Reasons for the Private Equity Investment Trend in Sports and its Implications
The recent European Super League (ESL) disaster underscored a change in sports team investors, demonstrating a pursuit of money and power by a small group of owners, without the consultations of fans, which defies European football traditions. Since then, analysts and sports fans have been inquisitive about the reasons for the change in investors as well as the overall effect of this variation on the investor decision environment.
In analysing the environment during which the private equity (PE) investment in sports accelerated, the COVID-19 pandemic evidently comes to mind. The sports industry has been one of the hardest hit during the pandemic, suffering the effects of lockdowns, competition cancelations, and infected players. The NFL lost $4 billion in revenue in 2020 and top European soccer teams are set to lose $2 billion in comparison to 2019. These important operating losses have led several clubs to experience cash flow concerns.
On another front, sports team valuations have been steadily mounting. With the stay-at-home atmosphere brought on by the pandemic, streaming and TV watching has surged. Further, in the longstanding internationalization of football, top players from Africa, Latin America, the Middle East, and North America play for European football clubs, attract fans from their home countries, and increase at home viewership. In 2011, the most valuable European football club was Manchester United at $1.86 billion. In 2020, more than 10 clubs exceeded the $1.7 billion mark. The valuations have been growing to the point where football clubs’ previous owners, who were mostly individual billionaires, are not plentiful enough to sustain a franchise market of this size. Given the sheer magnitude of the valuations, many investors resort to using leveraged buyouts (LBOs), which involve financing an acquisition through debt and establishing the sports clubs’ assets as collateral. Private equity firms, such as KKR, popularized LBOs. The factors contributing to rising valuations have also affected the performance of sports club investments relative to principal index funds. Using 25 years of data, it has been found that the return on an investment in a major league sports franchise, in the last five years, overtakes that of leading index funds.
In parallel to growing valuations, the accumulation of dry powder, which refers to liquid securities and cash by PE firms has reached record highs. This trend was emphasized during COVID-19 because of the special purpose acquisition company (SPAC) frenzy, during which PE firms raised millions. As an illustration, a SPAC called RedBall Acquisition Corp was created by private equity firm RedBird Capital Partners, to acquire a sports team or group. The PE industry rose from $1 trillion in assets in 2004 to an overwhelming $4.5 trillion in 2018. Furthermore, fundraising by PE firms went up by $240 billion from $60 billion in 2010 to $300 billion in 2019.
The pandemic caused severe operating losses and cash flow concerns, resulting in a need for liquidity in sports clubs. Rising valuations had the by-products of establishing LBOs as more common in sports and allowing sports investments to outperform major indexes, both of which are attractive to PE firms. Additionally, stakes in sports clubs are extremely eye-catching to PE firms because they provide the uncorrelated asset in a portfolio that needs diversification. The increase in PE firm dry powder provided the liquidity needed by these sports clubs. Given the necessity of liquidity during the pandemic, the LBO normalization, an outperformance of main indexes, and an uncorrelated asset class weren’t enough to ascertain an adequate inflow pace of liquidity. To adjust to trends, the sports teams proceeded to decrease prerequisites to own a sports team by increasing the debt limit for LBOs.
The result is a large influx of liquidity heading towards sports teams. Silver Lake, a California-based PE firm, is considering buying 12.5% of the revenue generated by the All Blacks, a New Zealand Rugby team. Luxembourg-based CVC, which formerly owned both Motor GP and Formula one, took advantage of the aforementioned trends. The racing league was worth $2.5 billion during CVC’s buy-in and $8.1 billion when it was sold to Liberty Media. Now CVC started a contest to fund the Serie A Italian Football league’s growth plans. Nine other firms aim to get a share of the deal, including Bain Capital, Apollo, and Blackstone’s credit division GSO. RedBird Capital Partners, mentioned earlier, pronounced a share in Fenway Sports Group, which owns Liverpool Football Club and the Boston Red Socks. ALK Capital bought the English Premier League Club Burnley with an aggressive debt structure.
The reaction among stakeholders has been mixed depending on the type of ownership. Minority stakes have been preferable since they are not controlling. They satisfy the liquidity needs of sports clubs without imposing any major change in strategy. Majority ownership, however, goes beyond the fragile threshold needed to activate the clash between PE firm profit and sports tradition, since it has the power to redirect strategy. Bernie Ecclestone, the former chief executive of the Formula One Group, was not fond of CVC’s ownership, since their goal was to maximize returns. Minority and majority investments are viewed undesirably if they are financed through excessive debt since that would increase risk. Going back to the European Super League two-day calamity, the threshold activating the profit-tradition conflict was surpassed. Fans gathered on the street protesting the money-making project in which the best European football teams would compete without the possibility of being relegated. Many felt that smaller teams and their fans were being left out. Private equity investors themselves were also divided since those with stakes in teams that were omitted from the European Super League would lose out. In the end, though, the clubs who ended suffering most in terms of reputation are those that were involved in the ESL because of its annulment, casting worry among PE firms that invested in them.
The PE investment in sports trend was propelled by a plethora of factors, the first one being operating losses by sports clubs due to COVID-19. Rising valuations caused by pandemic trends led to LBO normalization and index fund outperformance by sports investments. A growing sports investment market was highlighted by the SPAC frenzy brought on by the pandemic. Further, sports investments are inherently attractive since they are uncorrelated assets to diversify a portfolio. To add fuel to the fire, there was a significant increase in PE firm dry powder and the removal of prerequisites for sports investments. The observed responses of this trend have been mostly positive on minority investments, except in the case of debt financing, and primarily negative on majority investments because of the clash between sports tradition and the maximization of returns.
Given the space in innovation that was made clear by the PE investments in sports trends, such as the creation of more complex investment vehicles, like the Series A deal tied to media rights, it would be reasonable to expect this trend to continue and grow in the future. However, the resulting intensity of the clash between profit and tradition will decide whether the PE investments in sports trend is here to stay.