Money(ball) Pit

Investment Note #16 - 12th July 2024

Money(ball) Pit

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Synopsis

• Valuations for sports teams have been soaring and the number of deals in the space is increasing. The annual value of announced sports M&A and investment deals has jumped 8x to almost $37bn in the last four years. (source: Deutsche Bank)

• Rules around ownership in some leagues have changed to allow investment firms and private equity ownership. This has resulted in some of the largest clubs in the World changing hands, in the last few months alone Oaktree Capital Management took control of Italian champions Inter Milan and NBA champions the Boston Celtics were put up for sale.

• With the European Championships ending this weekend, in this Investment Note we look at the appeal of sports clubs as an asset class and whether the business fundamentals warrant the valuations.

Slam Dunk

• In April 2003, executives at the National Basketball Association (NBA) were in crisis. Michael Jordan, who had been so integral in popularising the sport around the globe since the early 1990s, was retiring from professional basketball for the third and final time.

• Such was the effect that Jordan had on the sport that NBA commissioner David Stern went on record, just two months after Jordan’s retirement, to say he should be back in a management capacity the following year. He then worked with Jordan on an attempt to purchase the Milwaukee Bucks but unfortunately for Stern and the NBA’s marketing department, the deal didn’t go through.

• However, seven years later Stern got his wish. In 2010, Michael Jordan bought his hometown team, the Charlotte Hornets, for $275m and installed himself as General Manager.

• In August 2023, Jordan sold the team to a group of investors led by Gabe Plotkin (Principal of Melvin Capital and of GameStop meme-stock infamy) for $3bn, almost 10x what he paid 13 years previously.

• With that level of return seemingly available, do the business fundamentals stack up?

Sports as an Asset Class

• Let’s start by asking, from a business perspective, what is the appeal of owning a sports team?

• Largely immune to the business cycle. Teams can be less likely to suffer from the problems that companies face with the natural evolution of the business cycle. Few sports that were popular 50 years ago are smaller today.

• Barriers to entry. Sports leagues are frequently oligopolistic, and these closed dynamics and network effects ensure that the barrier for new entrants is almost always insurmountable. There are few examples of upstarts usurping profitable incumbent leagues. Even with the backing of major participants, projects like the European Super League fell apart quickly. The Saudi-backed LIV Golf is the most significant ongoing effort to displace an incumbent league, whether it is successful is still far from certain.

• Customer loyalty. Brand value and the emotional appeal of sports are higher than for most other industries. Between 50% and 56% of young people in the US and UK say that their favourite sports team is part of their identity (source: Deutsche Bank).  

Where to Buy?

• The biggest distinction in the value of professional teams is the leagues they operate in.

• Against the run of history, European football leagues have largely developed into an open market where teams compete like firms in any other industry.

• In the US however, leagues have grown into a quasi-guild system with complex rules and regulations (which in any other industry, would likely qualify as an unregulated monopoly).

• The English Premier League (EPL) has the largest revenues of the major European football leagues, but this has not led to consistently profitable businesses. An average of 73% of revenues are spent on player salaries, if the ‘Big 6’ clubs are excluded it rises to 87%. Since 1992, salaries for EPL teams have increased 36x while revenues have only increased 27x. The result is that in 2022 only seven teams reported a profit. (source: JP Morgan)

• In the US a combination of the closed system, revenue sharing and a byzantine rule set (salary caps, player trades, drafting) all contribute to better fundamental economics for the individual businesses. Salary caps in particular help improve operating margins. The presence of a limit on salaries prevents an arms race from deeper-pocketed owners seen in European football.

The Jordan Sale

• Given the tenfold increase in the price tag of the Charlotte NBA franchise, you would be forgiven for thinking that the Jordan ownership era was successful. The opposite was true.

• On the court, under Michael Jordan’s ownership, the team never won a single playoff series and became known for bad trades and worse drafting.

• Off the court, per SportsValue, Charlotte has the lowest gameday revenue of all NBA teams and according to Forbes the team only generated about $269m of total revenue in 2023. After paying their players that $269m results in just $35m of operating income.

• As a private business, detailed financials aren’t readily available but if we pretended that the $35m was the net bottom line earnings then the $3bn sticker price equates to an 86x P/E (price to earnings) multiple that Michael Jordan was able to extract from the buyers. Truly a man of many talents.

Opportunities in Public Markets

• Ownership opportunities exist for the public market investor in some of Europe’s largest football clubs. Manchester United, Juventus, Borussia Dortmund and AFC Ajax are all publicly listed major clubs with long histories of domestic success. Since the end of 2018 through June 2024, investors in these clubs have lost an average of 38% (Juventus investors are down 67%). The broad European equity market is up 75% over the same period. (source: Bloomberg)

• For public market investors, the US does not provide the same depth of choice as seen in European football. The Madison Square Garden Sports Corp owns the New York Knicks (basketball) and Rangers (ice hockey). Despite the preferable economics of these leagues, from the end of 2018 through June 2024 investors have earned a paltry 3% compared to 139% for the S&P 500. (source: Bloomberg)

Summary

• When Roman Abramovich was forced to sell Chelsea in 2022, football finance academic Kieran Maguire noted that the club was run as a trophy asset that lost €1m a week over his 19-year reign.  

• This appears to be a feature, not a bug. The extreme prices exchanged in the private market are reflective of price-insensitive (read billionaire) buyers interested more in emotions than returns.

• When clubs are exposed to the unfeeling eye of public markets, results much more closely follow their underlying earning power. Investors interested in earning a return may be better off staying in the stands.