Value Driver Considerations in Appraising Sports Franchises
The valuation of sports properties is often perceived as one of the most exciting areas of the appraisal profession. Sports business mandates constitute an amalgam of traditional valuation approaches applied to a specialized industry niche possessing its own distinct value drivers and considerations.
Sports property valuations may be required in a variety of situations, including:
- mergers and acquisitions;
- fairness opinions;
- business reorganizations;
- shareholder disputes;
- structuring shareholder agreements;
- income tax;
- estate planning;
- commercial litigation; and
- marital disputes.
While the purchase and sale of professional sports franchises and arenas constitute the most visible event necessitating the participation of an experienced valuator, the foregoing situations also can give rise to valuation mandates. For example, in 1994, the Toronto Maple Leafs NHL franchise and the arena in which the team played, Maple Leaf Gardens, were owned by a public company, Maple Leaf Gardens, Limited, which was being taken private. Consequently, the fairness opinions that had been prepared in connection with this going-private transaction were called into question by The Public Guardian and Trustee of Ontario and the Attorney General for Ontario. A vigorous litigation ensued, in which the valuation professionals played a central role.
As is the case with many businesses, shareholder agreements can necessitate valuation mandates, as sports teams and arenas are often owned by numerous individuals and/or corporations. For example, at the date this was written, the Calgary Flames NHL franchise was held by over two dozen owners, and the Green Bay Packers NFL team was owned by several thousand individuals, most of whom were members of the local Wisconsin community.
Both friendly transactions and acrimonious disputes among shareholders occurring under such shareholder agreements will typically require the involvement of one or more valuation professionals to determine the value of the entity holding the sports-related assets (or interests therein).
Income tax and estate planning also constitute frequent sources of valuation work involving sports organizations. Those sports properties that have been owned by families will often, at some point, require valuations to be performed for intergenerational transfers of ownership among family members. Moreover, considering the significant appreciation in value experienced by professional sports franchises around the globe during the past few decades, owners of sports properties eventually may need to contend with capital gains-related issues. Valuation professionals often provide integral assistance in this process.
Insolvency or restructuring involving either a professional sports organization or one of the owners thereof is another event that will frequently necessitate the expertise of business valuators. For example, in the 1990s, there were several high-profile bankruptcies of English Premier League football (i.e., soccer) organizations that occurred after several previous rounds of financing had been obtained. At every step of the way, from the initial financing to the restructuring or asset liquidation process, business valuations are typically required to provide an indication of worth of the sports franchise and related properties.
Price Versus Fair Market Value
The valuation of professional sports properties provides an excellent illustration of the difference between price and fair market value in a “real world” setting. As valuation professionals are well aware, there are generally two distinct sets of circumstances where the value of a business is determined:
Notional Market Valuation. Fair market value, fair value or some other legislated or defined value is often notionally determined in the absence of an open-market transaction. The value standard most frequently applied in notional market valuations is “fair market value.” The generally accepted definition of this valuation term by North American courts is:
The (highest)1 price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.
Open-Market Transaction. Price is negotiated between a vendor and a purchaser acting at arm’s length. The term “price” is defined as “the consideration paid in a negotiated, open-market transaction involving the purchase and sale of an asset.”
In a sports market context, sentimental value may occasionally represent a component of price. This concept is evidenced by a sports team owner who is an extremely wealthy individual and does not view the acquisition of a sports team from an economic perspective but rather as a “trophy.” An investment involving sentimental value, in other words, may be ego-driven in nature and made by a purchaser who is willing and able to absorb significant losses.
Special interest purchasers are often present in the marketplace for professional sports properties. Special interest purchasers are generally defined as: “acquirers who believe they can enjoy post-acquisition economies of scale, synergies, or strategic advantages by combining the acquired business interest with their own.” Examples of these types of purchasers are large companies possessing broadcasting, media and entertainment operations that can avail themselves of synergies presented by controlling assets relating to professional sports organizations. In recent years, a number of such companies have successfully acquired professional sports properties in order to benefit from the content provided to the purchaser’s media distribution network.
In the sports business world, both of the above sets of circumstances are frequently encountered. As is illustrated below, there may be significant differences between fair market value and price. For example, fair market value typically assumes the following conditions exist:
- equal knowledge and negotiating skills;
- no compulsion to transact;
- generally no special interest purchaser considerations;
- imprudent actions and emotions are not considered;
- vendor and purchaser are assumed to deal at arm’s length; and
- transaction is assumed to be consummated for cash.
