Vroom Vroom: A Formula for Private Equity in Sports
How Catching Emergent, Less Popular Sports is the Value Play, and Secondaries Suggests Future Growth in Sports PE
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Back to business, specifically the business of private equity in sports. In this issue, we’ll discuss:
I. What Globalization Means for PE
II. Case Study: CVC and Motorsport
III. Parallels with Secondaries PE Markets
This article by PE International (PEI) is a nice prequel to mine. It contains some valuable information on the EPL and other European soccer investments (common in private equity). Below, I try to go beyond the tried and true European sports scene, while responding to a couple issues raised by PEI authors Adam Le and Alex Lynn. Let’s get after it.
I. What Globalization Means for PE
For the past month I’ve been practicing with the Wharton Rugby Club, a popular campus club that doesn’t shy from post-game beers at the local tavern Bonners. We run scrimmages, practice rucking, drills, touch, and tackle. It’s truly international as well - we have players coming from Italy, Mexico, and INSEAD, France, running tight lines and nailing tries (tries are like touchdowns).
This diverse mix is symbolic of the wider globalization of sports. The number of rugby fans grew by over 60m to 405m between 2018 and 2019. In the U.S. Major League Rugby (MLR) was founded in 2017, attracting high profile players from around the world. In just a few years, the league has grown to over 125k players. Rugby is not alone. Soccer, another sport more popular outside the U.S., is gaining popularity - notice how the number of MLS teams has grown nearly two-fold over 10 years. Salaries grew over two-fold from 2017 to 2019. The only metric that has not kept up is attendance (see the chart)- it’s taken more than 20 years for attendance per match to grow by less than 30%. What do these numbers mean? Higher salaries and team counts mean the MLS and its teams are incurring increasing costs. However, attendance, a proxy for revenue, has not kept pace. Decreased profitability is ailing the sport.
Some would argue we’re at an inflection point. These sports are attracting a wider berth of renowned players. Zlatan, for example, joined LA Galaxy a few years ago. These stars could draw more fans, boosting attendance. However, stars are joining MLS teams after their professional career in Europe is near retirement. They want to continue earning past their prime, but we’re not getting top talent. If attendance has lagged for 30 years, it’s tough arguing with the data. So what does it actually take to boost attendance and arrive at that inflection point for a newly popular sport? (1) Investing in America’s youth and (2) turning the fan climate more European. On the first point, our best players are heading to Europe, while we’re left with aging players - this won’t motivate big audiences. On the second, our fairweather fans don’t bring the same energy - and therefore, the same recurring revenue - to the arena. Look at this amazing video of a fan switching allegiances midway through a MLS game - surprisingly left the scene unscathed.
What does the globalization of sports like rugby and soccer mean for private equity firms? To understand this, we need to understand how teams make money (see figure below). The large bulk of their spend is on coaches and athletes. Stadium costs are another big ticket item. How can they be offset by revenue streams? Sponsorship and promotions can be huge - Met Life pays $19m per year for naming rights to Giants Stadium - though these contracts do not have huge in-built escalators. “Negotiated TV deals” is circled below because THIS is where revenues have been increasing the most and have the most potential. Stations like FOX and ESPN bid on TV airing rights. Amazon has made small forays as well into the streaming space. My view is that sports viewership is social and individual streaming won’t replace TV in the next 10-20 years (unless Roku/Chromecast/Fire stick get popular). Viewership and subscription growth drives the station ad revenue.
So as rugby and soccer get more popular in the United States, investors keeping the above economics in mind can employ the following strategies:
Timing the investment: It makes sense to buy/sell in the final year or two of an 8-year media contract. This is where risk and reward are maximized. Buyers should engage in deep (ideally tipsy) conversations with the VP of Sales and understand what the next auction with TV stations will likely look like (based on viewership trends). There may be room for creative strategies here - including ESPN-branded merchandise on player jerseys as a kickback in turn for an ESPN slot.
