SBJ/October 24 - 30, 2005/Other News

Nets pay price to cover operating losses

The New Jersey Nets borrowed $60 million last month from a hedge fund at very rich terms to cover operating losses, financial sources said. The move came after team owner Bruce Ratner approached limited partners to cover the shortfall, but the team opted for the pricey borrowing instead, the sources said.

The Nets are losing money at Continental Airlines Arena but hope to be flying high at a new home in Brooklyn.
Fortress Investments lent the Nets the money at a rate of more than 10 percent, which caught the attention of the NBA. Sources said the league had concerns about the rate and reviewed the deal with the assistance of an outside consultant, though NBA approval was not required.

The Nets, who now have $210 million of debt, declined to comment. An NBA spokesman said league policy is not to comment on team financials.

The transaction highlights the risks new owners such as Ratner assume for teams that often sell for hundreds of millions of dollars and can lose substantial sums of money. Ratner paid $300 million last year for the Nets after a contested auction drove up the price.

“If you want the highest prices, you have to get creative on the financing,” said Mitchell Ziets, a sports business adviser with his own firm, MZ Sports. In particular, when limited partners are hard to find or, in the case of the Nets, may be resistant to throw in more money, pricey loans are an answer, Ziets said.

It’s no secret the Nets are losing money playing in northern New Jersey’s Continental Airlines Arena, where crowds were modest even during the team’s march to two NBA Finals several years ago. That is why Ratner plans to build a new arena in Brooklyn, N.Y., by 2008.

“The Nets are currently operating at a loss and are projected to continue to operate at a loss as long as they remain in New Jersey,” said Forest City Enterprises, which owns 15 percent of the team, in its annual 10-K filing with federal regulators in April.

The Nets have been funding losses through a reserve in the team’s credit facility, Forest City said last month in a quarterly filing.

Recently, however, Ratner went to his dozens of limited partners to help cover the club’s losses, the financial sources said. Precise figures for the loss could not be determined, but the sources described the situation as one in which not all the limited partners were willing to give Ratner money, leaving him with a $20 million hole.

Another source said it also was possible Ratner decided in the end it was better to borrow from Fortress for tax purposes because that debt would be deductible, whereas payments to equity investors are not. Equity investors can require a guaranteed rate of return.

When Ratner bought the team in 2004, he borrowed $150 million from JPMorgan Chase and paid the rest in cash with the help of a host of limited partners. Forest City Enterprises has a joint venture with Forest City Ratner Cos., the New York City real state developer that the Nets’ owner runs.

Nets owner Bruce Ratner also is refinancing his original acquisition debt.
With the Fortress money in hand, Ratner also is refinancing his original acquisition debt. The Nets plan to borrow $85 million from the NBA leaguewide credit facility, which lends money to teams at very low rates, in a transaction expected to close shortly. JPMorgan would then lend another $65 million to the team.

But it is Fortress’ $60 million loan, which closed in September, that has the market buzzing.

The league allows teams to borrow up to $100 million with the franchise as security. The interest rates for loans secured by franchises are very low.

Teams that still have more debt needs often then create a holding company to borrow more money, with the collateral commonly being revenue generated by the team and ownership guarantees. Because the team is not part of the collateral, the money is more expensive at this level, though not exorbitantly so. The JPMorgan loan would be at this level.

Usually after a holding company loan, the borrowing is done. But not in the Nets’ case. Financiers have dubbed the Fortress debt a “super holding company” loan, because it is even further removed from the franchise.

Known in part for lending money to companies in poor shape, Fortress has dabbled in sports recently. It lent money to Frank McCourt to buy the Los Angeles Dodgers and is talking with Dave Checketts about financing his bid to buy the St. Louis Blues, sources said.

Fortress declined to comment, and Checketts did not return calls.

The firm’s money comes at a steep price. In banking, this type of borrowing is generally termed “mezzanine” financing.

This means the lender is usually one of the last in line behind more senior creditors in the event of a bankruptcy. But that low-pecking-order rank also brings with it a high interest rate — higher risk, higher return.

“I have never seen a rate that high,” said one sports lender who declined to be named, of the Fortress loan to the Nets.

Fortress’ rate for the Nets is 650 interest points over the London Interbank Offered Rate, a floating rate index that today is about 4 percent. That means the Nets’ rate on the Fortress loan would be about 10.5 percent.

Mezzanine financing is not new in sports, but it is uncommon. Jim Nash, head of Banc of America Securities’ powerhouse sports lending practice, recalled a mezzanine deal in 1990 that he did for a racetrack, but there have not been many since.

But with team values having risen so much, Nash said, owners are increasingly looking to more complex means to cover costs and pay for the clubs. As a result, pricier debt is more fashionable, and that is why lenders such as Fortress have begun to eye sports.

Ziets, the sports finance adviser, said he sees owners having a hard time finding limited partners. Whereas a decade ago limited partners might have put in a few million dollars, now they may be asked to invest tens of millions of dollars plus cover what can be substantial losses, as with the Nets.

So, owners are looking for debt that can fill the gap left by equity shortfalls, he said.

“Fortress has recognized this is a gaping hole in our market, the difficulty in finding limiteds,” Ziets said.

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