Backcourt assist: the NBA opens the door to institutional investors as minority owners

Like many other sports leagues and institutions, the U.S. National Basketball Association (NBA) has been investigating means for its clubs (or “franchises”) to raise funds to plug the sizeable hole in their revenues caused by the COVID-19 pandemic. The NBA has already expanded its debt facilities and the introduction of additional franchises may be on the horizon. But the NBA is also turning to private equity and other institutional investors as a potential source of capital. In every crisis lies an opportunity.

An exclusive club

NBA franchises are typically owned by a tight circle of high-net-worth individuals. The franchise model of U.S. sports, with a single league and a static selection of sports clubs, leads to a scarcity of U.S. sports franchises available for a prospective buyer. Any change in the ownership of a franchise is subject to approval by the league. (As seen with Donald Sterling being forced to sell the Los Angeles Clippers in 2014, continued ownership of a franchise is also subject to approval by the league.) This has seen the value of NBA franchises grow dramatically, as franchises today are worth $2.1 billion on average, whereas no franchise was valued at even $1 billion in 2011.

The franchise model also offers a lucrative investment opportunity. With no promotion or relegation, unlike many European sports leagues, no NBA franchise is at risk of suffering from the dramatic loss of revenue caused by relegation from a sport’s top tier league. The presence of a collective bargaining agreement with NBA players also converts each franchise’s largest expense into a predictable and (soft) capped amount (that was able to be efficiently renegotiated in response to the pandemic). Broadcasting contracts and many other commercial relationships are agreed on a league-wide basis. Together with revenue sharing between franchises, this means that all franchises, even those based in smaller media markets and population centres, can expect to be profitable each year.

Minority stake

The NBA’s Board of Governors – which consists of NBA commissioner Adam Silver and the owners of the 30 NBA franchises – has agreed parameters for NBA franchises to accept investment from private equity and other institutional investors:

• any particular institutional investor may own up to 20% of the equity of any single NBA franchise;

• each NBA franchise may have no more than 30% of its equity (in aggregate) owned by institutional investors;

• each NBA franchise is now permitted to have more than 25 individual beneficial owners; and

• any particular institutional investor may own equity in no more than five NBA franchises.

Dyal HomeCourt Partners (HomeCourt) is the only such institutional investor currently approved by the NBA. HomeCourt is still in the fundraising process but expects to raise $2 billion towards its NBA investment strategy “focused on acquiring minority equity stakes in NBA franchises”. Public filings disclose that, subject to ongoing negotiations, the NBA is expected to provide services to HomeCourt and receive a portion of HomeCourt’s management fees and incentives.

The investment parameters and the proposed relationship with HomeCourt suggests that, while franchise owners will sacrifice some of their long-term financial upside, owners (and the NBA as a whole) will not cede control of any franchise as part of this fundraising exercise.

A win-win investment

This opening presents an exciting opportunity to private equity and other institutional investors. NBA franchises are in the middle of a record nine-year $24 billion national broadcasting deal, which does not threaten their capacity to also enter into lucrative regional broadcasting contracts. The NBA is a proven organisation with a world-class record in terms of market development, especially in key markets like China. By any standard, it has been successful in its attempts to mitigate the impact of the Covid-19 pandemic, limiting its revenue decline during the 2019-2020 season to $1.2 billion. While the sports calendar has impacted each U.S. sport differently, Major League Baseball reported a decline of $7.7 billion for its 2020 season and the National Football League is expected to suffer a decline of around $4 billion for its current season. As such, investors will be expecting a financial return in addition to the cachet of being a franchise co-owner.

On the other side of the table, the opportunity also appears to be a win for NBA franchises. As with all professional sports teams across the world, financial results over the last year have been impacted and bringing private equity players to the table is a valuable financial lifeline. Based on the current valuations of a NBA franchise, selling a minority stake could result in a substantial equity injection. It would then be up to the majority owners to either take the financial relief or reinvest the money in players’ salaries in order to build (and pay for) a “super-team”, which has proved to be the most effective strategy to win a NBA championship over the course of the last 15 years.

As expected, following the announcement we have seen a flurry of activity, including some of the existing minority owners of the Golden State Warriors exploring the sale of a 5% stake in the franchise for around $200 million and CVC Capital Partners reportedly pursuing a 15% stake in the San Antonio Spurs for around $195 million.

Comment

The NBA's decision signifies that the trend for increasing private equity investment into sport – kickstarted in 2020 – looks set to continue in 2021. Whether it is baseball and basketball in the U.S., or football and rugby across the globe, clubs and franchises are increasingly being joined by sports leagues and their organising bodies in receiving investment attention from a range of traditional and specialist financial investors. There appears to be a general expectation that over the medium-term the interest in, and valuations of, sports clubs will continue to rise. Investors will accordingly be hopeful that they can profit from any valuation discounts extracted in return for choosing to invest in cash-strapped clubs and leagues at this time.

Yet the nature of these investments varies significantly, perhaps reflecting the distinct nature of sports administration and the business of sport between North America and the rest of the world. Whilst the NBA looks set to permit essentially passive investors to hold a minority stake in multiple franchises, investors in European sports come to the table with grand strategies for expanding the commercial performance and media exposure of clubs and leagues, amidst stringent regulations regarding investments in multiple clubs and maintaining the sporting integrity of a competition.

Despite the nuances in approach, the sense is that, amidst the disruption of the pandemic, sporting institutions’ need for financial support combined with the private equity industry's sense for a good deal is the perfect match-up.

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