Intro
There has been a growing interest among private equity firms in the past 5 to 6 years towards sports. During these past recent years, the sports industry has become a major economic sector, exceeding €600bn in value and growing at around 7% annually. The sports’ market is divided into two broad sectors depending on the type of engagement: participatory sports and spectator sports, the former accounting for 56.4% of the market in 2018 but the latter expected to be the fastest-growing at a CAGR of 5.9%. Furthermore, the sports’ market is well-known for its very fragmented market, made of well-known small-to-medium firms but with limited resources operating in different fields of activities. These attractive future growth prospects and the market fragmentation make the sports industry an appealing investment opportunity for Private Equity, promising high returns with a diversified risk profile. David Blitzer from the Tactical Opportunities Group of Blackstone explained that as long as the sector is growing, there is room for success: “Rather than seeing the purchase of a team as merely the purchase of a team… see it more as buying a stake in an entire league.”
It’s rare to find a greater brand loyalty and business repeat than in the sports market, hence investors are directing their efforts throughout the whole supply chain, ranging from team/league ownership to the supply of merchandising players and live streaming licenses. Distribution channels for sports streaming are increasingly evolving through technology. This allows businesses to develop new platforms allowing people to connect to their teams. Along with matches, advertisements effectiveness is strongly enhanced by consumer behaviour’s data analysis, which justifies investors paying premium prices to make even higher profit margins. Overall, it’s worth linking the reputation of sports stars, teams and leagues to price valuations, which result to be highly sensitive to single scandal events hits. They are also subject to economic downturns, which as historical data shows, lower ticket demand paired with new generations’ preference shifts affect super-bowls and other major national tournaments.
Structure
Private equity firms seeking to gain exposure to the sports and entertainment industry can do so either by acquiring a minority or a majority stake in a company.
Minority investments, those representing less than 50% ownership, do not confer full control over the target company. As such, they are considered riskier because the acquirer cannot steer the company’s strategy. To mitigate that risk, some private equity firms use special provisions or employ a preferred share structure. For instance, the private equity firm may require getting back its original investment in full upon exit and receiving a percentage of the remaining proceeds, alongside the dividends it has collected over the life of the investment. The private equity firm may further protect itself by limiting future capital raises or redemption. This offers the private equity firm downside protection at the expense of ordinary shareholders. Private equity firms structure their investments in this way particularly with riskier assets in the sports and entertainment industry: Silver Lake, for instance, reached out to distressed radio broadcaster iHeartMedia in 2018 to invest $500m in convertible preferred shares, betting on the risky but high-growth profile of the firm.
Minority investments can also be attractive to private equity firms because they tend to be smaller and require less debt to finance them, a feature which increased their popularity during the aftermath of the 2008 crisis. They are particularly suited for target companies which need a capital injection – especially given that minority investments allow the target company to roll over its debt, whereas a majority stake usually prompts a change of control provision, which forces the target company to repay all its debt. Recent examples of minority investments by private equity firms include Silver Lake’s acquisition of around 10% of the City Football Group for $500m this November. This deal allowed Silver Lake to gain exposure to the football industry while also providing CFG with cash to acquire more football clubs and build a new stadium in New York. Another example is CVC’s £500m bid to acquire a 30% stake in Six Nations Rugby, a move which provides the rugby franchise with the means to seek better sponsorship and broadcast deals.
Majority investments, which involve acquiring a stake greater than 50%, are often structured as leveraged buyouts. The first private equity firm to acquire a majority stake in a basketball club is Platinum Equity, a firm which in 2011 paid $325m for a 51% stake in Palace Sports & Entertainment Partners, which owns the Detroit Pistons amongst other assets. In contrast to minority investments, the majority ones give the acquirer more steering power and opportunities to add operational value. CVC’s acquisition of Formula One for $2bn in 2006 is a striking example: CVC’s focus on cash generation, which involved moving F1 from free-to-air channels to pay television and increasing the number of races, allowed the private equity firm to generated a 750% on its investment.
