The Value of Cooperation

The economic model of sports leagues is unlike any other in global markets. In automotive manufacturing, Ford and Tesla compete to sell vehicles, differentiating based on price, quality, and brand. The process of establishing a defensible market position in a highly competitive market takes significant resources. In contrast, professional sports leagues incorporate—in fact, must incorporate—elements of both intense competition and cooperation to provide a compelling product to consumers. For example, teams compete to sign the best players and win on the field but cooperate at the league-level to license content and sell sponsorships. If they did not occasionally compete, the product would feel staged or scripted; if they did not occasionally cooperate, standalone teams would not have the leverage necessary to capture the full value of their content. This ‘competitive-cooperative’ model is the gold standard across sports leagues in the U.S. and globally.

However, the balance between cooperation and competition varies considerably across leagues and is a major factor in investment decision-making. The level of cooperation within a league is a function of its structural design. In particular, the design of the North American leagues^[1] ensures ongoing cooperation among franchises, ensures stronger and more equitable revenue growth across all franchises, and provides shared incentives to deliver sustained profitability. In contrast—and as we discuss below in more depth—European leagues^[2] exhibit lower levels of intra-league cooperation. The upshot is that North American franchises, on average, are safer investments with stronger governance and more secure financial positions. Nevertheless, a focused, risk-aware approach with respect to opportunities in European Football has the potential to yield similar risk-adjusted returns.

Most leagues—North American and European—are organized as joint ventures. This allows teams to coordinate actions to increase value across the ecosystem. However, they diverge in how the leagues and its participants centralize decisions, extend membership, redistribute talent, and allocate resources.

Among North American leagues, control is split between the owners who form the board of directors and a commissioner, who is the de facto CEO. Certain decisions—such as a team membership, franchise relocation, or transfer of an ownership interest—are recommended by owner subcommittees and approved by the board. Nevertheless, the broad power afforded to a commissioner is unparalleled. Commissioners are elected by the owners and are league employees but act semi-autonomously. Commissioners serve as an internal governance mechanism acting ‘in the best interest of the league’, including investigating and sanctioning any owner’s activity, arbitrating disputes among franchises, and voiding contracts.^[3],[4] Crucially, Commissioners have wide latitude in directing overall enterprise growth by using their power to ensure teams act in coordination to create shared value.

This contrasts with European Football leagues, which are ultimately a loose federations of clubs. For example, in the Premier League each club is granted a vote on rule changes and central contracts but largely operates independently. The PL’s elected Executive Chairman is focused on negotiating central broadcast rights and marketing the league internationally, however lacks the same authority as a that of a North American counterpart. This decentralized system results in less coordination across league stakeholders and greater competition amongst clubs for sponsors, players, and fans.

The issue of governance among European Football leagues is further complicated by their ever-changing membership. While franchise participation in North American leagues is fixed, European Football uses sporting performance from the prior year to determine participation (i.e., promotion-relegation). This system ensures: (i) every game matters regardless of the competing teams’ positions in the table and fans are incentivized to support their club in good times and bad, and (ii) strong performing teams are rewarded with a move to a higher division. However, promotion-relegation challenges the overall business model. First, this system forces a departure from the optimal allocation of teams. The relegation of a well-supported team in a strong market can impact the league. Second, promotion-relegation ensures constant turnover preventing owners, and fellow stakeholders, from becoming familiar partners and acting in coordination to grow the enterprise. Third, relegation places clubs under significant financial pressure^[5] and who as a result are willing to make costly short-term decisions, such as changing managers and overspending on players at midseason to avoid demotion.^[6]

North American leagues are also unique in how they re-distribute talent on the playing field. European Football clubs can sign players with little to no limits^[7] or develop players via an owned and operated academy. This gives top clubs a built-in advantage versus smaller clubs for attracting, developing, and retaining talent while maintaining their perpetual dominance. By contrast, North American leagues limit how much a team can spend to attract talent via salary caps and luxury taxes. They also eschew the academy system by relying on high school, travel, and collegiate athletics for talent development. The leagues have each instituted a draft whereby teams that finish towards the bottom of the standings have the first choice among new players entering the league. These drafts are intended to prevent an expensive bidding war for young talent and ensure this talent is distributed to teams by need rather than financial capacity. The result is a league that promotes greater competitive balance.^[8]

