With an estimated $1.5 to $2 trillion in investable capital at its disposal, private equity increasingly looks to adjacent verticals and new business activities to maintain its recent superior returns. Although still embryonic in North America, a serendipitous confluence of events suggests professional sports franchises are emerging as new targets for this massive trove of “dry powder.” In particular, recent changes in team ownership rules for pro-sport franchises, which historically disqualified private equity, may spur intrepid investors to jump into the sports arena.
Sports Franchises Prove Tempting
The “game” is changing. In recent years, professional team finances have improved dramatically. Owners, who used to see their teams as local, family-run, prestige-oriented businesses, now view them as diversified global media companies with far greater potential due to these factors:
- Greater operating margins: The aggressive pursuit of new revenue streams beyond game-day receipts and media rights have boosted previously unimpressive margins, with merchandising and naming rights revenue approaching those of the traditional standbys.
- Predictable revenues and expenses: Long-term contracts and collective bargaining agreements limit short-term earnings volatility.
- Increased media revenues: Live sports represents one of the last remaining sources of aggregated audiences, filled with deeply loyal fans who watch in real time. Leagues are capitalizing on this by launching their own media networks and retaining certain valuable rights.
- Equity appreciation: In the last 20 years, sports franchise valuations have grown at above-market rates, reflecting the extreme demand-side scarcity and uncorrelated nature of these unique assets, further buoyed by their countercyclical risk profiles.
- International exposure: Increasing global interest expands an untapped customer base.
- Ancillary opportunities: The liberalization of sports betting laws and introduction of products like non-fungible tokens (NFTs) present potentially lucrative optionality value.
Leagues Historically Boxed Out Private Equity
There have been relatively few private equity sports team investments in North America, primarily because the leagues prohibited or discouraged it. Their highly restrictive rules historically favored ownership by one or more affluent individuals and public corporations, and disallowed even non-controlling shares to institutional funds because this was believed to preserve the privacy, civic pride, and sense of community long coveted by leagues.
Leagues also heavily restricted franchise acquisition and operational debt amounts to keep financially stressed or insolvent owners from reallocating capital to the detriment of team performance. In addition, ownership continuity allowed tight control over decision-making, which was preferable to leagues skeptical of the profit motives, shorter-term exit outlooks, and rapid management changes of institutional owners, who also enjoy the competitive advantage of greater access to capital.
Playing Field Starts Leveling
However, leagues are now realizing that their historical reliance on a limited pool of billionaires—those able to pass strict eligibility screens and willing to assume the highly visible and sometimes reputationally risky role of team owner—has likely run its course. Spiraling valuations further limit that pool, increasing the pressure for ownership diversification, while existing owners are increasingly seeking to unlock liquidity from that outsized appreciation. At the same time, leagues have become more forward-looking in expanding their global brands and remaining relevant to younger, more diverse demographic groups.
As a result of these trends, ownership rules and financial guidelines are being loosened, creating nascent but expanding opportunities for private equity investors.
Opportunities Vary by Leagues
What’s happening differs by sport, but the three most popular North American leagues help tell the tale of the tape:
National Football League
Long the leader in monetizing its assets, the NFL maintains fairly tight control over its IP and media rights and has successfully leveraged its players’ union into favorable collective bargaining agreements with salary caps and non-guaranteed contracts. As a result, average franchise valuations hover slightly above $3 billion, which equates to annualized growth of nearly 20% over the past ten years.
Still, the league’s challenged by:
- Limited streaming options, underdeveloped social media, and technology hesitancy
- Increasing concern over player injuries
- An estimated $5 billion in aggregate pandemic-related losses
- Racial and social justice issues impacting attendance and viewership
However, the league has been fairly nimble in meeting these challenges, and recently concluded a long-term media rights package that dramatically expands its media offerings to include exclusive and simulcasted streaming rights on multiple platforms, which will increase annual media rights fees by 75%.
The NFL still strictly limits ownership to individuals who can fund at least 30% of the acquisition price with cash. Despite recent increases in debt caps and rumors that it’s seriously evaluating the impact of minority ownership changes in other professional leagues, the near-term outlook for private equity is not promising.
National Basketball Association
The NBA is by far the most progressive of the major leagues in pursuing innovation and digital media to build and expand their audience among younger fans and beyond the United States. Global superstar Lebron James epitomizes this trend as one of the most sought-after brand influencers with more than 80 million social media followers, a profile that dwarfs stars in other leagues. Aggressive global expansion has generated some political controversies, partly stemming from the NBA’s spectacular popularity in China and fan fallout as players speak out about hot-button issues.
This is counterbalanced by several league attributes, which have driven strong franchise valuation growth:
- Aggressive distribution of highlight clips
- Support of video game development
- Popularity as the most-streamed sport on the live-streaming platform Twitch
- A favorable collective bargaining agreement and owner-to-players’-union relationship
- Materially more lucrative upcoming media rights package, potentially tripling current fee levels
In early 2021, the NBA changed its rules to also allow private equity firms and other institutional investors to own up to 20% of a single franchise and hold stakes in as many as five. The league is actually forming its own investment vehicle, led by New York-based Dyal Capital Partners, to purchase passive interests across multiple teams and provide owners with more access to liquidity.
Over one-quarter of NBA teams are currently owned by private equity principals, such as Tom Gores, David Tepper, Steve Cohen, Joshua Harris, and David Blitzer—proof that the NBA may present the most compelling short-term opportunity for private equity.
Major League Baseball
The economics of MLB are not as evenly distributed as other leagues, as it features more limited revenue-sharing, less restrictive collective bargaining agreements, and weaker salary caps. The league’s demographic trends are also concerning, with a median age of 57 and a decreasing fan base. Exacerbating this trend is the game’s slow pace and lack of viral highlights that limit its appeal to younger audiences and hinder social media and gaming exploitation, all of which hurts MLB’s ability to more broadly diversify revenue sources beyond game-day and media sources.
On the upside, operating results and franchise valuations for most teams have nevertheless substantially improved in the last decade, and the MLB has some distinct advantages in its corner:
- Exciting young players like Fernando Tatis Jr. with active social media profiles
- Upcoming media rights deals likely to generate significant increases
- Massive volume of content generated by its daily six-month schedule
- Superior streaming innovation, app development, and fantasy capabilities, evidenced by Disney’s majority interest acquisition in BAMTech, the league’s streaming platform
- Pioneering technology to generate the sophisticated metrics demanded by fans and allow the league to benefit tremendously from the liberalization of sports betting laws
Although owners were formerly either wealthy individuals or public companies, MLB updated its bylaws last year to allow institutional funds to acquire minority stakes in multiple teams and is considering allowing investment vehicles to own passive stakes in multiple franchises (a la the NBA). This provides an opportunity for private equity to gain a foothold in a league with considerable upside potential.
It’s a Whole New Ballgame
Although these leagues, along with the NHL and MLS, are at different stages, they all clearly see the potential benefits of private equity investment. Additionally, private equity firms know that sports teams have not typically been run as efficiently as other businesses, creating significant potential value for savvy investors. This trend of opening up more potentially lucrative investment opportunities is almost certain to continue and attract interest from a broader range of private equity interests.
At Focus Search Partners, we keep a close watch on the latest business trends happening in the private equity space. Our observations and analysis help both mid-market private equity firms and accomplished executives find new and exciting opportunities in which to excel.
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Contributing writer Steven Brunell, a COO/CFO in the digital media/mobile gaming sectors, is also a member of Focus Search Partners’ The Focus Forum, a community of engaged CFOs.