Buyouts can be financed using any combination of loans, bonds, mezzanine debt and equity. For instance, the capital used to finance the F1 acquisition came from one of CVC’s funds and a $1bn loan provided by RBS. The first key players in the buyout process are the financial sponsors, which raise the funds and make the investments. Some of the most active private equity firms in the sports and entertainment space are CVC, Silver Lake, KKR, Bain Capital and specialist sports funds such as Nascar and Bruin Capital. Hedge funds Lindsell Train and Elliot Management are also said to be important investors in the industry. Investment banks participate in the buyout process by providing financing for the transaction and acting as strategic M&A advisors while other banks and institutional investors provide shorter-term financing such as revolvers and amortizing term loans. Legal firms assist in drafting the terms of the agreement and consultancy firms can get involved throughout the life of the investment, to improve operational processes.
How is value created
Private equity firms aim to create value for investors even when it draws the criticism of fans. Private equity firms that focus solely on the sports and entertainment sector, such as Bruin Sports Capital or Sports Investment Partners, can leverage their industry contacts and experience within the sector to create value. Other private equity firms bring their technical expertise to the table. Silver Lake, for instance, is famous for its investments in Skype, Dell and Alibaba but the firm claims its expertise in technology can easily extend to sports. Indeed, as consumption of sports content increasingly moves away from traditional platforms to on-demand video and live streaming, developing the right digital channels for distributing content is crucial to the success of the investment. Moreover, the large private equity players benefit from their international relationships, which can help expand a sports franchise to new markets. CVC, for instance, has expanded the reach of Formula 1 races beyond Europe, increasing non-European rounds by 50% throughout the investment. Private equity firms can also contribute their expertise in identifying and pursuing M&A opportunities, a key part of the expansion strategy for some firms like the City Football Group, in which Silver Lake invested. Finally, established private equity players can put in place better governance systems than those of founders or private owners.
CVC – Premier Rugby Ltd
In December 2018 CVC Capital Partners closed a deal worth £230m, translating into a 27% stake in Premier Rugby Ltd, Gallagher Premiership’s holding. Premier Rugby Ltd is owned by its 13 member clubs, by the 12 teams joining the Gallagher Premiership and by London Irish.
The British Private Equity firm already tried to acquire a majority stake (51%) in November 2018, however, the offer was refused due to two main reasons. CVC as a minor stakeholder, citing Premier Rugby Ltd., better reflects the fact the owner clubs invested a huge amount into the game throughout the years, therefore a minority stake is a better option to reflect that; secondly, valuation and price: Bath owner, Bruce Craig, was against accepting the first offer, as it fell short of his £800m valuation of the Premiership business.
The impressive track record in the sports industry made CVC the perfect investment partner for Premier Rugby Ltd. CVC had already been the owner of Formula One Group (the group of companies responsible for the promotion of the Formula One, exercising of the sport’s commercial rights). The deal is acknowledged as one of the most lucrative deals in the history of Private Equity. In 2006 CVC paid around £1.2bn for a majority stake. In 2014, turnover was roughly £1.1bn, with only £630m going to the teams. In 2016 CVC sold its controlling stake in Formula One to Liberty Media in a deal worth £8bn. The buyout fund took also control over Dorna, a Spanish sports management company that has the exclusive rights to promote and manage MotoGP, the motorcycling racing series. They were eventually forced to sell Dorna as a condition imposed by the EU to purchase.
Premier Rugby Ltd. pointed out that the new funds injected by CVC would not boost player wages but will instead go towards improving facilities at club level, helping the league growing globally. The acquisition makes sense for the single clubs as well: most of them are unprofitable and together they made a combined annual loss of around £28.5m last year. While some clubs like Bath or Saracens are planning to spend the new funds for stadium redevelopments, there are concerns other clubs will look to strengthen their teams and thereby inflate rapidly growing wages. Premier Rugby Ltd., however, hopes such short-termism will be avoided with the £7m salary cap to remain for at least the next two years and has urged the clubs to invest in “operations and infrastructure” given the last unprofitable year. CVC is expected to focus its attentions on Gallagher Premiership’s commercial activities. Income from sponsorship and broadcasting is expected to rise significantly, as a result, the clubs will be better off in the long run only if their income from central funds rises significantly more than the 27% stake acquired by CVC.
Silver Lake – Man City
The multibillion-dollar prices paid for football media rights by broadcasters and internet groups have recently attracted the California-based fund Silver Lake in acquiring a $500m stake in Manchester City. The US private equity firm is buying more than 10% of City Football Group (CFG) at a valuation of $4.8bn, injecting new capital into the Abu Dhabi-controlled organization that owns Manchester City and affiliated teams in the US and China. The fund is planning to hold its stake for about a decade, without excluding the possibility of cashing out through an IPO or selling the stake on the secondary market. The $500m cash injection will help fund CFG’s aggressive expansion plans, including the acquisition of more football clubs globally, as well as the planned construction of a stadium in New York.