Women’s sports leagues: One of the key expenses for teams is coaches and athletes. How can buyers target low-cost teams? Women’s leagues. The pay gap between male and female athletes is enormous; look at the chart below (source data here). The units for women’s sports are in millions to highlight the gigantic delta (tennis is the most equitable). As their voices get louder, we hope women will see this gap shrink -- but consider that in baseball and basketball, women’s salaries are less than 1% of men’s. To make matters worse, “NBA players receive ~50% of shared [ad] revenue within their league, whereas [women] receive ~20%,” as Kelsey Plum explains. Any value investor will see the opportunity here. As female athletes grow vocal about their needs, we see strong male figures at home paying attention. This blog post illustrates how they need support and participation from fathers - that includes playing WNBA and NWSL (that’s soccer) games on the TV. While that thesis takes time to play out, it makes sense to invest in lean cost women’s teams now.
Combination acquisitions: The private equity firm Linden does a great job of combination acquisitions in healthcare that allow them to own a full value chain. This formula applies to investing in newly popular sports within a region as well. Instead of targeting an EPL team where there is already heavy private equity competition, it makes sense to go after rugby and soccer in the U.S., or basketball outside the U.S -- coupled with either a JV or acquisition in the media space (online trade rag/content provider like Deadspin - R.I.P.) that can boost viewership. There’s a reason Bezos bought WaPo. Media outlets deliver value. Another example of a combination acquisition is leveraging sports data across portfolio companies. CVC recently invested in an annual European rugby tournament called Six Nations (£365m) and is also investing in South African rugby union. Sure, Six Nations delivers 10% of the investment cost annually but if CVC is wise, they are leveraging data from both portfolio companies and planning to sell this audience data in a nascent sport as an additional revenue stream to media rights and ticketing. Silver Lake is looking to leverage synergies across its portfolio City Football Group, and its sports retail and entertainment companies.
II. Case Study: CVC ad Motorsport
We saw CVC making intelligent investments in the sports arena. It’s worth looking at their 2006 $2Bn investment in Formula One as a case study ($966m was CVC equity). At the time, Formula One made just under a billion in revenue. Most of it was broadcasting partnerships (featuring annual price escalators, which means stable, predictable revenue growth) and race promotion (fees paid to host and promote F1 events, generates tourism for the destination country). This second one is amazing: in most industries, even entertainment related, the content provider is paying for advertising and promotion. F1 flips this on its head, and is actually collecting revenue for offering the ability to host its events.
F1 eventually sold 10 years later for $8Bn in equity out - this is a <15% return yoy, which really isn’t great. What went wrong here? Nothing per se - the truth is CVC just ended up sharing a larger chunk of its revenue with the F1 teams and taking a more collaborative approach, which is a strong lesson for what’s expected of PE in sports. Indeed, CVC paid over a billion to F1 teams by 2017. CVC conducted a $2.9Bn debt refinancing during the hold, as well, and though deal terms are not disclosed, this contributed at least $200m to interest expenses. Furthermore, as developed countries’ tourism grows, the need for local promotion dips, and the market is left with cash-strapped buyers (developing countries) that cannot lob high bids. These financials hampered the astronomical growth CVC needed out of F1.
III. Parallels with Secondaries PE Markets
With the lifting of regulations around private equity firms owning minority stakes in sports teams, there is a lot of discussion around how these investments are different from investments in other sectors like consumer retail. One of the main differences - and we saw this in the F1 example - is that sports investments are long-dated and sticky. The well known sports private equity firm Arctos has assembled secondaries PE investors for this purpose - to recruit professionals that understand long-term contracted positions and the challenges of not being able to exit early. These characteristics influence investment horizon.
The next order insight from this relationship though is that we can better understand the promise of sports PE by looking at the history of secondaries. Consider the graph below from the CAIA (Chartered Alternative Investment Analyst Association). What drove growth was (i) fundraising, (ii) increased acceptance, and (iii) regulations in the wake of the financial crisis. The corollary for sports PE? (i) We’re seeing funds like Arctos and RedBird raise larger sums to invest in not just teams but leagues (like the XFL in RedBird’s case, motivated by the thesis that American football fans are hungry for more). Regarding (ii) and (iii), sports investments have just benefited from rule changes allowing for minority stakes in teams that are part of the NBA, MLS, and other leagues (besides the NFL). As long as private equity firms are careful about not taking too active a part in team management, acceptance will gradually come and the market for sports PE will grow more robust.
Thanks to contributions from Jay Yadav.
Vroom Vroom: A Formula for Private Equity in Sports
I do see some counterexamples in the industry - e.g. Arctos is investing in minority stakes in higher-performing teams. There may be a lot more risk in value investing in a low grossing team than you let on. Interesting recommendation nonetheless!