Another differentiator between North American and European Football leagues is that the former can prevent local competition through exclusive territorial rights. This development can be explained by the league’s closed membership and geography. Geographically, the U.S. is larger than any single European nation with a widely dispersed population. This is conducive to defined territorial rights for each team. As a result, franchise owners acquire the unilateral right to monetize a team’s ‘home territory’ (e.g., staging matches or broadcasting local games).^[9] The ability to control the exclusive rights to a ‘home territory’ ensures franchises do not compete with one another for fans and protects against local competition. Teams can also extract maximum value from local sponsors, fans, and broadcasters. While it occurs to some degree in European leagues, this is practically difficult.^[10] European cities and populations are more concentrated and league membership is fluid. As a result, Football clubs have, very successfully, targeted international expansion to grow their fanbase and monetize their brand.^[11]

In addition to their advantageous structural designs, North American leagues are intended to be more economically attractive for the average franchise. This is driven by larger, longer-term media rights. But it is reinforced by a structural design that promotes a more equitable distribution of revenue across teams, shared incentives to increase profitability, and access to cheaper financing.

The North American media market is unique due to the size and wealth of its audience, the depth of high-quality bidders, and the economic evolution of cable distributors and broadcast networks. It represents ~50% of the global cable video market with an average revenue per user of $47.95 (vs. $14.72 in Western Europe). The U.S. alone represents ~38% of the global video advertising spend. These factors have made sports rights valuable to broadcast networks and led to rising fees. The demand from viewers has been sufficient to sustain multiple bidders for rights, and to attract interest from new players such as Amazon and Twitter. Furthermore, the long-term nature of contracts has helped networks build sustainable businesses on the back of sports rights (e.g., DirecTV, ESPN, TNT).

Media rights in Europe have similarly exploded over the last 20 years, but that is beginning to change. Since the early 1990’s, pay TV services (e.g., Sky UK and BT) have used sport rights as a “battering ram” to win and retain customers for their core pay-television and broadband product. Nevertheless, the maturity of the European television ecosystem, combined with relative paucity of aggressive sports rights bidders, has resulted in domestic broadcast rights fees stalling.^[12] Revenues from these deals are expected to remain flat across Europe’s top leagues in 2021 as pay TV offsets decreasing subscriber count with price increases. This is also exacerbated due to the financial ramifications of COVID.

Valuations across North American franchises are further supported by a more equitable division of enterprise revenue. Across major North American leagues, central revenues are split equally amongst the league’s teams. In practice this means that the least and most popular teams receive the same league financial payouts. This contrasts with the European Football leagues. Most allocate broadcast rights based on a formula of on-field performance and television appearances. North American leagues go even further. They incorporate mechanisms to ensure that discrepancies in local revenue generation do not impact competitive balance. Leagues pool each team’s local revenues, only to re-distribute it back to teams. This disbursement provides lower local-revenue-generating franchises with a greater share. Revenue sharing and re-distribution promotes financial equity, an important safety net for the less prosperous franchises within a league.^[13] That is not to say that revenue sharing is a positive for every team. For high local-revenue-generating North American franchises, the resulting value leakage can be substantial. Meanwhile, top revenue-generating European Football clubs are insulated from the re-distribution of wealth and as a result can compound growth.

In addition, North American leagues—except for MLS—are monopsonies; they are the financially dominant global leagues for their respective sport. This is unlike European Football, where a player can move between leagues that offer similar compensation. North American leagues have strict mechanisms to curtail excess spending and ensure a base level of profitability. Leagues limit spending to an agreed upon threshold with buy-in from the players unions through collective bargaining. These mechanisms benefit franchises by tying wage growth more closely to revenue growth of the league thereby improving the economic sustainability for all stakeholders. These cost controls also foster greater competitive parity.^[14]

As a result of these measures, North American franchises have better managed their largest cost—player-related expenditures. North American leagues pay 40%-50% of team- and league-generated revenues towards player wages whereas European Football clubs generally pay 60%+ of revenues. When factoring in net transfer spend, which North American teams do not pay, the player-related expenditure is even higher. From 2009 to 2018, net transfer spending among ‘Big 5’ European Football clubs grew in-line with revenue at 12% annually, and 50% of these clubs spent 10%+ of revenue on transfer fees. The wage bills of ‘Non-Big 5’ clubs averaged ~70% of revenue. Given that other—mainly fixed—operating costs tend to hover around 30%-40% of revenues, these ‘Non-Big 5’ clubs must rely on the sale of players to breakeven. This is problematic. Income from transfer fees is unpredictable. Even a club with a long-term track record of profitably selling players can risk of operating loss and funding requirements should there be any disruption to the transfer market or specific player sales.