In contrast, the price determined in an open-market transaction may be influenced by the following considerations:
- unequal knowledge and negotiating skills;
- compulsion to transact may be present (e.g., a sale made in an insolvency setting even if the purchaser intends to continue the sports organization as a going concern);
- special interest purchasers may force the price upward;
- price may be struck as a result of imprudent decisions by the vendor, the purchaser or both;
- sentimental value considerations may force the price upward;
- outwardly, vendor and purchaser may appear to act at arm’s length, but may have common interests due to the elements of the transaction, such as vendor employment agreements, noncompetition agreements, etc.; and/or
- the negotiated price may contain noncash elements, such as contingent “earn-out” or bonus payments, freely trading or restricted shares and/or debt instruments.
As is the case with most businesses, a sports franchise’s value is derived from its future benefits, such as revenues, EBITDA and net cash flow. Among the factors influencing the perceived future benefits for a sports franchise include its management team, trademarks, brands and logos, customer “fan base” relations, customer contracts (e.g., season tickets, corporate boxes, personal seat licenses), player relations and contracts, broadcasting contracts, arena ownership or lease agreements, team-alliance synergies, local demographics (e.g., population size, wealth, popularity of sport), etc.
Simply put, the fundamental goal for a sports team owner is to maximize the number of fans in the seats (or viewing the matches via broadcast media), and the goal for an arena/ stadium owner is to minimize the number of “dark nights” in which no event is occurring in the building.
Admittedly, while future benefits often cannot be measured with absolute certainty, franchise values will change in a manner commensurate with perceived increases and decreases in such benefits. In the sports business world, while no single approach or formula can be used to determine the value of sports properties in every situation, different approaches and methods have been adopted for estimating future benefits and franchise/asset values.
In sports business valuations, the Market Approach is often frequently utilized, considering the active market that exists for many professional sports properties. In the Market Approach, the subject sports property is compared to similar properties by performing a detailed analysis of prior transactions involving similar sports properties and/or in the ownership of the subject sports franchise or asset.
In analyzing transactions in sports properties, aside from reviewing the amount and structure of the transaction price, it is frequently necessary for the valuation professional to identify and quantify key organizational elements that generate value for the subject professional sports club, such as (but not limited to) management team and personnel, corporate operations, finance and technology.
It is a sports business paradigm that the management team should, in maximizing franchise value, maintain and enhance the quality of the team brand. Such brand value enhancement may be performed in a variety of ways, including winning on-field victories and championships, attracting individual “marquee” players, fostering positive community relations and developing a robust tradition ultimately bestowing “iconic” status on the sports franchise.
For example, the valuator should examine the quality of the management team, employees and players, focusing on the club’s ability to retain talent and expertise (on the field, among the coaching staff and in the front office). In order to enhance value, the sports organization should possess the potential to develop future leaders (for both players and management), avoid labor actions (e.g., strikes, lockouts), motivate commitment in its players and employees to the club’s culture and ethics, and strengthen relationships among management, players and employees.
In assessing value of sports franchises in a transactional setting, the valuation professional should also examine the ability of the organization to maximize the potential of its corporate operations. For example, the franchise organization should constantly strive to improve capacity utilization wherever possible (e.g., selling out games, maximizing advertising and media revenue). Recent revenue maximization trends by franchise owners in this context have included selling advertising on fixed or rotating panels in close proximity to playing surfaces, inside arena corridors, on building exteriors and on game tickets. Sports team management should also be seeking to optimize other areas of business potential (e.g., creation of team-alliance synergies, increase in the number of official sponsors or partners with the club, etc.).
Moreover, the sports organization should periodically assess what investments are required to expand or improve fixed-asset infrastructure (e.g., addition of seats, creation of premium or “club” seat categories, addition or expansion of facility restaurant, bar, concessions and parking facilities). Management should also be cognizant of ways to strengthen the franchise’s market position in the presence of other forms of entertainment competing for the same consumer, media and advertising spending sources.
The valuation professional must examine the ability of the sports organization to maximize the value of its intangible assets. Aside from traditional items such as the franchise logo, influencing the popularity of merchandising and licensing revenues, in recent years, savvy sports-marketing experts have derived new sources for professional sports franchises to obtain revenues, notably the leasing of stadium/arena naming rights. Typically, building naming rights are leased for several million dollars annually for terms of 10 to 20 years; these stable revenues often flow directly to the bottom line of the club/building owner.
