Last month, the Federal Reserve approved the biggest interest rate increase since 2000 in an attempt to curb 40-year-high inflation, and six more similarly sized bumps are expected before the end of 2022. The high inflation and rising interest rates that have depressed stock prices has yet to negatively affect the sports industry—at least as far as team sales go. Chelsea and AC Milan traded at two of the highest prices ever for a team sale in recent weeks, and the sale of the Denver Broncos is expected to be the most expensive franchise purchase in sports history.
As for the balance of sports-related assets, M&A activity has all but come to a halt over the last quarter as the cost of capital increased and market uncertainty reigns supreme. Deal volume is expected to remain slow until a “new normal” is established.
JWS’ Take: Sports-related investments fall into one of two buckets. There are highly desirable, rare assets that only the wealthiest can afford (see: franchises in prominent professional leagues), and then there is everything else, such as a sports tech or sports media startup.
Former Goldman Sachs partner Eric Grubman—currently the chairman of the Super Group Holding Company and DroneUp, Inc.—believes that the macroeconomic environment has yet to influence the market for the former. That’s because those capable of buying controlling interest in a team (or the entire team) are unlikely to be concerned, at least in the short to medium term, with inflation and interest rates.
“[Those individuals] have accumulated vast wealth, and they are ready to spend it,” Grubman said. “They are [also] not buying [teams] on a multiple of cash flow or their rate of return. They are buying because they want it [and it] is exclusive. In some cases they may have waited for years or decades to be in a position to get control of a franchise.”
That dynamic likely won’t change change unless interest rates and inflation remain elevated over the next several years. But a more modest period of elevated interest rates could possibly affect the LP market. Grubman explained that because limited partners do not enjoy many of the perks or benefits associated with ownership (think: voting rights, public profile), they may be more concerned with the rate of return on their cash, or other low risk assets, than a control owner.
“If [the interest rate] is zero, [a prospective LP investor] has little sensitivity to using excess cash for buying an LP asset,” Grubman said. “But if they are able to get 3%, 4%, 5% on cash as interest rates go up, maybe they will be more sensitive [to what the franchise returns].” And outside of the NFL, not every pro sports team is profitable.
As franchise valuations continue to rise, prospective control owners are increasingly looking for LPs to help reduce their cash outlay. So, a smaller pool of potential buyers for those stakes could eventually have a negative influence on team valuations. Fewer interested LPs does not ensure sales prices will slide, but it could prevent some less well-capitalized control buyers from being able to compete.
While the macroeconomic trends cited could eventually slow interest in LP ownership, there is no reason to believe a flood of existing limited partnership stakes are about to hit the market. “People [tend to] sell LP interests when the owner sells the controlling interest or when they run out of money,” Grubman said.
As long as the franchise remains profitable, existing LP investors typically do not have to worry about making capital calls (or running out of money). But if the costs associated with an extended inflationary period increase at a faster rate than club revenues, the franchise will eventually require an influx of capital. “People may begin to choose to sell LP interests if they can,” Grubman said, as capital calls increase in frequency.
Some people believe sports teams are immune to inflation because they can simply pass their increased costs on to fans (remember, fans is short for fanatics). But there is no evidence to support that notion, at least not without alienating the fan base. The industry has not experienced a period of sustained inflation since team valuations began to climb exponentially ~30 years ago.
The PE firms now permitted to buy LP stakes in NBA, NHL and MLB clubs could be among the few beneficiaries of prolonged high inflation and high interest rates.
“They’re not in a hurry to sell anything because their business model is to only sell when the controlling interest goes,” Grubman said. “So, consequently, they are pretty [stable] as an [LP] holder and therefore pretty attractive to a franchise owner and to leagues.” The likes of Arctos Partners and Dyal Capital could end up seeing more opportunities at lower valuations.
Team deals aside, there has been little sports-related M&A over the last three months. The slowdown in activity may be attributable to perceptions of risk that seem to have taken hold, as well as the increasing interest rate and inflationary pressures. “Corporate entities buying other corporate entities look at their cost of capital,” Grubman said, and both equity and debt costs have risen in recent months. “[The] equity cost of capital has gone up because stock values have come down and the debt cost of capital has gone up because interest rates have gone up.”
The rising cost of capital means buyers are not going to be able to pay as much for an acquisition target. But asking prices have yet to adjust accordingly, making it a challenging environment for a deal. “To get a deal done in this period of uncertainty, you still have to pay a high premium over the current price,” Grubman said.
Perceptions of risk are not limited to interest rates. Geopolitical conflict, supply disruptions and the continuing effects of the COVID-19 pandemic are all present in the minds of corporate decision-makers. “When neither side has conviction [on markets, interest rates, geopolitical conflict etc.], things slow down,” Grubman said. Many are still trying to figure out if inflation is transitory and what will happen with interest rates long-term, as well as the impact of the Russia-Ukraine conflict. Expect activity to remain slow through at least the summer months as buyers and sellers wait until they have a better read on what the new normal will look like.
As the “new normal” begins to take hold, deal volume may increase. Companies with cash flows and a strong balance sheet are likely to be both acquisition targets and the acquirers. “The more you have interest rates higher than zero, the more focus there is on profits versus non-profit growth,” Grubman said. Various prognosticators have suggested 10-year rates could be 3% or higher by year-end.
The downward pressure on public market prices could push some companies to go private in the coming months, since private market valuations are not declining as fast and private market investors are going to be more patient. “The public market is in a very fickle and uncertain period. While private buyers—typically funded by private equity—have a short-term view that is five to seven years as opposed to the market that has a view quarter-to-quarter,” Grubman said.