The impending restructuring of the largest regional sports network (RSN) operator, Diamond Sports Group (DSG, or Diamond), has been a major focus of teams and leagues of late. We believe that this event will catalyze significant change for the local media rights marketplace, though the exact path forward remains unclear. We have spent significant time studying RSNs to better understand how the model will evolve. Our current Arctos Operating Advisor Jeff Krolik (former Fox Sports CEO) and former AOA Billy Chambers (former Fox Sports CFO)[1], have been incredible thought partners to us and our franchises in this regard.
This piece reviews the possibilities as we see them today. We highlight why we feel good about how our portfolio is situated, why the impact on valuations due to this dislocation has and will be muted, and how there may be opportunities in a post-RSN world.
The Local Sports Media Ecosystem
There are 38 RSNs in the U.S. with exclusive rights to broadcast regular season and early round playoff matches for 83 teams in MLB, NBA, and NHL.[2] In total, these networks should realize nearly $6.5B in revenue in 2023, supporting roughly $4.7 billion in contracted local rights fee payments to these teams.
The industry is comprised of five major RSN owners. The largest, Diamond Sports Group, currently operates 19 RSNs, paying $2.0B of rights fees to 14 MLB, 16 NBA, and 12 NHL teams.[3] The remaining RSNs are owned by Comcast (5 RSNs), Charter (2), and Warner Bros. Discovery (3).[4] Finally, there are 9 independent RSNs, most of which are majority owned and operated by teams (Figure 1).
Figure 1: U.S. Regional Sports Network (RSN) Landscape
Source: SNL Kagan, Arctos estimates. As of Feb. 2023. Estimates do not add due to rounding.
1. Includes YES Network, NESN, Marquee Sports Network, MASN, MSG Network, SportsNet New York, NBC Sports Washington (now owned by Monumental Sports & Entertainment), ROOT Sports, and Altitude.
2. Nine excluded teams are all based in Canada.
Starting from modest beginnings forty years ago, RSNs grew rapidly by leveraging their programming tonnage and—for national operators—by bundling RSNs with their other channel offerings to eventually command some of the highest distribution (or “affiliate”) fees in the cable industry (Figure 2). Combined with their long-term contracted cost base, RSNs benefitted from significant operating leverage for decades, with operating margins peaking at 30-50% for most RSNs in the mid-2010s. In effect, RSNs successfully crafted a strategy of offering sports teams long-term revenue certainty in exchange for upside, which grew to be material. As a result, teams were—in effect—significantly underpaid for their local TV rights for decades.
Figure 2: Top Cable Network Revenue Per Subscriber Per Month (“Affiliate Fee”)
Source: SNL Kagan. For Fiscal Year 2022.
Now the RSN growth story has been unsettled by both secular forces and changes in the RSN industry:
First, in August 2019, Disney sold the FOX Sports RSN group—what is now known as Diamond—for $9.6 billion to Sinclair Broadcast Group, in a deal mandated by regulators as part of Disney’s acquisition of 21st Century Fox. Poorly understood at the time was the power of being part of the FOX family of networks. The loss of FOX’s support gave distributors who pay for these RSNs renewed negotiating leverage.
Second, distributors with the most leverage over the now-Diamond RSNs began to demand lower affiliate fees or tiered carriage. Prominent among these groups were the virtual Multichannel Virtual Programming Distributors (vMVPDs)—think YouTube TV—and the (predominantly rural) Dish Network, who have dropped—or “disaffiliated from”—the Diamond RSNs since 2019. Other RSN groups have also been affected. As a result of disaffiliations, subscriber losses have been higher for RSNs vs. other cable networks. Subscriber losses should remain elevated for RSNs going forward, since virtual MVPDs continue to grow while traditional MVPDs (Comcast, Charter, etc.) have seen churn accelerate.
This reversal of fortune for RSN revenue is compounded by the contracted growth in rights fees owed to teams under long-term deals. The resulting squeeze has taken margins down across the RSN complex—from 30-50% at their peak to 20% in 2022 and likely 12% in 2023.[5] In particular, of the five major players, Diamond and Warner have suffered disproportionately:
Diamond: Sinclair’s acquisition of Diamond in 2019 was financed with nearly $9 billion in debt, translating into $550M in annual interest expense, which the business can no longer support. Diamond generated only ~$160M of EBITDA in 2022, and according to our estimates, without a significant cost take-out, EBITDA is likely to be negative in 2023. Diamond had hoped to generate significant new revenue from their recently launched streaming product, but they have had limited success to-date. Given this stress, on February 15th, DSG skipped a $140M interest payment, initiating a 30-day grace period before filing for Chapter 11 bankruptcy protection.
Warner: Discovery acquired the three wholly owned AT&T SportsNet RSNs as part of their acquisition of Warner Media in 2022. The Discovery management team has been significantly more cost-conscious, and the WBD parent company is dealing with its own substantial debt service. The Warner RSNs were historically poor performers, but with the recent disruptions detailed above, are now projected to be in a material loss position in 2023 (we estimate somewhere between $60 and $90 million). As a result, Warner has proposed that their seven teams take control of the RSNs (and in effect eat the loss), otherwise, Warner has threatened to liquidate the RSNs by March 31.
