curriculum “amministrazione e governance delle aziende...

Anno accademico 2017-2018

Corso di Laurea Magistrale in Economia Aziendale

Curriculum “amministrazione e governance delle

aziende” (ex DM 270)

PRINCIPLES OF BUSINESS VALUATION

The Valuation of:

1) Sports Franchises2) Automobile Dealerships

Andrea Sagone

Managing Partner,

Cross Court Capital

November 2017

“The Valuation of Sports Franchises” Page 2 November 2017

1) THE VALUATION OF SPORTS FRANCHISES


Sports Franchises & the Entertainment Industry

Professional sports teams, usually part of wider franchises, are part of the

entertainment industry

Entertainment businesses seeks to maximize value in 2 ways:1. attraction of large audiences: The most important goal is to maintain and increase this

2. brand development and extension: Allows the franchise to have additional revenues

The economics of a sports team depend primarily on four variables:1. the relationship between the owner and the players

2. regulatory environment: specific laws and league regulations

3. broadcast and cable television contracts (in recent years the media is the first client of

franchises and/or sport leagues)

4. venue attributes

The valuation of Sport Teams can be carried out through:— the market transaction method

— the discounted cash flow method

These valuation methods would need to be adjusted on a case-by-case

basis


Owner / Player Relationships (1/2)

In the United States, the largest team expense is player compensation.

This expense represents about 60 percent of team revenue

The growing level of player compensation is an increasing issue— team expenses are increasingly reaching unsustainable levels

In the U.S. leagues and team owners have tried to cope with this problem

by instituting salary caps and revenue sharing agreements

Nowadays, traded media companies own teams in quite all sports— In this way, sport leagues can offer future career opportunities to players and try to slow the

growth of cash compensation

— Also the use of ESOP induces star players to remain more on the same team

In Italy, player expenses are normally recorded as intangible assets and

written off over a pre-defined period of time— About 10 years ago, the level of annual write-off was so high that most soccer teams

couldn’t reach a profit. As a result, the well-known “Decreto salva-calcio” was issued,

allowing all soccer teams “ to impair” for capitalized players expenses and, so, to

restructure the firm.


Owner / Player Relationships (2/2)

With reference to the owner / player relationship, the analyst

should understand:

1. the contribution that each player makes to his team

2. his contract terms and conditions

3. his ranking in terms of performance

4. his importance and attractiveness within the league


Regulatory Environment: Specific Laws and League Regulations (1/2)

Laws and rules governing professional sports have a significant

impact on the process of valuating sports teams

These laws and regulations can be analyzed from three different

point of views:

1. organizational

2. revenue sharing

3. owner/player relationships


Regulatory Environment: specific laws and league regulations (2/2)

Organizational issues

Antitrust laws allow leagues to enjoy exemptions. It means, for example,

team owners have the exclusive right to control the merchandising process

or other “uncommon” revenues (vs. “common revenues”)

Revenue sharing (“common revenues”)

In the U.S.A. the Sport Broadcasting Act was issued in 1961. It provides

for the league to negotiate “in concert” with television networks— National television revenues are divided among the teams, which receive the same amount

of television revenues. The amount is independent of the market share and by the success

(number of wins) of each sports team

There are also many other revenues that are not divided, such as local

televisions rights, cable TV rights, gate receipts— A great disparity between teams exists

Owner / player relationships

The analyst should understand the rules governing this relationship: free

agency, salary caps, player mobility


Broadcasting and Cable TV Rights (1/3)

In professional sports, in the U.S., television revenues represent 60

percent of revenues from rights

Television rights not only permit professional sports franchises to

generate cash each year, but also to build and maintain powerful

brands

The demand for television sport content is increasing worldwide,

despite declining live sport viewership

What is the volume of national broadcast and cable TV rights?



Some examples of national broadcast and cable TV rights deals:

Some examples of national broadcast and cable TV rights deals:

UEFA got the sport’s richest clubs to signed a new Champions League agreement. The

accord runs from 2018 through 2021. A larger share of the annual billion-dollar prize

money, made up of television and sponsorship rights sales, will go to big teams like

defending champion Real Madrid, Barcelona, Juventus and Bayern Munich.

— UEFA’s annual commercial revenue for the Champions League and the second-tier

Europa League is 2.24 billion euros ($3 billion)

— Each of the 32 teams that qualifies for the initial group stage of the Champions

League gets a basic fee of 12 million euros, with incremental increases based on

results and the size of the national television market in the country they are based.

