SBJ/20090525/Opinion

How franchise sales will fare in challenging credit climate

Recent announcements about sales of the Chicago Cubs and San Diego Padres indicate that, despite a deep recession, opportunities will arise to purchase professional sports teams in 2009. Finding the equity and debt financing to complete these deals will be challenging, but the right combination of motivated sellers, favorable prices and creative buyers should lead to completed deals in the coming year. Here’s how that can happen.

First, what would prompt a team owner to sell in the current business climate? Most likely a financial meltdown, whether it be the trucking business of Jerry Moyes of the Phoenix Coyotes or the media empire of the Tribune Co., although death (Georgia Frontiere, St. Louis Rams), divorce (John Moores, San Diego Padres) and tax considerations (Wayne Huizenga, Miami Dolphins) are other reasons. This type of seller will be highly motivated to sell and may help structure favorable purchase terms.

Sale prices should be reasonable, but unlikely to be significantly reduced for healthy franchises if the agreed-to sale valuations for the Cubs’ properties ($900 million) and Pittsburgh Steelers ($800 million) are any indicator. Distressed properties such as the Coyotes (reported $45 million operating loss) will be different, with bankruptcy proceedings further complicating matters.

Assuming a motivated seller at a reasonable price, a prospective owner will still have to be creative in this environment. On the equity side, the lead owner will need to be willing to commit substantial equity personally unless the seller is willing to take back a note, as with Bill Davidson’s sale of the Tampa Bay Lightning to Len Barrie and Oren Koules.

The challenge will be getting minority partners to sign on. Typically, minority partners have put up substantial capital for very little in return other than good seats and bragging rights. Majority owners should be prepared to offer more in the way of cross-promotion of investors’ businesses, regular partners meetings and greater access to financial and other information on the team, inside access to players and coaches, special events and the like. Voting rights usually aren’t part of the equation as minority owners are typically busy with other ventures.

I don’t believe that private equity firms or corporate investors will be the answer. While the purchase of the St. Louis Blues in 2006 included a significant private equity component and media companies such as Time Warner, Fox and Tribune previously invested to buy content, the private equity strategy to grow asset value and sell quickly runs counter to the longer-term appreciation model of sports teams, and strategic corporate buyers have virtually all sold their teams in recent years.

My advice to the prospective owner: Unless seller financing is an option due to a distressed sale, stretch to put up as much as possible personally, then offer more benefits to local, deep-pocketed minority investors to lure their precious capital into the deal.

No doubt the biggest challenge for a team buyer in 2009 will be obtaining sufficient debt financing on reasonable terms. Neither the NFL nor MLB leaguewide credit facilities were renewed, at least temporarily removing attractive debt that buyers had used, although in recent weeks the NBA renewed its $1.96 billion leaguewide loan pool. Many sports lending institutions are not currently lending. Structured capital markets transactions are currently unavailable for the most part.

As government capital infusions and lending mandates increase liquidity at financial institutions, debt financing is becoming available. Initially, lenders will be leery of high-profile sports financings, fearing adverse publicity when so many other types of borrowers are failing to get loans. From a credit perspective, however, sports teams should be more attractive to lenders than many other types of industries this year. The Cubs’ and Steelers’ sales prices are both based on very healthy valuations. National broadcast contracts and collective-bargaining agreements are in place at all four leagues beyond 2009. Fan passion and demographics for sponsors and advertisers remain high. Unlike professional golf (financial institutions) and NASCAR (automobile industry), none of the four big leagues have too large a concentration of sponsors in any one industry.

Leagues and owners have an enormous incentive to assist lenders in collecting loans to preserve franchise values. While sales of tickets, sponsorships and advertising will dip for a period of time, fundamentals should remain strong.

The Ricketts family has pursued investors in its
$900 million purchase of the Cubs and Wrigley
Field using a debtlike form of preferred equity.

However, buyers should expect less debt at a higher cost. Lenders will have stricter standards than in the past. The relative strength of leagues, teams and markets will be an issue. Teams will need to demonstrate strong cash flow and buyers will need to provide significant financial support. Debt-to-equity ratio as well as loan size will be reduced and financial covenants will be tightly crafted, necessitating more equity than in the past. Pricing and fees will be higher.

How to fill the gap if there is a shortfall? I would advise using mezzanine debt (unsecured, subordinated debt at higher interest rates) or preferred equity at the level between the senior secured debt and the owner’s common equity. Be prepared to offer a paid-in-kind return added to the principal or preferred investment and repaid on sale or refinancing rather than current payment, as leagues and senior lenders will be opposed to additional demand on cash flow.

This additional capital has not been common in sports financing deals because of strict debt limits at the leagues, the availability of senior debt and the fact that it reduces the ultimate return of the owners, but it may be needed in the current environment. Care will be needed in structuring such capital given league restrictions on holding company and enterprise debt, but there is precedent for its use. The Ricketts family is pursuing investors for a debtlike form of preferred equity in the Cubs.

Potential owners can assemble sufficient equity and debt capital to purchase sports teams in 2009 if they employ some or all of the approaches described above. A conservative transaction structure with more total equity including more minority investor benefits, a smaller, more expensive senior debt component and perhaps a mezzanine debt or preferred-equity piece will be the ticket in 2009.

Lyman G. Bullard Jr. (lbullard@choate.com) is a partner at Choate, Hall & Stewart LLP in Boston, chairman and governor of the Portland Pirates of the American Hockey League and immediate past chairman of the executive committee of the AHL.

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