We have a rough sense of what could unfold next, though we stress a lot can and will change over the proceeding months and years:
Resolution of Diamond: We expect Diamond to voluntarily file for Chapter 11, which will allow Diamond to prioritize rights payments to teams over interest payments. In the meantime, MLB and Diamond are negotiating a potential deal that would allow Diamond or a Diamond NewCo to continue operating, with various flavors of outcome possible (Figure 3). Not well understood by the market is Scenario #2: namely, that should Diamond seek to reject specific local TV contracts under bankruptcy protection—which, if it does, will likely focus on MLB, given the scale of their deals—MLB will claw-back the affected rights. At that point, Diamond would begin to lose programming outright. To this end, MLB has hired our former advisor Billy Chambers as EVP of Local Media to facilitate a league-managed solution, which appears increasingly likely to be activated. If MLB exercises this option, we believe it could stand up a business that generates revenues from distributors like Comcast and Charter sufficient to support most of Diamond’s $2.0B in rights fees. But given cord cutting trends, our best educated guess for Diamond teams is that rights fees need to come down ~25% in aggregate over the next few years (Figure 4). This assumes no new streaming revenue—nascent now, but a potentially large opportunity as the pay TV universe shrinks further. Moreover, we do not expect the impact to be spread evenly across all Diamond teams—those with the largest contracts relative to their subscriber base or ratings performance, or whose RSN is highly unprofitable, will take the brunt.[6]
Figure 3: Diamond Restructuring: Three Possible Scenarios
Source: Arctos. As of March 2023.
Figure 4: Diamond Pro Forma Model
Source: Arctos. As of March 2023.
Resolution of Warner RSNs: As of this writing, we expect the seven Warner teams—Rockies, Pirates, Astros, Jazz, Rockets, Penguins, and Golden Knights—will see their total rights fees drop between 15% and 20% in year 1, with further declines thereafter in line with further subscriber erosion. This is our best guess at the average decline in payouts to teams, were all teams to buy back their RSN from Warner for $0, which is the offer on the table. In some markets, there may be disputes among teams who shared an RSN over how to split the pie going forward. If these disputes prove unresolvable, teams may “go it alone” or rely on their league, like affected Diamond teams—in either case, rights fees will need to come down modestly. Under new ownership, we believe there is upside possible from leaner RSN management, cost take-outs, better ad sales, new sports betting partnerships in Texas once legalized, or better streaming offerings over time.
Impact to other RSNs: The other RSN systems—NBC, Charter, and the independents—are not unaffected by the dislocation that is hitting Diamond and Warner the hardest—they are suffering disaffiliations and tougher carriage negotiations as well. However, NBC, Charter, and the independents all enjoys substantially better margins and relationships with distributors—in fact, the independents alone generated nearly 80% of the entire ecosystem’s EBITDA in 2022 and would generate >100% of industry EBITDA in 2023 if Diamond is not restructured. NBC owns the rights to iconic teams like the SF Giants, Warriors, Celtics, Blackhawks, and Bulls; Charter owns the rights to the Lakers and Dodgers; the independents represent some of the most prestigious sports brands in the largest markets, e.g., Yankees, Red Sox, Cubs, Knicks, Rangers, Mets, and Bruins, to name a few. Unsurprisingly, the highest quality properties are best positioned to weather this disruption and continue earning their contracted rights fees.
The Good News, Pt. 1: Implications for Long-Term Value Creation
Despite the negative drumbeat, there are bright spots to keep in mind for sports team investors.
First, none of the above is happening because of the fundamentals of the IP—ratings remain resilient over the last seven years, despite significant subscriber erosion. Both national and local broadcast viewership has been roughly flat—a meaningful achievement in a world where subscribers have left the ecosystem at a 5%+ rate annually.
Second, new franchise buyers have clearly been undeterred despite being fully informed of Diamond’s situation. The Phoenix Suns, whose local TV rights are controlled by Diamond and comprise 8% of its overall revenue, according to Sportico, recently sold for an NBA-record $4 billion despite being in one of the weakest local TV rights markets in the country.[7] Similarly, the Nashville Predators, whose local TV rights comprise 9% of its revenue and are contracted to Bally Sports South, sold for $780 million, the second highest control price ever paid for an NHL franchise.
We do not believe that owners view an 8-12% revenue stream potentially declining to a 5-9% revenue stream as a significant deterrent to buying or holding a team. No new selling pressure has emerged over the last three years despite 100% visibility into Diamond’s difficult financial situation.
If anything, many owners have been frustrated by the loss of reach that partnering with an RSN has meant over the last few years: due to subscriber losses, most RSNs are only available in 50% of TV households in any given market. And we know many owners are exploring alternatives that would mean 100% in-market distribution in exchange for a larger revenue hit today. Many owners realize that wide access and ubiquity within your home market is critical for relevance and brand value growth over the long-term. More reach means more impressions for the best ad that any team has for their live, in-game experience: the local broadcast.
Longer term, with sports streaming at the national and global level having clearly arrived, and the difficulties of replicating the distribution leverage of the old cable model in an “every team for themselves” approach, we suspect local TV slowly becomes another centrally sold media package. This is easier said than done, so it will take many years to fully play out. However, the benefits of centralization are clear, as it would allow individual teams to leverage their collective strength and the entire IP portfolio of their leagues in the marketplace to drive value and field multiple bidders. Local TV markets have been dominated for years by just a single incumbent with little competitive tension. In contrast, competition continues to grow for Big 5 national media packages.
[1] As of January 2023, Billy Chambers is no longer an Arctos Operating Advisor and has been hired by MLB as EVP/Local Media.
[2] NFL and MLS both earn de minimus rights revenue from local networks and instead earn nearly all their media revenue from centralized, or national, sources.
[3] Excludes two minority interests: (I) Marquee Sports Network (Cubs) and (II) YES (Yankees, Nets).
[4] Spectrum SportsNet LA is 50/50 JV between the Charter Communications and the Los Angeles Dodgers.
[5] Our estimate absent a Diamond or Warner RSN restructuring.
[6] We have strong visibility into where there is most / least risk across teams, based on these factors.
[7] We believe that Bally Sports Arizona (Suns, Coyotes, Diamondbacks) is significantly unprofitable.
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