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Nic Couchman | The long view – investment opportunities in the rebuilding of sport

Nic Couchman, head of sport at Charles Russell Speechlys, considers the role that private equity might play in the building of ‘Sport 2.0’

Nic Couchman, head of sport at Charles Russell Speechlys.

As the impact, operationally and economically, of Covid-19 continues to rampage through the sports industry, restructuring and new investment will now be essential to achieving a sustainable and profitable future. Sports bodies, events and leagues own unique assets of considerable attraction to investors, from control of sporting calendars, regulations and commercial rights, to valuable data sets and heritage brands. For well-funded private equity investors with the right ‘partnerial’ approach and long-term vision, opportunities exist to benefit significantly from a new sport industry environment.

Sport in crisis

As we gaze around the Covid-19 battlefield at the charred and damaged remains of sport, it might be hard to imagine the reset and rebuild that inevitably will now take place. Sport has been sideswiped in the most brutal way and yet the continuing appetite to play and watch sport is such that even virtual horse racing and charity golf matches are gaining record audiences, and immense efforts are being made to get top level football games behind closed doors back on our screens.

The sports industry saw decades of more or less continuous growth but is now experiencing its worst economic disaster in recent times. The growth story, however, obscured some financial truths which are now becoming increasingly apparent. For all of its many successes in creating revenue streams from commercial rights exploitation, the sports industry is in most areas undercapitalized. Most of the income that comes into the sports goes out into event operations, player wages/athlete prize money, agency commissions, infrastructure investment and grassroots development. Reserves in most sports are minimal, with many highly reliant on Olympic distributions or public subsidies.

The sports industry essentially has mass social gatherings at the very heart of its business model and so Covid-19 is about the worst unforeseen event that could have hit it. For sports with an international dimension, the problem is exacerbated. Different and changing pandemic situations and regulations in different countries mean that border closures and major travel disruption will likely continue for an indefinite period to come, making international fixtures, series and tournaments very difficult to organize profitably.

The ensuing, highly probable global recession presents a ‘double whammy’, as corporates and brands will look to control or reduce their level of investments in sports marketing in favour of focusing on business survival.

Added to this the ongoing risk of second and third waves of viral escalation, the rigid and much restricted regulatory environment in which sports will now have to operate even as lock down measures ease, and the understandable fear factor that will no doubt continue to permeate the sports fan community, and the return to anything resembling normal conditions for sport looks a very long way off.

Public funding of sports will also no doubt be under enormous pressure, whether for vulnerable mega events or grassroots sports, as other calls upon the public purse take precedence in depressed economies. And there will be a limit to the extent that the larger sports bodies, such as the IOC, can provide financial support to their membership.

It has yet to be seen how much damage has been inflicted on this $700bn industry, but it will clearly run into multiples of billions. In this very challenging environment, sport is having to look at the new realities – cancelled events, massively reduced income, cash flow shortages and staff lay-offs, etc. – and examine their strategies both to meet the immediate challenges, and to reset and rebuild.

A new, entrepreneurial mindset, with a spirit of innovation at its core, will be needed to get the industry back on track.

Investing in ‘Sport 2.0’

A new, and potentially radically different chapter for sport is beginning to emerge. Tougher market and regulatory conditions, reduced budgets, tighter cost control and fewer events will all feature together with the acceleration of phenomena that were already impacting on the sector, in particular digital and technological transformation, and private equity investment.

US sport, football clubs and motor racing have long embraced private investment and ownership, especially at a team level. Specialist suppliers to sport, such as agencies and tech providers, have also long had private investment or have raised funds on the capital markets. Outside of these categories, however, there has been reticence from some areas of sport to engage seriously with private capital providers, and for private equity to see a compelling investment case to invest in sport itself.

There has been a cultural clash in many instances between sports stakeholders and private equity, not least because many sports are not run as businesses with profit as a primary driving motive, and private equity has not been able to perceive of sport, for all its ubiquity and growth trends, as something it could reliably quantify, sufficiently control and generate investment returns from.

