Is Private Equity Buying Into Peak NFL?

Editor’s Note: My annual NFL predictions follow at the end of this article.

The NFL recently confirmed that they will let private equity buy small stakes in NFL teams. This caused much consternation that private equity will somehow ruin the NFL.

Today, I will argue the opposite. Buying into the NFL is a bad investment for private equity.

Let me first address probably the biggest misconception. PE will have no operational control over teams. They are limited to a 10% stake. They will be silent partners.

They are not going to be firing employees, raising ticket prices, cutting maintenance on the stadiums, or any of the other familiar tropes about “evil” private equity ownership.

Furthermore, they are not going to increase the leverage of the team to pay themselves big dividends. NFL teams don’t generate the kind of cash flow typical for a private equity investment.

In fact, NFL owners are raising this money from private equity instead of taking on more debt. It is a deleveraging event.

So why is private equity doing this? Because they think franchise values will continue to increase. They are betting on multiple expansion. My argument is this may be a bad bet.

The NFL’s Capital Problem

NFL owners are learning about “mo money, mo problems”. Many NFL owners are cash poor. Most of their wealth is tied up in an illiquid asset.

Some owners have owned their teams for decades and have made 100X their money. But because sports teams are notoriously low margin businesses, the owners have not built their liquidity in accordance with their net worth.

Then you have the more recent owners who had to write several billion dollar checks to get a team. While they may be billionaires, they still, in most cases, had to borrow heavily to buy their team.

This means they have large debt service to manage further straining the cash flow coming from the team.

Thus, whether you are a new owner or legacy one, you are not generating much cash flow to support your lifestyle or transition wealth to your family.

The way owners have bridged this over the last couple decades is by borrowing from banks. However, the NFL naturally worries about cash poor owners taking on too much debt.

Thus, there are restrictions on the amount teams can borrow. Many teams are near or at these limits.

That leaves only one other option. Selling off part of the team.

Minority Owners

The problem with that is who wants to spend huge $ on an asset with no influence over the outcome?

When teams were worth $500M, maybe a billionaire wouldn’t mind spending $50M for a 10% stake. Now the team is worth $5B, so you’re asking someone to write a $500M check just to sit in the owner’s suite.

Very few people are willing to sign up for that. And let’s be honest, the type of people who can spend that much money don’t want to be silent partners.

There is also a simple math issue. There are fewer people who have $500M to spend on a passive investment than $50M. So the pool of potential buyers has shrunk.

Thus, an NFL owner looking to sell a small stake to raise cash faces a smaller buyer pool as valuations have exploded and an even smaller pool of those willing to be passive.

The obvious solution is to find institutional buyers. But even there, limitations exist. A pension fund may face political backlash for investing in a team. A corporation usually doesn’t want to be a passive minority owner, especially if it isn’t receiving dividends.

So the only option left is private equity. But is it a good option?

The Costs of Private Equity

Private equity is expensive capital. It is far more expensive than the debt owners have used in the past. It is also more expensive than equity from a passive individual.

People in that group want the status of being a minority owner. This means they are less valuation sensitive and also likely less demanding about terms and conditions.

Private equity buyers are likely to demand a haircut on valuation and receive plenty of structural protections that are one-sided (e.g. right of first refusal if other minority owners sell, guaranteed returns if the team is sold, etc.).

PE is the least desirable option for an owner. The NFL is only agreeing to it because they are running out of alternatives.

Is PE Buying The Top?

If you read closely, I already answered that. Have you figured it out?

For PE to make an attractive return on their investment, they need to have an exit strategy.

While sports team values have only gone up over time, that doesn’t guarantee they will continue to in the future.

There are two ways to make a return – either the earnings grow or the multiple expands. Both of these are less likely than in the past.

Revenues grow largely with the growth in TV money. The problem there is TV rights have grown so much in recent decades that they probably are approaching their natural limit, especially as their broadcast partners are struggling financially with the streaming transition.

But even if broadcast revenues keep growing, there is another challenge – multiple. I told you the supply of potential buyers continues to shrink as prices rise. So who will PE sell to?

If there is not a next buyer, they will have to exit at a lower multiple.

If that reminds you of the potential challenges PE owners of insurance brokerages face, you are spot on. When you are at peak multiple and peak earnings, it is awfully hard to find someone who wants to buy your stake.

At some point, there are more sellers than buyers and multiples crash.

It is interesting that the NBA, which is further down the private equity path, has recently seen owners of teams with private equity and venture capital backgrounds sell their team. Perhaps they are beating the rush to the exit?

While the NBA (and especially MLB) are more likely to hit the wall on franchise valuations first (they are more at risk of declining future broadcast rights deals), private equity should probably wonder why they are only being invited to the party now.

They are usually not the suckers at the poker table, but maybe this time is different?

NFL Predictions

Brief reminder on how I do this. Most NFL “experts” predict most of last year’s playoff teams to return, even though history suggests only half of them do. So, the average expert gets 7 teams correct.

My approach is to guess which seven teams will return and which seven new teams will appear. This resulted in me getting 9 of 14 correct each of the last two years. Could be better, but beats most “experts”.

So on to the playoff picks for this year and then my Super Bowl picks follow.

Playoff Teams

Teams returning: Miami, Houston, Kansas City, Philadelphia, Detroit, Green Bay, San Francisco
Teams out: Buffalo, Baltimore, Cleveland, Pittsburgh, Dallas, Tampa, LA Rams
New entrants: NY Jets, Cincinnati, Jacksonville, LA Chargers, Chicago, Atlanta, Seattle

It was hard to find seven for the new bucket this year. I feel least comfortable with the Chargers and Bears. Seattle is my favorite pick for a surprise team.

On the not returning list, there are some controversial ones there, but that is how the process works. You have to risk looking stupid to get these right.

Buffalo and Baltimore lost a lot to free agency and, Baltimore in particular, has high injury risk with Lamar Jackson.

Both the Cowboys and Eagles are candidates to be dysfunctional this year and play worse than their talent. I chose Dallas because of the distraction about whether Dak Prescott will leave in free agency.

Super Bowl Picks

It’s easy to pick the Chiefs but people forget how precarious their path was the last two years. They had a difficult regular season last year before rebounding in the playoffs. In the prior year, they were very close to losing to the Bengals in the AFC Championship game and the Eagles in the Super Bowl.

So I’m not picking the Chiefs to threepeat. The second favorite in the AFC is the Ravens and I don’t even have them in the playoffs!

So I am looking for a top contender with better odds. The Texans are really interesting to me at 16-1. We have seen the second year coach-QB combo work several times in the recent past, and they added a lot of talent this offseason.

In the NFC, it’s a similar tale. People want to default to the Niners again, but do they remember how the Lions dominated them in the first half of the NFC Championship?

Those teams are not separated by much, yet you get twice the odds (12-1) on the Lions. They are also the hungrier team with something to prove while the Niners’ stars are fighting over money.

So I feel good about a Lions-Texans matchup. Tough call for me, but I’d probably lean Lions as the winner.

Longshots

Remember, they’re called longshots for a reason, but if you’re looking for teams that could surprise, I really like Seattle this year. They’ve a slightly above average team but they have a new coach with a very successful defense and a new offensive coordinator who is very creative.

They could be the team that comes out of nowhere and I’ve seen odds as high as 80-1.

Out of the more reasonable bucket, the Jaguars have talent, but have been waiting for Trevor Lawrence to play like the #1 pick. If he breaks through this year, they would be a steal at 50-1.