Category: Pac 12 and College Sports

Opinion – Should the Pac 12 Sell a 10% Equity Stake? Why the Pac 12 CEOs Need a Second Opinion

(This article is Part 3 of my series on the Pac 12, including whether they should have brought on a strategic partner in 2012:

Did the Pac 12 Need a Strategic Partner in 2012? Part I at Athletic Director U
Did the Pac 12 Need a Strategic Partner in 2012? Part II at Athletic Director U
Did the Pac 12 Need a Strategic Partner – Director’s Commentary)

 

If you found out you had a serious medical issue, a life threatening condition, you would get a second opinion, wouldn’t you? I mean, this is your life we’re talking about.

However, say you have a toilet running in your house. You call a plumber and he says he can fix it. Do you call a second? It’s one toilet and the guy can fix it for probably a hundred bucks or so. No second opinion needed.

Really, it’s a cost-benefit analysis, even if we don’t think of things in these stark of terms. A life is valued—no really, governments around the world calculate this—between a few hundred thousand to millions. A toilet getting fixed costs a couple hundred dollars…maybe.

When Larry Scott proposes to the Pac 12 leadership that they sell 10% of their future media rights, are they contemplating a small repair or major surgery?

This is major surgery, and the Pac 12 patient needs a second opinion.

That’s the message I’m here to deliver today, along with how to do it right. Hopefully all my readers have read my two articles analyzing the Pac 12 decision not to use a strategic partner in 2012. (And my follow up yesterday.) If you have, you know the Pac 12 likely made a big strategic mistake in 2012, and this decision could exacerbate it further. But let’s focus on the “how” of making the right decisions, not the past, with some other thoughts for the Pac 12 CEOs.

Thought 1: Hire a Devil’s Advocate

I’m a big believer in using a “Devil’s Advocate” when making tough decisions. Essentially, you need to pick someone who will make the strongest case possible for the opposite case of what you are pursuing. (The key is—in a corporate environment—that you don’t judge them for zealously doing this, if they do it respectfully.) There is a reason why we have an adversarial justice system; having two dueling cases helps uncover more information and discourages confirmation bias.

Confirmation bias is really what the Pac 12’s strategy screams to me. You have a charismatic leader in Larry Scott who believes in his vision. Which is great. And you need that. But if he has made serious strategic missteps in the past, he could be making them again. By the time all these bills come due, it may be too late. 

Now is a crucial time in the life of the Pac 12. My read of the news coverage is that the Pac 12 is very serious about selling some portion of ownership of their media rights. Whether it gets $750 million for 10% remains to be seen, but it seems likely they will try. (My gut is that they get $750 million, but for a lower valuation. Say for 20-30%.) That decision absolutely needs someone to come in, look at it, and tell you if you’re making the right decision over the long term. Here’s why and how to do it:

Why to get a second opinion

Two reasons. First, despite what they may tell you, this decision is likely irreversible. If the Pac 12 appreciates in value, then the partners who bought in at $750 million may ask for $1 billion to get your equity back. Where are the universities ever going to find that type of cash? So basically, once this deal happens, you never get that equity (of your media rights) back. You’ve permanently sold your ownership.

Second, do you really think you are getting a great deal here? That’s a huge judgement call. Do the universities really think they can outsmart the investment bankers (or ex-investment bankers at giant tech companies)? They have teams working on this. They do it all the time. And they usually win. You hired an investment bank which may have compromised judgement. (I’ll explain that next.) So why not just keep your ownership unless the offer really is too big to pass up?

Why to hire an outside advocate: Combat personal economic self interest

One of my eventual themes will be “understand economic self-interest”. In short, a lot of behavior can be explained by profit maximization. I mean, that’s economics 101, isn’t it?

Unfortunately, in the business press, individual economic self-interest is usually ignored. Here’s an example of what I mean. Say a biz dev guy sees a huge potential deal with a partner, but his firm has no ability to deliver on it. Still, he pushes and pushes, gets the deal through, collects a big bonus. Six months later, he bounces to a new company. That’s a decision that was bad for the company—when they fail to deliver—but good for him personally because he got a big bonus and resume bullet. Individual and firm incentives are often not aligned.