Nonetheless, some questions can be raised about the timing of the investment, considering that the entire media rights market lies on shaky ground. The broadcast revenue boom stoked the rise of super clubs with global fan bases, nurturing player transfer valuations, hence magnifying the potential impact of the revenue decline. The football leagues in Italy, France and Spain are more exposed to the risks of broadcast licensing revenue decline. While the Premier League’s model looks robust, last year domestic rights’ auction still witnessed a 10% decline in the total amount paid by broadcasters. Also, fewer people are choosing to pay to watch football on the TV in Italy, UK and France. This might be, beyond doubt, an issue for Silver Lake’s IRR, if the California based fund plans to hold the stake for a long period. Furthermore, at the time that this article was written, Man City was being scrutinized for potential unfair financial practices. However, following due diligence, Silver Lake executives agreed that, even in the event of revenues lost due to UEFA’s fines, the business would still be worth $4.8bn.
The valuation puts CFG above its sporting peers. Joe Tsai, the co-founder of Chinese Alibaba, bought a controlling share in the Brooklyn Nets basketball team this year at a $2.35bn valuation, the highest for a US sports team. Whereas, New York-listed Manchester United, historical rival of Manchester City, has a market capitalization of $2.8bn.
It is not a secret that Silver Lake approached other English clubs such as Chelsea. The fund specifically targeted Premier League clubs which, in terms of media rights, are the most paid in the world. Moreover, Premier League matches are highly followed in Asia. As a result of their huge international fan base, Premier League clubs can also benefit from a considerable stream of revenues in merchandising: in 2016 Manchester United acquired Paul Pogba from Juventus for €105m; in two days of his shirt selling they recovered the outflow.
Outlook
As sports have seen consistent growth worldwide both in participation and revenues over the last couple of years, national sports federations have become stronger and richer. However, they have usually struggled at the franchise level as there are too many unprofitable and unsustainable business models. Sports businesses are also seeing the appeal of selling to a professional investor. As sports businesses get bigger, many traditional owners realise that they don’t have the commercial tools to maintain such growth themselves. Private equities are aiming to better commercialize these franchises by heavily investing in technology. One of the pillars of this strategy is to focus on optimizing and personalising the fans’ experiences: by using the fans’ data, the franchise could advertise targeted content, and in a near future, immersive technology may allow viewers to watch the games in Virtual Reality.
During the past five years, many sports-focused private equity firms have been growing. For instance, former Nascar and IMG executive George Pyne launched Bruin Capital in 2014, which initially raised $80m, and last month received $600m from CVC and Jordan Company to further increase its portfolio. Another big player is Inspiring Sports Capital, founded by former Sporsora chairman Laurent Damiani, which has $250m across its funds and is investing heavily in Continental Europe. However, many analysts believe that the risk/returns profile is probably not there for the usual private equity’s hold period. Knowing that the average hold period is 3-5 years for a fund, getting a 2x or 3x in that short time-span seems challenging to say the least. Indeed, private equities that have recently invested in sports have announced that they are expecting to hold their investments for at least 5 years to restructure and properly turn around the business. The point of any private equity investment is to make a return, and although the sports industry is on a significant growth trajectory, winning on a particular franchise bet might be complicated. Managers need to have a clear vision on how to improve the core business in this very conservative industry, heavily regulated and with important governance issues.
City is already working on several technology initiatives beyond the smartcard that many fans now use to gain access to the stadium. Additionally, City and Oak View Group, which Silver Lake is an investor in, are planning to build a new 20,000 seat arena on part of the Etihad site, which will be supported by new infrastructures such as bars and restaurants. The early adopters of new strategies could kick-start completely new revenue streams.
A final reason for investing in sports is to gain visibility and influence. Some people could argue that as Silver Lake buys for $500m from one arm of Abu Dhabi (CFG), another arm of its various sovereign funds invests into a Silver Lake fund. Consequently, CFG valuation makes the initial Abu Dhabi investment look good and Silver Lake stays in the good books of one of the largest pools of capital on the planet.
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