The biggest earner gets about 100 million euros

Agreement Sky/Italian Soccer League: “Platinum live” (rights for “Serie A” for seasons

2010-2011 and 2011-2012) = 580 million € per year. In 2009 “Conto TV” opposed a

motion to the “Corte d’Appello” and the motion has been accepted in November 2010.

The general meeting of “Serie A” contested the decision of the “Corte d’Appello”.

Recently, Conto Tv has presented an “interlocutory injuction” (ricorso cautelare) to the

Milan Court; the injuction has been rejected.



Why is it so relevant to know the amount of “revenues get” through

television rights?

Understanding the terms and conditions of the contracts between a

team (or a league) and the TV or radio broadcasters is a part of the

valuation process that cannot be ignored

It’s also important to remember that there is a big disparity in local

broadcast fees between teams

— The bigger the team becomes, the higher is the fee (in the U.S., local TV and

cable TV revenues make up between 11 percent and 16 percent of total

revenues)


Venue Attributes (1/2) Venue = a venue is a place where an action or event has been arranged to

happen (Collins Cobuild “English Language Dictionary”).

In the Nineties the new frontier for sports teams was the exploitation of

real estate: building stadiums and arenas

Team owners are currently trying to pressure the cities where teams play

to have a new stadium or to renovate the existing one

New arenas can be used to set up additional events, like family shows,

religious meetings, corporate annual meetings, etc..

Why are stadiums and arenas so important? — Revenues generated by stadiums and arenas are not shared among other league teams!

In the U.S.A., the majority of NHL teams own or control their venues— This control allows sports franchises to enjoy other revenues resulting from venue

operations

— Venues with 100 events, or fewer, per year generate revenues that are adequate to pay a

small staff of full-time employees

— Venues with 250 events, per year, or more can obtain an economy-of-scale benefit: they

may, in fact, retain trained in-house staff, which is an important intangible asset and a

relevant source of revenue


Venue Attributes (2/2)

Revenues $000s % of total

Premium seating 22.750 43,80

Ticket rentals 5.850 11,20

Concession sales 8.450 16,20

Novelty sales 1.300 2,50

Parking 3.900 7,50

Advertising 5.850 11,20

Other revenues 3.900 7,50

Total revenues 52.000 100,00

An example:

Statement

of Revenues –

New Arena

with Hockey

and Basketball

Teams


Valuation Methodology (1/4)

The analyst first has to examine the market dynamics of the business

The sports market is unique. Its uniqueness arises from several factors.

The emotions sports teams evoke in their fans, in fact, make this business

different from others

The success of a sports business is measured not only in economic terms,

but also by the ability of team to lose or to win (and hence to win over

fans).

The primary approaches for estimating the value of a sports team are:— the income approach

— the market approach

The income approach

In an Anglo-American perspective, the most applicable income approach

method to value sports teams is the DCF method

Using this method the analyst can:— consider and analyze value drivers related with merchandising

— make reasonable assumptions about the possibility of maximizing these drivers



The valuation process is developed trough the following steps:— Revenue analysis and financial performance (income, balance sheet, cash flow

statements)

— “benchmarking” of team revenues and expenses (side-by-side analysis)

— choice of a number of case studies of successful (or unsuccessful) teams;

— analysis of business scenarios

— building of the perspective cash flow, based on the selected scenarios

The variables to be projected are many and complex. Analyst should be

particularly sensitive to bias

What is the discount rate to be used?— It’s the weighted average cost of capital (WACC)

— To estimate the cost of equity capital, the Capital Asset Pricing Model can be used. What is

the right “beta” to use for sports team? It’s not possible to observe the movement of sports

franchise stock, because pure play or near-pure play companies are very few. For the U.S.

market an average of betas from the entertainment industry can be used (84 firms; beta =

1) and the betas of companies which profitability depends on sports (Nike, Reebok, Russell

Athletic, etc. – beta for the 16 shoes firms = 1,20).