The Pac 12 likely has quite a few potential “individual versus collective” conflicts in this deal. Start with your lead adviser in The Raine Group. They are an investment bank. They don’t collect pay checks on deals that aren’t done. So they have an incentive to find a deal and, more importantly, to sell it really hard. If you know that, you can see why you need devil’s advocate, or you’ll only hear the positive case from the bank. Again, it’s not their ownership, and they get paid more based on a successful deal. Do you see that conflict of interest? (And if they get paid either way? Well, I mean that’s money straight from the university’s pockets.)

Second, I think there is a good chance that Larry Scott has a bonus structure tied to the distributions to schools. If that is true—and I don’t know for sure—then if he sells an equity stake and gives that to the schools, and calls it an increased distribution, he could collect a bigger bonus. That’s surely a conflict of interest, isn’t it? We can’t want the head of the Pac 12 to have a financial incentive in selling a portion of the equity because he would personally benefit in the short term do we?

How to Do it Part 1: Insist on the skeptical approach

Insist that the consultant you hire gives you the bad news. The skeptical approach. The takedown of your current strategy. At best, you’ll decide not to pursue an unwise course of action. At worst, she’ll identify flaws in the plan that can be corrected in time. So the key is an approach that interrogates the numbers harshly. That identifies all weaknesses and flaws in reasoning up front.

This person will need all the Pac 12 financials, ideally. They need the Excels and data too, not just power point summaries. Then they can build alternative models.

How to do it Part 2: Don’t hire anyone else who can profit from the Pac 12

Category one of this group is the Wasserman Media Group or IMG or any other sports media related entities. The bummer is they have tons of great knowledge to apply to this problem. The reason I still recommend avoiding them, though, is because their advice will likely come back to, “You should hire us instead!”, which is still conflicted. So only consider hiring them as a consultant if they sign something like a no-work clause for 20 years. (Or let them do a free analysis, and still have another Devil’s advocate.)

Category two is non-sports consultants, who are better but not perfect. The challenge with every consultancy is they also just want more business. Most of the recommendations will conveniently include “hire us for more analysis”. So you have to be careful. They are also plenty expensive and the Pac 12 is already spending some unknown fortune on consultants.

The problem with this recommendation—no matter how important it is—is that I’ve sort of eliminated the entire universe of potential partners. So consider getting creative with it, Pac 12 leadership. You have how many business schools in the Pac 12? Everyone or nearly all? Why not hire one of them to do this analysis? UCLA’s business school handles consulting projects all the time and even has a Sports Management club. They’d leap overthemselves to answer this question. In a dream scenario, have each club come up to an undisclosed location for a week, and make it a case competition. (And you know what? I’d take that work over a lot of consultancies…)

(Oh, I’m available too. And I guarantee my day rate is much less than all the people the Pac 12 is currently paying. If you are an athletic director and reach out to me, I’ll answer your questions. Seriously, my email is on the contact me page.)

Thought 2: Don’t Pay Bonuses Tied to This Deal

The key to “creating value” is to increase the willingness to pay for customers (in this case, distributors) or lowering the costs of producing your product. This is how smart strategists think about their customers and how to deliver products to them.

Selling ownership is neither!

Really, I can’t emphasize this enough. If you sell a part of yourself, you aren’t generating revenue, you’re giving part of you away. I’ll try to explain this in two ways. First, the traditional finance explanation. When you sell equity as a publicly traded company, you don’t report that on the “income statement”, which is about revenues that flow down to profits or losses, but on the “statement of cash flows” under “cash flows from financing activities”. This is because it is about generating cash, but not from business activities.

Here’s the common sense case for that. Take your house. If you take out a home equity loan, did you “generate” additional revenue? No, you got cash in your bank account, but you have to pay it back. In an equity sale, you do that by paying out a proportion of future earnings. If a company sells more stock, they don’t say they boosted revenue.

If the Pac 12 increases its distributions to schools based off this equity sale, then claims that this increased distributions to schools and hence bonuses tied to distributions should be paid out, then yell, “STOP!”. That’s using an accounting gimmick to boost salary. That would be crazy. (And if it happened, the UC Board of Regents should investigate or consider litigating, if their own universities won’t.)

Thought 3: Demand Accountability in All Consulting Payments

Just casually looking at the books of the Pac 12—via the Form 990s and Jon Wilner’s reporting—a lot of people get paid millions from the Pac 12. This is one of those situations that has me scratching my head. You pay your CEO the most of any conference, he has more higher paid lieutenants than other conferences and yet he still pays millions to other people to advise him what to do. (Right now another consultancy is reviewing officiating, but I definitely agree with that hire.)