Furthermore, in transactional contexts involving professional sports organizations, the valuation professional should assess the financial strength of the subject business. In particular, the valuator needs to place particular emphasis on the extent to which leverage has been (or may be) utilized to finance capital assets and franchise operations. Other financial issues should be reviewed, including the club’s ability to recognize and maximize all revenues (i.e., deferred revenues) from an accounting standpoint and to depreciate or amortize the franchise itself, player contracts, capital assets, etc. If the franchise is being positioned for sale, it may be desirable for the club to “clean up” the balance sheet, (e.g., eliminate redundant assets such as excess cash, marketable securities, non-operating real estate, inter-company or shareholder loans), adjust overvalued assets and other reserves in order to present the sports business’ true earning power, accelerate the collection of accounts receivable, etc.
Finally, sports business valuation experts have increasingly focused on a franchise’s ability to enhance value through the creative use of technology. In recent years, technology has been utilized by sports team owners through innovations such as the use of web-based resources featuring fan club sites and live or archived game broadcasts. Many sports business experts predict a proliferation of fee-based broadcasts of matches and related content through television, Internet audio and video, as well as mobile phone media. Other uses of technology that may create franchise value relate to the extent to which technology can be implemented to improve communications (e.g., within the internal organization, with the fan base and among the league and its members).
Both of the concepts of price and fair market value are often influenced by numerous value drivers that relate specifically to professional sports franchises. Among the frequently encountered examples of “external” value drivers (over which a franchise owner exerts little, if any influence) are included, but are by no means restricted to:
- degree of control of franchise operations by league;
- finite number of teams permitted in league (i.e., barriers to or ease of entry through expansion);
- franchise expansion fee (this often constitutes a “floor” to franchise value, as well as a windfall profit to franchise owners when received). For example, in the NHL, the most recent expansion fee paid for a new franchise, occurring 15 years prior to the publication of this paper, was U.S. $85 million. Media reports have stated that the next potential round of NHL expansion could command franchise fees as high as U.S. $400 million;
- extent and terms of revenue sharing;
- presence of salary cap;
- local market barriers to ownership entry/exit;
- availability of government grants or other forms of financial assistance;
- market demographics;
- market radius protection (in the NHL, each franchise is protected by a 50-mile radius, within which another franchise in the league cannot be operated without the existing owner’s permission);
- ability of the franchise to relocate; and
- extent to which league approval is required for franchise ownership transactions.
Moreover, included among the various salient “internal” value drivers over which a franchise owner typically possesses some ability to influence are:
- ticket revenue (e.g., season ticket base, ability to increase or vary ticket prices);
- broadcast revenue (e.g., from television, radio and Internet media);
- team-alliance synergies (i.e., synergies and benefits derived from common ownership of two or more sports teams);
- player-transfer fees (i.e., these represent highly lucrative sources of revenue in international soccer);
- advertising revenue;
- playoff revenue (revenues from post-season play often contribute significantly to profits);
- concessions revenue;
- merchandising and memorabilia revenue (including revenues from licensing team name and logo); and
- stadium/arena ownership revenues (derived from building sources such as luxury “club” seating, corporate boxes, naming rights and ancillary events such as concerts, unrelated sporting events, conventions, etc.).
Interestingly, two factors that do not always constitute significant value drivers for a sports franchise are the win-loss record of the club, as well as the individual players comprising the team. The impact of possessing (or lacking) either championship trophies or superstar players must be assessed by the valuation professional as to the incremental contribution of each to the value of a particular sports organization.
Among the important items on the expense side of the income statement that may materially impact the value of a professional sports franchise are included player salaries, which are, in turn, influenced by permitted contractual increases, free agency, union collective bargaining agreements, long-term injuries to or retirements of players, etc.
Franchise owners who do not own the stadium/arena facility will also be subject to leases for building rental, as well as possibly leases for concessions, merchandising and/or parking facilities. Moreover, some teams, such as Canadian NHL franchises, must contend with material foreign currency risk, as their revenues will be received in the local currency while some of their expenses (e.g., player salaries) may be denominated in a foreign currency. Finally, the ability of a sports club to claim amortization expense on its franchise cost, player contracts and capital assets will impact its fiscal situation, as well as its operating cash flows.
While the sports business field may be a source of some exciting mandates for the valuation practitioner, as the above narrative indicates, sports properties encompass a highly specialized segment of our profession that is subject to its own distinct challenges.
This article originally appeared in Wolters Kluwer’s Business Valuation Alert, January 2015.
About the Authors
Drew Dorweiler, MBA, CPA, ABV, CBV, ASA, CBA, CFE, CVA, FRICS, is Managing Partner at IJW Co.
Don Erickson, ASA, is Managing Director of Mercer Capital.
1 The word “highest” is added to the Fair Market Value definition in Canada.