Chapter 3

The Rise and Ruin of a Black Institution Risk Defined: A measure of the uncertainty of returns- Uncertainty about future conditions ------------------------------------------- The gain or loss of an investment over a period of time is the rate return. The easiest way to measure the return of an investment is in dollar terms Impacts: Interest rates Bond rates Cash flow estimations Cost of capital Capital structure The Rise and Ruin of a Black Institution By Neil Lanctot (2004)

RISK Dollar return is simply the result of subtracting the amount invested from the amount received: Dollar return =amount received- amount invested Disadvantage is: 1. Must know the size of the investment. 2. Timing of the return is important because time value of money.

Are Sports Recession Proof? WSJ, 2009: Are sports too big to fail? Do people turn to sport to escape during times of economic uncertainty? Economic slowdown is having an effect: Arena Football League canceled 2009 season LPGA eliminated events and cut prize money WNBA lost Houston Comets

THE HOUSTON COMETS Formed in 1997, the team was one of the original eight WNBA teams and won the first four championships of the league's existence. The Comets were the first dynasty of the WNBA and won more championships than any other team in the WNBA. They began as the sister team of the Houston Rockets. The team was folded and disbanded by the league in 2008 because new ownership could not be found. BIG THREE: CYNTHIA COOPER SHERYL SWOOPES TINA THOMPSON

Rates of Return and Risk Deferred compensation: Structure contracts to fit under salary cap Buy now, pay later

Mario Lemieux’s Solution Forgave $7.5 million, transferred $20 million from debt to equity. Received only $5 million of the amount owed to him (15.4% of original amount). Also received controlling interest of the team. Note: 10 other players owed $7.4 million  he bought the Penguins and their top minor-league affiliate, the American Hockey League's (AHL) Wilkes-Barre/Scranton Penguins, out of bankruptcy, and is currently the team's principal owner and chairman. He is widely acknowledged to be one of the best players of all time.[1] A gifted playmaker and fast skater despite his large size, Lemieux often beat defencemen with fakes and dekes.[2]

VOLATILITY IN THE MARKET Is the amount of fluctuation that occurs in a series of similar investment returns. More volatility translates into greater risk. Time is a factor is risk.

HOW CAN YOU MEASURE RISK? You measure risk to determine a profit or loss. There are two ways to accomplish this: 1. Level of Risk: is a comparative evaluation of risk. It is done by comparing one asset of a company to another. Example: In MLB, the risk of owning the Boston Red Sox is less of a risk than owning a team in a smaller market like Kansas City. 2. Risk of Time: is based on the fact that risk increases as the length of time funds are invested increases. Example: Exhibit 3.3 shows as the length of time between issue date and maturity date increases the risk increases. In professional sport, risk impacts players as they negotiate salary, especially when deferred compensation becomes part of the negotiation. Deferred compensation (deferred salary) - Salary that is paid in a different year than when it was earned.

Measuring Risk

Investment Risk: Stand-alone basis: Defined: The measure of the likelihood of low or negative future returns 1. Stand-alone basis-analyzing investment return and risk as if only asset were held. Example: St. Louis Rams: NFL franchise value increased annualized 8.4% from 2006 to 2008 Rams increased 7% over same period 2. Portfolio Return and Risk-when holding more than one asset, investor can eliminate the risk. Stand-alone basis: No potential owner should invest unless the expected rate of return is high enough to compensate for the perceived risk of the investment. Rams: Expected rate of return is 1.4% less than the league’s average increase. Investor might be hesitant to purchase the franchise. Or, might purchase at a discount as compared to the average price of a NFL franchise. Lower team values represent greater risk because the reduction of risk or uncertainty of future cash flows is a component of value.

Your Viewpoint If you were advising an investor who is interested in buying a sport franchise, what advice would you give? Of the various leagues (MLB, NFL, NBA, and NHL), is there one you’d recommend to the investor? One that you would not recommend?

Sources of Risk: Current financial conditions: 1. Capital finance-the economy impact on the bond market affects teams/cities financing endeavors. Example: Jerry Jones, Cowboys owner refinanced $435 million of debt for the new stadium. He refinance at a fixed rate of 5%. 2. Operating budgets- A slow economy can affect budgets. Example: MLB attendance took a dive in a slow economy so they discounted tickets, promoted two for one tickets, family night, gave away gas cards, and dollar nights. 3. League loan pools- provide lower-cost- capital to affiliated franchises. It is create by the league or banks. Example: the NBA teams can borrow from a fund. The loan pool is $1.96 billion. The NHL also renewed its loan pool during May of 2009. It totals $200 million. 4. Global issues-In North America the league most affected by this is the National Hockey League. NHL’s collective bargaining agreement requires that all player contract be paid in U.S. dollars. As the Canadian dollar strengthen, the Canadian teams revenue increases. Read the Sidebar and discuss 3.B Capital finance: As lending standards tighten in a credit crisis, debt becomes more expensive Arlington, Texas example Synthetic fixed rate bonds - elements of both a fixed rate and a variable rate bond. Tightening credit market caused increase in the interest rate during Spring 2008, to 7%. Three months later, the rate climbed to 8%. The bonds were issued in 2005 with interest ranging from 3 to 4%. Peaked at 9% during the summer of 2008 leading to a $500,000 monthly interest rate increase. Converted $104 million to 6% fixed rate. Changes in rates added $44 million to cost of project. Auction-rate bonds – reached 22% for New York Giants on $53 million and 11.5% on $71 million Operating budgets: Decreases in attendance (2009 MLB down 5% during first 6 weeks of season). Guaranteed income protected teams and league somewhat. League loan pools: Risk of individual franchise is greater than entire league. Leagues borrow at lower rates, then lend to franchises. NBA renewed $1.96 billion debt May, 2009. Cost 1% higher than previous loan pool

Revenue Sharing and Risk Each league has two basic pools of revenue that may or may not be shared by teams: 1. Central revenues are revenues paid directly to the league and then distributed to the teams. 2. Local revenues are revenues from ticket sales, TV, radio, advertising, and etc. Revenue sharing - Support weaker franchises and increase the level of competitive balance within league. A by-product is an individual organization’s risk is lessened Central revenues – directly paid to league. CBA governs how shared Local revenues – also shared; varies by league

Revenue Sharing Models 1. Higher revenue allocations to teams with low local revenues 2. Equal allocation to all teams in league 3. Higher revenue-generating teams receive more revenue 4. MLB has used this model, the NFL has begun using this model too. 5. Old NFL model. 6. English Premier League model.

Reducing Risk— National Hockey League 2002–2003 operating loss of $273 million No salary cap 2004 lockout: The league then implemented a hard salary cap and increased revenue sharing. 2002-2003 NHL season, operating loss of $273 million Player costs were 75% of league revenues Cap 54% of league revenues

Average Value of NFL and MLB Franchises, 2004–2008 (in millions)

Valuations of College Football Teams, 2007 (in millions)

Your Viewpoint: Some sports teams do not have a recent winning history, yet are still ranked as very valuable. Why do you think that is?

Questions? Read Case Studies: Answer assigned question