If the Pac 12 wants to increase distributions, insist that the Pac 12 find the cash savings in consulting fees. I bet the Pac 12 could find $1 million per year, easy. You could likely do this immediately. (And if he or his lieutenants won’t, find someone who will.) I’m also not the first to suggest this, as both Pac 12 Jon/John have suggested it. 

 

(But seriously, keep the independent review of officiating. That’s needed.)

Did the Pac 12 Need a Strategic Partner – Director’s Commentary

(This article is Part 3 of my series on the Pac 12, including whether they should have brought on a strategic partner in 2012:

Did the Pac 12 Need a Strategic Partner in 2012? Part I at Athletic Director U
Did the Pac 12 Need a Strategic Partner in 2012? Part II at Athletic Director U)

When Athletic Director U reached out a couple months back, I knew I wanted to collaborate with them on an article. Live sports will be a key component of future digital video bundles, and they currently prop up MVPD bundles. And I love UCLA and college basketball/football. So that’s a no brainer on my end.

I don’t know if Athletic Director U knew what they were in for. When I finally sent in my finished piece, it had exploded to 3,000 words. It’s like a New Yorker article, destined to sit in an unread pile for being too long. (So we split it into two.)

I went deep into the Pac 12’s finances so, of course, I had extra ideas. Those ideas would have interrupted the flow I had and since I was long already, many of those thoughts ended up on the cutting room floor. So here they are, including additional homework assignments for myself (and hopefully follow-ups to Athletic Director’s U). Today is thoughts about the model and what I learned; tomorrow is an opinion article with my advice for the Pac 12 CEO Board, from a business perspective.

The Missing Piece: Bottom’s Up Analysis

My initial “concept of the operation” to value the Pac 12 was to roll out a back of the envelope, top down and bottom’s up look. Like most plans, it didn’t survive first contact with the enemy, which in this case was a lack of data. Here’s my half-built bottom’s up model:

Table 1 - Bottoms Up Model

It was still useful to build, even without the data, because I got a great sense of the drivers of the Pac 12 Network, and what I did and didn’t know. Still, a model with that many guesses instead of estimates would have misled more than it educated. How much does it cost to run the Pac 12? In what areas? How much do they make on advertising? I just don’t know.

Though, if I can ever get my hands on Pac 12 financials…

New Scenarios

One of the great things about building a model is, if you do it right, it can be very easy to update the model with a few inputs or tweaks and you can get a new output. And a few jump out that I absolutely want to build:

The $750 Million Equity Sale for 10%

I conveniently used $750 million valuation as the middle case in 2025, because that’s the number currently being trial ballooned by the Pac 12. (And it’s about one-third higher than the amount initially expected.) The key difference is this $750 comes a few years earlier than the 2024 “all distribution deals expire” scenario. Being 5 to 6 years earlier means the Pac 12 gets to keep more of the cash in a “time value of money” sense. So an equity sale could change the model. 

But not quite so fast. As hinted in today’s column by Jon Wilner, an equity sale isn’t a long term solution. If you get money up front now, presumably your equity partners gets paid later. (Otherwise, how do the bankers make their money back?) This would mean estimating how much distribution the partner gets starting in 2025. It’s really a trade off of cash flows. It isn’t about generating more revenue or cutting costs, but timeshiftimg your flow of cash. (More on this tomorrow.)

The ESPN Extension

This is an intriguing deal too. As reported by the Sports Business Journal and confirmed by Jon Wilner, instead of getting $750 million in equity sales, the Pac 12 could have extended their deal with ESPN to 2030, and ESPN would have taken over distribution (with a split of revenue, presumably) of the Pac 12 Networks. The Pac 12 passed on this deal and my gut is that makes sense, but I could still run the numbers on it to prove it.

A Higher Cost of Capital

Sensitivity analysis is the name of the game here. Basically, you test your model on various inputs to see how much it changes. I sort of already did that with the low, medium and high revenue loss scenarios. But the other big input is the “cost of capital” which is how much the Pac 12 would lose or gain depending on how much return it expects on its capital. As you’ll recall, the current WACC is 9.4% for entertainment, but I used a lower 8%. That was generous to the Pac 12.

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