benefit of everybody that will come after them? Especially when they have a whole roster of kids coming out of college and high school, in certain cases, right behind them? So it will be really interesting to see how cohesive the players union can remain in negotiation.
Jeff Phillips:
Tim, if you could play arbitrator for a day and you have one rule or element of the league you can change, what would it be?
Tim Cummins:
I think the rookie contracts have just gotten way out of control. And that should be an easy one to solve because the kids coming out of college now do not really have a lot of say in the matter. It is not like they are going to pursue another profession because in lieu of signing a contract for $50, $75, or $100 million they are going to decide to do something else for $25 or $30 million. So the players union should be able to reconcile that because it will not change the dynamics of total compensation going to the players. The others issues are not a simple fix. But I think you touched on it about the NBA and the NHL where you look at the league in total having negative cash flow. In those situations, the biggest challenge on the ownership side is negotiating the player contract expense. You will have teams which suddenly take $50 or $70 million off of their payroll and it drops right to their bottom line while the rest of the owners in the league break even. That is where this revenue sharing amongst the owners will become even more contentious.
Rich Brand:
If you think about the NFL it has this terrific model from the perspective of an owner because you do not have the same type (or level) of guaranteed contracts as in other leagues. But in the NFL you also do not have the same situation with respect to rookie contracts that some of the other leagues have in terms of having agreed upon caps for rookie salaries. So this is an area which might need fixing. On the other hand, MLB is kind of puzzling to me because they have no cap, they have large guarantees, and they have very little control over who pays what. The Yankees can go out and offer $142 dollars to whomever they want. There is a luxury tax but you have seen that the luxury tax is not stopping a lot of people in baseball from putting up these contracts. But guess what – it works. They are doing extremely well.
Jeff Phillips:
Just to explore that, would the fan in Kansas City agree with you that it works? Do they go into the season thinking we’ve got a chance to win this year?
Rich Brand:
I do not know what the fan in Kansas City says, but if you look at the playoffs each year, there is always that surprise team with a surprisingly low budget doing very well. Now the problem is that when they do extremely well, the next year they have to sell off all of their assets because they cannot afford to retain the very same players who were responsible for their success. But the fact is in MLB, you do see an awful lot of these teams, that are not profitable, have low payrolls, and just happen to be going into the playoffs year after year. So compared to the other sports there seem to be greater opportunities in baseball for the smaller salary structured teams to compete. Maybe it is because they have so many players on the field. Maybe it is because of that one super pitcher, that special closer who is a difference maker. I am not sure exactly why it is but I will say there have been some very good examples of teams without money ending up in the money.
Rich Walden:
Is parity good for a league? I think it is as people want to see their team able to win. But there is not necessarily a correlation between how much you spend and whether or not you win. Maybe on an overall percentage basis, but certainly not as it relates to a championship.
Jeff Phillips:
We used to run a regression analysis that compared payroll to winning percentage. And it used to be relatively a strong correlation, but the local revenue pools have actually sort of thrown that regression analysis out the window in last few years.
Tim Cummins:
This year eight of the top ten highest payroll teams failed to make the playoffs in MLB.
Rich Brand:
My theory is that it has something to do with the number of players. In basketball, five players make a big difference but in baseball and football you have many more players. In basketball you can sign three very good players and send them down to Miami. And that makes a big difference. In baseball and football you can sign three really good players to some really big contracts but guess what, that’s not necessarily going to make them competitive. In football, nobody says, “Oh my god, Kansas City just signed three great players so it is game over – no reason to even play the game.”
Jeff Phillips:
So let us talk a little bit about the business models. Would you agree that the NFL model is the strongest model from a
parity standpoint?
Rich Walden:
Generally speaking, I would say so, but the NFL model is built on the fact that it is America’s TV sport. Everyone is watching it on Sunday. The model works because you are getting $100 million a year per team in TV contracts.
Tim Cummins:
Part of that is driven by fantasy leagues. So it is not just your local team that you wish to watch. If someone is big into fantasy, they are watching every game, or at least interested in every game. And this drives a lot of those things from which the NFL derives revenue – like the DirectTV package and things like that. The other leagues have not benefited from fantasy leagues to the same degree, even MLB which is really where it started.