Market approach

The analyst may apply two methods within the market approach:— market transaction method (comparable transactions)

— traded company method (comparable companies)

With the market transaction method, the analyst (prior to applying the

multiple referred to the sample of comparative transactions) has to:— collect and analyze recent market transactions

— make adjustments on the basis of a comparative analysis between the market transaction

and the sports firm

The comparative analysis should be conducted considering:— size, location and demographic data on the different markets

— the possibility of scale economics

— local television agreements

— ownership of venue

— players contracts

— liabilities and obligations

— venue revenue splits



The difficulty in applying this method is complicated by the

presence of buyer synergies which are often impounded in the

purchase price

With the guideline publicly traded company method, the analyst

should:

— select a sample of public companies, similar to the subject company

— gather and analyze publicly available date (market-derived pricing multiples)

— apply multiples to subject company parameters

The problem with this method is (i) that equity of sport teams is

often in private hands or (ii) sports teams represent only a small

part of public company’s business.

Which multiples are better to use? In my opinion:

— P/S or

— P/CF or

— EV/EBITDA


Feasible Venue Development Projects

One of the most topical subjects (common in Italy) about valuation of sports

teams is venue development project feasibility

Venue project feasibility is judged in the same way as the practicability of an

investment project in the real estate industry: economic feasibility exists if “a

project obtains the required rate of return on the full replacement cost of the

individual assets employed”

Objectives of a project relative to a venue are to:— provide investors with an appropriate rate of return

— obtain brand expansion

— enhance core assets

In the U.S.A. (in the years between 1988 and 1996 alone) more than 80

percent of hockey and basketball teams carried out financial operations to

operate from a new venue (moving into a new one; constructing a new venue;

obtaining from a governmental entity a commitment to built a new one).

It’s important to point out that venue feasibility is not part of the valuation: the

analyst doesn’t have to seek the theoretical value of the project, but he makes

a recommendation about the possibility of the project.


2) THE VALUATION OF AUTOMOBILE DEALERSHIPS

“The Valuation of Automobile Dealerships” Page 18 November 2017


Reasons for Valuation

The most common purposes for valuation are

the following:— dealer succession. Because of franchise relationship, the

valuation of a dealership for estate and gifting purposes is very

common

— M&A transactions. Most dealerships are transacted directly

between existing dealers

— marital dissolution

— litigation. Valuations are used in disputes with manufacturers,

usually in the form of lost profit computations

— sale of dealership franchise: the selling dealer wants to obtain

an accurate value estimate before placing his business on sale



Analysis of the business (1/2)

An Automobile Dealership is likely to encompass several different

businesses (i.e. complexity):— new vehicle department

— used vehicles department

— parts department (retail and wholesale activities)

— finance and insurance department

— lease and rental department

Key functions are also— relationship with manufacturers

— relationship with key buyers

N.B.: in the U.S.A. most well-run dealership have net income that is less

than 2 percent of total revenues.

Relative to new and used vehicles departments, it’s important to point out

that the methods for acquiring and marketing these two types of vehicles

are very different. In recent years, gross profit from used vehicles has

increased



Analysis of the business (2/2)

Parts department: if well combined with service department, can have a

strong effect on firm profitability

“Back end” operations are able to increase business profitability, also in a

period of global crises (people spend their dollars to repair rather to

replace existing vehicles)

Finance and insurance department: it’s the one requiring the least

overhead and producing the largest gross profit

Largest dealerships may also have separate departments for lease and

rental sales

A very important driver for the success of the business is the relationship

with the manufacturer and key buyers

The most well-run dealership operate, on average, on after-tax net income

of less than 2% of total revenues!



Key risk areas

Environmental Issues – The analyst has to evaluate off-balance-sheet

liabilities (such as environmental contamination)

Franchise Agreement Terms – Terms and conditions of franchising

agreement can strongly affect value (such as the transferability of the

franchise)

Viability of the dealership location – the manufacturer is looking to have its

dealership located in the most profitable areas

Manufacturer relationship and manufacturer policies – the manufacturers’

policies on financing terms can greatly influence a dealership performance

and profitability

Economic issues – automobile industry is affected by historic and

economic events

Regulatory issues – the imposition of a luxury tax, for example, may

decrease the profitability of the business



Valuation methods

Excess earnings method

Income approach

— a simple capitalization of earnings or a discounting of future cash flows may not

reflect all the elements of the value of the business

Market approach method

— Limited information on transactions involving dealerships is available from

market databases; the size of the transactions is generally small and the

transactions may vary widely in their terms and prices

Empirical method:

— Adjusted net assets + blue sky

— Blue sky = multiple * normalized pre-tax, pre-LIFO earnings (between 1 and 3

times).


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