That is not to say that European Football eschews regulations to protect club profitability. Beginning in 2010, UEFA phased-in Financial Fair Play (“FFP”), a set of regulations that sought for clubs to “live within their own means”, which would “improve financial fairness in European competitions and the long-term stability of European club football”. FFP has had a significant impact on clubs in two respects: first, by limiting major losses; and second, by limiting equity investment from rich benefactors. UEFA has enforced these rules over the years and punished clubs accordingly (e.g., Paris St. Germain, Galatasaray). Where violations have occurred, the punishment has not fit the crime (e.g., minor fines and lack of Champions League suspension for Manchester City). In practice, however, FFP has had the unintended effect of crystalizing the existing competitive pyramid by inhibiting smaller clubs from moving up the table through increased owner investment thereby reducing parity.

North American franchise valuations also benefit from lower financing costs. Access to cheaper financing is a result of the strong economic model, conservative fiscal policies at the league level, and state and local policies. To limit risk, leagues have imposed strict leverage limits and have demonstrated a willingness to step in to aid distressed teams. Franchises can also access a league-wide, fixed-rate facility or borrow on the strength of their own credit. Lastly, franchises have historically benefitted from tax-exempt municipal bonds. Between 2000 and 2016, 36 of the 45 newly constructed, majorly renovated, or under construction professional sports venues were in-part funded with ~$13 billion of these bonds.

Unlike North American franchises, European Football clubs typically lack the same access to affordable capital. Although FFP has lowered net debt among Europe’s top-division clubs—from 65% of revenue in 2009 to 40% of revenue in 2018—significant leverage and the lack of debt limits has resulted in instances of distressed asset sales (e.g., Liverpool) and defaults with creditor takeovers (e.g., A.C. Milan). European Football clubs have historically lacked the coordinated approach to establish league-wide credit facilities.^[15] As a result, most European Football clubs have only received financing due to (i) guarantees taken against real estate (e.g., stadiums, training grounds, etc.), (ii) securitization of media rights payment, and/or (iii) pledges by ownership groups. The debt received is also more expensive since creditors must price the risk that relegation impairs a club’s financial position and asset value.

A natural response to the points laid out above would be a strategy that altogether avoids investing in European Football. This is not at all the case. First, European Football offers a large addressable market. Europe’s top 10 leagues generate net revenues of ~€20+ million. Football has a fanbase of ~4 billion worldwide and ~105 million fans attended matches in Europe in the 2019 season. Second, European Football clubs present an opportunity to acquire a professional sports team at a lower price. The median Premier League team is valued at 2.1x TEV / Revenue (vs. 7.0x for NFL teams and 5.7x MLB teams). This substantial discount is due to proliferation of teams, lower profitability, and the risk of relegation. North American franchises are scarce assets. Prospective NBA owners only have 30 investment opportunities to own a control position of an inalienable piece of the national league and corresponding territorial rights. This is unlike investing in European Football clubs where there exist hundreds of investable clubs of varying financial profiles, geographies, and levels. Potential investors can choose their own adventure—a title-contender in Italy, a promotion candidate in the Belgian second-division, or any level, in any league.

In addition to the scarcity value, embedded within the European Football club valuations is unconstrained player spending, the risk of relegation, and unequal revenue growth. When compared to valuations of North American franchises, there is much greater dispersion. This is partly a result of the largest clubs operating with the lowest wage bills as a percent of revenue and smaller clubs spending a greater portion of their relative earnings on players. It is exacerbated by unequal revenue growth between top performing and bottom performing clubs.^[16] Combined with the high likelihood of relegation,^[17] this analysis suggests an implied ~2.5x–3.5x discount to similarly performing North American franchises. For low-performing clubs, the embedded discounts present a unique buying opportunity should an investor improve underlying on-field performance. For high-performing teams, there is little reason to believe that promotion-relegation significantly impacts valuations.

Any investment in European Football must compensate for key structural protections and economic advantages that are a feature of North American leagues. Three separate approaches to mitigate these risks are:

As previously described in detail, sports as a business are exceptional. However, just as not all businesses are created alike, neither are all leagues. Amongst different leagues, professional sports have taken distinct approaches with respect to cooperation and competition to grow the enterprise and maximize value while staying true to the cultural and historic roots of the game. The result is different outcomes in league structures and financial profiles of teams in North America and Europe. Franchises in North American league are, on average, safer investments. Nevertheless, bespoke opportunities to invest in European Football clubs and execute on a focused strategy can similarly produce attractive returns.