Rich Walden:
The NFL works on a variety of levels, but I do not know that it works forever. As media delivery systems change, I do not know if at some point, some day, the model changes.
Rich Brand:
I think we are all in agreement that the NFL model works. One of the biggest differences may be that the average fan doesn’t even know what the average football player looks like. In the NFL, they wear helmets. And because they wear helmets, nobody knows who they are. This results in a perceived continuity of personnel and therefore greater fan identification with the teams even if the composition of the teams change each year. And because nobody knows who half of the players are when they watch the game, fans do not mind as much (or at least are willing to tolerate) the fact that each year their team is completely different. I grew up a Giants fan, and each year it takes me until the fifth week to find out who is on that team. But it works. And you have parity since people are changing teams every year. But I do not think that necessarily works in the NBA if your team suddenly has three out of five new starters (unless those 3 new starters are LeBron, Chris Bosh and Duane Wade). In the other sports, fans identify with their players and they want to watch their players. It works perfectly well for the NFL, but I do not know if the NFL model works for someone else.
Jeff Phillips:
Let us talk about revenue. Robust revenue streams cure a lot of ills. If you look at the evolution of leagues, everybody went the new stadium route as they wanted the luxury suites and the luxury boxes. And now we are at the early stages of globalization and of possibly developing the revenue streams there. What is the next big thing that is going to take teams to the next level in terms of revenue generation?
Rich Walden:
I think that is hard to say as sports in the U.S. have reached a certain saturation point. Globalization is somewhat difficult in that most of the major U.S. sports were developed in this country and don’t necessarily translate well in other markets. I would like to see MLS pick up in the U.S. more as I think that is an exciting sport with some potential to grow. In lieu of globalization, I think you will see each of the leagues and teams focusing on corollary businesses. For example, the New England Patriots built Patriot Place, a 1.3 million square foot facility for dining, shopping and entertainment, next to Gillette Stadium. So if you have a nice brand, you may have the opportunity to market other products into other areas. Maybe the NBA can go global, but it is hard to say.
Rich Brand:
I read something the other day which was really interesting and which demonstrates the potential of the NBA going global. In China, the number of Shane Battier jerseys sold is phenomenal. How come? Well he plays on that Houston team, and who is the other guy that plays there? The big tall guy named Yao. On the other hand, when the NFL goes to England, it did not get the same pop as the NBA gets in China. So while I think globalization is a huge potential market for many of the leagues, it is not the same for each league. Another potential area of greater revenue growth is the introduction of greater flexibility in the sale of seats, suites and other products. One example is variable pricing – with variable pricing you pay more to see a rival than you pay to see another team and pay more to see Miami than you do to see Sacramento. Another example is slicing up luxury suites. Some arenas are cutting suites in half or combining them into a larger party suite. Arenas are renting out Suites by the game. Some of them include food, some of them do not. There are bunker suites. Bunker suites are terrific except that you cannot see the game. But you are there and part of the atmosphere and they are selling. The successful arenas are doing everything possible to slice and dice this thing up because a lot of people are being priced out of the game. And it is not just the Average Joe. Now companies are hesitant to write a check for $500,000 for the season, but they may write one for $75,000 and get 1/6 of the games. The other thing which is obviously huge and will never get smaller are the online possibilities and innovations. Whether it is streaming, social media, or some other to be determined product, new sources of revenue are being created every day. One final thought on the next big thing is perhaps a smaller thing – that is the growth of the minor leagues, although honestly this trend has been going on for a while. People love going to the games as the tickets are not that expensive, the events are kid friendly and the game is still the game. New leagues and new stadiums keep popping up and there is a reason for that.
Rich Walden:
That is partially market rationalization. For example, the NHL Whalers could not survive in Hartford. But The Connecticut Whalers, the AHL team, survives since you only need four or five thousand fans to make it work, not 25,000.
Jeff Phillips:
I think individual media is an area where they can start to capture more dollars. You are going to see more people walking around with their device, watching the game, watching something. You will be able to capture that on a per click or a per use basis, and they can certainly drive it. And I do not know that they have captured as much as possible from the fantasy sports.