All that is set to change, for a number of reasons:

  • Sport is in distress; under-capitalized and concerned for its future, it needs security and cash resources to stabilise and underwrite its short to medium term position, and to rebuild
  • Moreover, for the reasons set out above, resistance to change amongst leaders in sport will be much lower. Change is being forced upon sport, and it will need to adapt speedily to stay afloat
  • As global digital transformation is accelerated by the impact of the pandemic, the value of content and strong, monetisable fan bases in the longer term becomes more pronounced. Customer, athlete and live data become increasingly exploitable and sports asset valuations potentially carry a long term digital premium as a result
  • Rarity – sport comprises a limited number of available assets, some of which have decades of heritage and very deep roots, and some being internationally known brands with substantial legacy value, which have endured previous economic traumas and survived. Sports assets are not easily substitutable or replicable. Latent brand value and exclusivity are undoubtedly attractive features for investors. Investors may need to act now, or miss a ‘once in a lifetime’ opportunity.

New investment models

There have been several impediments to private equity investment in sports, some less apparent than others. Sports have not typically been structured as businesses and don’t have the governance arrangements that financiers would expect to see. They wish to retain autonomy over sporting and regulatory affairs, irrespective of the commercial implications. The integrity breaches in sport, from doping to corruption, have been a deterrent to investment. Governance frameworks in sport have not kept pace with the growth and globalization of sport. Good governance is, however, a pre-requisite for good investment. The Covid-19 crisis will accelerate changes to sports governance, eliminating some of the ‘old ways’, and making sport more investable.

Equally, the complex nature of sports structures and revenue streams can be a deterrent for outside investors. They naturally want to understand what they are investing in, who owns which IP, where the value lies and who controls it. The commercial frameworks, and collectively bargained arrangements between sports bodies, events, leagues, clubs and athletes, may well need to be remodeled and rationalized to optimize the conditions to attract private investors.

On the flip side, one of the fundamental problems for private equity investment in sport has been its own business model, typically requiring a buy out, followed by a three to five year drive to enhanced profitability and an exit for their investors, and to earn the coveted ‘carried interest’ for fund managers. Sport does not lend itself at all easily to this investment model – it essentially doesn’t want to be bought, built up and sold on. Nor does it want to part with, or be perceived as having sold, the ‘family silver’. In many cases, sports bodies will look at themselves as custodians, rather than owners of the sports they manage. In a sports context, successful private investment has to be attuned to this philosophy. There are signs that it is doing so. Having initially been reported as seeking a majority stake in Premier Rugby, for example, private equity giant CVC finally settled on a 27-per-cent stake in the league, and more recently on a 28-per-cent stake in Pro 14 rugby. CVC is now reported to be exploring a minority investment into Serie A in Italy.

A ‘partnerial’ approach

A more partnerial approach, helping sports to reset and develop their commercial platforms, providing the financial security from which to build value over the long-term, and without undue interference in sporting or regulatory affairs, is the formula likely to find most acceptance with sports current stakeholders and owners.

Investment funds are increasingly looking at a more blended approach, for example with minority equity stakes combined with debt finance structures, allowing some protection against the downside, whilst maintaining a sizeable interest in the upside. These are rare and complicated transactions. Our own experience advising the International Tennis Federation on its investment arrangements for the Davis Cup, for example, involved a challenging process of balancing and reconciling the interests of sports custodians and investors.

The sports market has now, finally, reached the stage where intelligently crafted, bespoke investment partnership arrangements are achievable to enable sport to continue to grow and to meet its many objectives, from elite competition to grassroots development. To some extent, private equity can replace the role customarily played by the larger agencies as long term business partners to sport, bringing both capital and commercial acumen to the board table, and allowing sports to structure more flexible and discrete arrangements with commercial agencies and partners. Investors can seek to achieve a measure of protection from going ‘all in’ in these hazardous times by linking some of their funding to performance metrics, e.g. the unfettered return to live sport.

Investors naturally like to reduce risk, and so issues such as cost controls, salary caps, and relegation/promotion rules also play a material role in investor decisions, and it is of course likely that increased investor involvement will lead to changes in traditional formats and approaches to these matters.

Future opportunities

Private equity has large reserves of deployable capital, and looking at long term growth trends for sport as we start to emerge from the depths of the current crisis, will see unique opportunities to enter the sports market at a time of great need at depressed prices.

From once being perceived as controversial imposters or ill suited partners with sport, smart private equity money could yet become the cavalry that an increasingly embattled sports sector needs, assisting in the re-emergence of a viable and profitable sports industry.

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