Economy will hold deals to higher standard

These certainly are trying economic times. It isn’t easy watching interest rates fall on savings accounts and the bottom drop out of the real estate market.

However, in the sports financing world, this credit crunch could be a blessing in disguise. It may lead to a level of sanity across sports deal-making not seen in some time.

Sports deals are always risky, and the prevailing thinking is that the economic downturn will chill sports deals across the board. My theory is that perhaps this atmosphere is good for bidding for franchises on the open market, and might be positive for the sports industry as a whole. Why? Because it will tend to keep out ownership groups that have not vetted fully their investment and lending institutions that fail to provide full safeguards against inexperienced management.

Over the past five years, if you wanted to enter the sports fray, money was easy to come by. Investor equity was plentiful and debt money easy to find. In fact, lenders were so eager to put money to work that they were requiring less from buyers in the way of covenants. These investors and lenders failed to require management groups to adhere to fundamental financial principles.

The three critical elements of any sports deal are:

1. Good operators who have the ability to create and execute on a solid business plan;

2. Sufficient (and sufficiently patient) equity investment that can withstand some losses;

3. Debt from a knowledgeable lending source that covers approximately 50 to 60 percent of the total investment.

For the past five years, operators obtained equity investors that were not so smart or diligent in understanding the pitfalls of sports team ownership. In their rush to put money to work, some investors failed to appreciate the need for long-term commitment and the need for a combination of quality managers with a quality business plan.

Those operators also found lenders competing for opportunities resulting in liberal loan covenants that were easy to achieve or avoid.

With the credit crunch, operators now have to meet far more rigorous reviews of their business plans. They have to demonstrate to both investors and lenders that they have the track record and sports business savvy to make the investment work. And they have to agree to tight covenants from lenders that demand meeting very specific revenue and cash-flow targets.

Investment in pro hockey teams is an example of what has worked in recent years. Whether it was our acquisition of the St. Louis Blues two seasons ago, or recent NHL club deals in Minnesota and Tampa Bay, the current state of the hockey business is lending itself to smart deals. Contrast these deals with the recent revelations surrounding the Nashville Predators, where overborrowing with “dumb debt” by one investor has resulted in some significant problems.

There is a cost-certainty system in place since the 2004-05 lockout. There is a rising tide of ticket and arena-related dollars that demonstrates revenue growth. And with TV ratings on the upswing, there is cause for optimism over future revenue growth. NHL teams can be run like a business, and that’s what investors and banks want to see. They care about winning because it adds to the bottom line in addition to the trophy case.

Sports are big business. Fans make it clear that they are willing to pay for quality performance. Smart operators, investors and lenders view fans’ and sponsors’ demands for better in-arena entertainment and high-quality food and beverage options as a business opportunity to seize. As a result of this strong consumer demand, the underlying business of sports should remain intact in times of recession.

During the credit crisis, the sports industry will experience a decline in the number of deals done. But what it won’t see are transactions where buyers are borrowing almost every dollar; where investors don’t understand the business; or where operators are not held to appropriate performance levels. And that’s good from any pro sports league’s business perspective.

Ken Munoz is a partner in SCP Worldwide, a sports, entertainment and media company with properties including the NHL’s St. Louis Blues and Real Salt Lake of the MLS.

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