Tim Cummins:
I agree, I think the big thing will continue to be the virtual world. You know the online delivery of content and how the leagues continue to figure out ways to monetize that. In terms of globalization, I agree with you about the NBA being the most viable, although the NHL certainly has some Northern European popularity.
Rich Brand:
And baseball is crazy popular in Asia.
Tim Cummins:
And in Latin America, but American football is never going to replace soccer. But even with the NBA, you know the concept has been batted around from time to time about potentially having a franchise, or a group of franchises in Asia or in Europe or what have you. I just do not see that as being realistic for a generation or two until the technical logistics of travel make that possible.
Rich Brand:
And it cannot be one team out there. It needs to be a whole division so that when you fly out there, you get to play this team and that team.
Tim Cummins:
Like the West Coast swings that NBA teams make. So with globalization, I think there will continue to be situations like with Yao and China which drive local popularity, but I do not think it will be enough to really change the leagues. I think online modernization is a much bigger opportunity than the thought of having a franchise in Shanghai.
Rich Walden:
Do you eventually foresee a Chinese basketball association and a true world championship which include Europe, Asia, Africa, and South America? Is there some possibility for a World Cup in each of the leagues?
Tim Cummins:
The problem is compensation. Until those local markets develop enough to retain talent, you will never have parity. Look at Japan, even with this mature market, the best baseball player in Japan gets like $5 million a year in compensation.
Jeff Phillips:
So where do you think you see things going, you put your crystal ball in there, what does the business of sports look like in 2020?
Rich Brand:
I do not think there are going to be any dramatic changes in the game, but we are already seeing a couple of very interesting changes in team ownership. For example, an NFL team may now be worth something like $1.3 or $1.5 billion. So in the old days, if you had a billion dollars, you had a lot of money and you could buy a sports team. Now if you have a billion dollars, you may or may not be able to even be a majority owner. So what we have now is a very small pool of individuals who can actually buy a team on their own. So you may have to have a large ownership structure with multiple owners. This is going to have an effect on financing, decision making, and even future sales of franchises. In lending to these alliances, you have to determine who will step up for capital shortfalls and things like that. And who decides who gets traded or relocates the team. It is also harder to have significant appreciation in the value of your franchise which affects ownership from a res-sale perspective. No longer can you buy a team and expect it to double. They talk about how the average person can no longer buy a ticket? Well, now we are at the point where the average multimillionaire cannot buy a team.
Jeff Phillips:
Ownership is where you will start to see globalization. And if the dollar remains weak, some international individual or organization will look at a team as a great investment.
On the other side, in the last 12 months, we have seen some bankruptcies of sports teams. Do you see these as unique events or as a trend? Is it because of the economics of particular leagues? How would you explain it?
Rich Walden:
Mostly it is the same old story – over leveraging is going to kill you. The reason we are seeing bankruptcies at this level now is that with an economic low point there was no outlet as it relates to adding debt to carry losses. There were some slightly different issues in the Coyotes than there were in the Rangers, but it is the same old story: too much debt, too little cash flow, bad results.
Rich Brand:
It is the same old story, but with a few twists. Is it a unique event or a trend? I think the answer is both. It is not quite a trend, but it is not quite a unique event. I do not think everybody is going to be filing bankruptcy. But I also do not think we have seen the last bankruptcy in sports. And in looking at these two bankruptcies, I think you will find a progression in league involvement. With the Coyotes, the NHL was very successful in essentially blocking a sale. Then comes the Rangers’ case, and the MLB has a “best interest in baseball” clause if they want to invoke it. Well they really did not want to invoke it, because if they did, there would have been lawsuits and the bankruptcy court likely would have stepped in. So they went through the process. In the future, I believe auctions are a realistic possibility. It will no longer be the league saying, “I want you to buy it.” Now the leagues will still be able to exert lots of influence – as they should but there will be other factors. With this progression from the Coyotes to the Rangers, the real question becomes, what is the next one going to look like? The bottom line is that everybody, including lenders, has to take seriously the fact that they will not be able to run roughshod over the bankruptcy courts.
Rich Walden:
The lesson is also that, if you are going to lend, you have to be pretty conservative in your franchise valuation. You cannot have a lot of blue sky valuation numbers with these teams, because when you go to sell in a bankruptcy scenario, it is a different animal.