[1] Includes major North American Leagues, such as the MLB, NHL, NFL, NBA, and MLS.

[2] Includes, but not limited to, major European Football leagues, such as the Premier League, La Liga, Ligue Un, Serie A, and the Bundesliga.

[3] For example, in 2014 Los Angeles Clippers owner Donald Sterling was banned from the NBA for life and fined $2.5M by the National Basketball after private recordings of him making racist comments were made public. These actions by the league’s commissioner, Adam Silver, effectively forced Sterling to sell the franchise.

[4] One shortcoming of European Football governance is the inability for leagues and UEFA to enforce existing regulations, including Financial Fair Play. For example, sponsorship deals between a club and related party that are not based on fair value effectively serve as a backdoor capital contribution to the Club. In such situations, profit-motivated owners are hard-pressed to compete fairly, and leagues are unable to effectively punish transgressors.

[5] One example is the steep drop in media rights payments upon relegation. While certain leagues have sought to limit the economic damage (e.g., parachute payments in the Premier League), the disparity between the first and second division is impossible to smooth away.

[6] Research on the EPL also indicates that coaching changes have zero positive impact on performance on average.

[7] It is important to note that UEFA has instituted Financial Fair Play, which prevent unsustainable levels of spending on play wages and transfers. This is discussed in greater detail below.

[8] There remains active debate as to the importance of competitive balance on the popularity of a league. Recent research has found that “limited evidence of support” for the uncertainty-of-outcome hypothesis as a driver of fan attendance.

[9] In select large markets (e.g., New York, Los Angeles, etc.) two teams are granted the right to jointly exploit a market. In North America, the only market in which a league permits 3 teams to jointly exploit a single market is the NHL in the New York Metro Area.

[10] Take for example, the 2021-22 English Premier League and La Liga campaigns where six clubs are located within the Greater London Area and four clubs are located within the Greater Madrid Area, respectively.

[11] Tottenham, which is firmly outside the top three most popular clubs in the Premier League, boasts of 180 million fans worldwide.

[12] In its 2020 Benchmarking report UEFA noted that increasing international rights are currently expected to cover the reduction in domestic rights value for the Premier League.

[13] In rare instances certain league-wide revenues are withheld from certain teams (e.g., franchise expansion fees and relocation fees).

[14] See Note 8 on competitive balance.

[15] As a counter to the 2021 SPV proposal offered by La Liga and CVC to acquire 11% of the La Liga tv rights for the next 50 years, Barcelona, Real Madrid and Athletic Bilbao proposed a €2 billion bank credit facility price at 2.5% - 3.0%. This is one of the few attempts to create a ‘league-wide’ facility across European Football.

[16] In 2018, UEFA noted that the average revenue growth reported by the 30 biggest clubs was three times the size of the average across all top-division clubs. Even then, that growth was concentrated in the top 20 clubs, with clubs 21–30 recording falling revenues on average (mostly on account of declines in UEFA payments).

[17] Bottom half of the Premier League based on underlying performance, which equates to a 50%+ probability of relegation over five years.

[18] The European Super League structure borrowed heavily from the North American league structure, including elimination of promotion-relegation, fixed governance, and semi-closed membership.

©Arctos Partners, LP, 2024. All rights reserved.

This material is provided by Arctos Partners, LP solely for informational purposes and is provided as of the date indicated above. Arctos Partners is not providing or undertaking to provide any financial, economic, legal, accounting, tax or other advice or recommendation in or by virtue of this material. The information, statements, comments, views, and opinions provided in this material are general in nature and (i) are not intended to be and should not be construed as the provision of investment advice by Arctos Partners, (ii) do not constitute and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action, and (iii) may not be current. Arctos Sports Partners does not make any representation or warranty as to the accuracy or completeness of any of the information, statements, comments, views or opinions contained in this material, and any liability therefor (including in respect of direct, indirect or consequential loss or damage of any kind whatsoever) is expressly disclaimed. Arctos Sports Partners does not undertake any obligation whatsoever to provide any form of update, amendment, change or correction to any of the information, statements, comments, views, or opinions set forth in this material.