This piece is part of a series and is based on a quantitative study put together in a collaboration of The Audible Group, RCM Alternatives and RCM Securities, and the University of Illinois at Urbana-Champaign and UCLA’s Masters in Financial Engineering Programs.

by Josh Moscot - The Audible Group - July 30th 2020

In our last installment of the “Pro Sports Team Valuations” series, we shared our proprietary factor model that looks at the sources of value behind the growing price tags of professional sports teams. This living model is being updated daily and has already yielded some fascinating insights. To briefly recap some of our favorites, we’ve been able to quantify the relationship between national and local revenues to sports franchises, the relative importance of non-monetary fan engagement metrics like social media and demographic composition, and the significance of a team’s player expenses as a key contributor to their overall value. Cutting across all these findings is the reality that a sports franchise depends, in some fashion or another, on their audience.

So what happens to sports team values in a world where sports have been abruptly canceled? We here at TAG, RCM Alternatives, and RCM Securities set ourselves to the task of finding out.

"We began this endeavor in January 2020 with the goal of using financial engineering principals to value professional sports franchises,” said Joe Signorelli, managing partner of RCM-X and advisory board member of UIUC and UCLA’s MFE programs. “Our initial hypothesis at the time was that most team valuations would have a solid correlation to things like TV contracts, fan base, and other more 'obvious' factors. Once the pandemic broke out in March, we found ourselves in a unique position to test our model in the midst of this unprecedented market disruption and to dig deeper on the more ambiguous elements that drive value after the disruption has run its course.”

Since the pandemic began, every major North American league has stopped or canceled their seasons and in some cases, started and stopped them once again. On March 11, 2020 the NBA announced their suspension of the 2019 – 2020 season. The NHL followed suit on March 12 and as of May 5th, the NFL announced they will not be going abroad for the 2020 season. Beware the Ides of March, indeed. Fortunately, the NBA and the MLB have led the way in getting the seasons restarted, but not without unprecedented changes to the operating structure of the season, alterations that beg the critical question of what the impact will be to the teams themselves. In order to answer that question properly, it helps to understand how teams make money in the first place. From there, and with the help of our factor model, we formed an educated forecast of where sports franchise valuations might be headed in the near-term and beyond.

Let’s begin with the sports business model. Put simply, team revenues come from two sources: national revenues and local revenues. The former is driven by two contributors: Global Media Rights deals (traditionally with major TV networks) and league-wide revenue sharing from sales of league sponsorships, merchandise, IP, and other “sport-related income”. The latter revenue source is driven by line items with which fans are more familiar: stadium sponsorships, ticket sales, concessions, etc. Delving into the mechanics of league revenue sharing and the league-specific rules behind sport-related income is the topic of a future article; it will suffice for our purposes here to understand that, with the exception of a handful of outlier teams in each league that generate larger amounts of local revenue, the most important contributor to a team’s cash flow is the revenue they receive from the league. This is important because it explains why resuming gameplay is so crucial to every team in every league. As our model illustrates, keeping that national revenue flowing to the teams is of the utmost importance to their valuations.

In our analysis of how the pandemic will affect these valuations, we considered it a given that league-wide stoppages and cancellations will not extend beyond 2020. Why? The short answer is that we believe all stakeholders in sports share the same sense of urgency in getting things going again (look at the MLB and the NBA’s quick restoration of play). As a result, the question that we found most interesting became: Just how big will the hit be to teams’ local revenues and how long might it take for that value to be recovered? That’s where things got interesting.

Our first approach was to use a scenario analysis framework and focus our efforts on the NBA. We began by using our model to identify the relationship between local team revenues and live attendance – everything from sponsorships to hot dog sales depends in some manner on people actually being at live games. Having identified that relationship, we scoured the news and the internet to come up with a handful of scenarios for live attendance figures that seemed realistic. At the time (and today), predictions of live attendance figures corresponding to 25% stadium capacity across the various leagues for the next full season seemed to be reasonable estimations. So we built our scenarios around that median attendance figure and found that the best case scenario corresponded to a whopping 36% drop in franchise value. (Interesting to note that this figure coincided with the US market benchmark drop, SPX Index on March 20th of 35%, 8 days after the NHL canceled their season.) But for sports teams, this figure is inaccurate. To understand why, it is helpful to understand how sports teams are typically valued.

Unlike traditional companies, sport team valuations based on book value, capitalization, discounted cashflow, etc. are often impossible to construct. There are three reasons for this:

1.       The data required to conduct these analyses can be impossible to obtain

2.       The business models are markedly unique

3.       Sports team ownership opportunities are so limited in quantity that it is a consistent “seller’s market”

Taken together, these reasons explain why professional sports team transactions generally use a different approach altogether: the “precedent pricing approach.” Because there are so few assets available (149 teams, including the MLS) with such limited data, a possible acquirer of a team often relies primarily on the valuations from recent transactions to assess the value of the sports team in consideration. Similar to fine art and real estate, these precedent transactions provide metrics that can then be adjusted and applied to the particular team in question.

Here is an example, by league, of the growth of the 10-year average valuation multiple of revenue from Forbes’ annual valuation data, a metric commonly employed in the pricing of team opportunities:

The key takeaway here is that sports team valuations are often heavily influenced by expectations around future growth. Coming back to our scenario analysis, it became clear that our predicted drop in NBA team valuations was an estimate looking exclusively at value as a point in time rather than as an element to factor in over time. To solve this, we built a dynamic sensitivity table allowing for a continuous adjustment of live attendance expectations that, before spitting out a valuation figure, takes into account a 6-month, 1-year, and 2-year recovery timeline for the local revenues. The results are fascinating.

When combining the teams together and assuming a two-year recovery timeline back to 100% of live attendance, we found that the average percentage drop in a given team’s valuation is roughly 10.0% at the close of the first six months after games resume, 5.5% at the close of the first year, and 3.0% at the close of the second year. Let’s look at a concrete example.

Based on Forbes’ latest valuation list for the NBA, the Indiana Pacers are today worth $1.525 billion. The below table summarizes what our sensitivity analysis forecasts the effect of the pandemic could have on their franchise value over the next two years:

So who cares?

The actual numbers might not generate excitement, but the underlying implication should: pro sports teams aren’t going anywhere. They can certainly expect to see a reasonable dip in their valuations as a result of the unprecedented stoppages caused by the pandemic, but nothing like the precipitous decline predicted by doomsayers and “point in time” analyses.

We are daily updating our assumptions to improve our model and expand this analysis across leagues.  Our ability to forecast possible valuation fluctuations improves with each passing day as teams figure out how to protect local revenues via sponsor negotiations and operating innovations to make stadiums safe for as many fans as possible, as quickly as possible. These are uncertain times, but there is a growing sense of excitement for the eventual return of sports, as ESPN recently found in a poll across the US.

As noted above, sports team values ultimately come down to audience. Right now, that audience is clamoring to get sports back into their lives in any way, shape, or form possible. With this in mind, it is certainly realistic to consider the possibility that teams may recover even more quickly than predicted above. All the pent-up demand for sports will likely translate into higher TV ratings and media consumption rates, which will mean more lucrative TV broadcast deals for leagues, and thus more money for the individual teams. It may even mean that operating innovations at the stadium level translate to a faster recovery of 100% live attendance. The future may be uncertain, but the demand for sport is not.

We here at TAG and RCM (which includes RCM Alternatives and RCM Securities), in conjunction with our partners at UIUC and UCLA are excited for the future of sports and the opportunities for growth this unprecedented period may bring.  Stay tuned for more in our “Pro Sports Team Valuations” series.