The Wallabies have been forced into a major shake-up of their team for Bledisloe 3, with James O’Connor ruled out with a knee injury.
This started as one article but became a bit too long and this is the first part only, hopefully clarifying for readers how private equity investments are being made in rugby.
A following instalment will then focus on how similar structures might be employed but reducing risks to rugby and does not sell out all the upside to private equity.
In his interview with Nick McArdle, Rugby Australia interim CEO Rob Clarke points out that it is not good business to be selling to private equity when the value of rugby union in Australia is low. I would go further and say that it is a terrible time to sell anything if you are driven by a desperation for cash.
There is no sense in looking to private equity involvement to solve its financial problems and Rugby Australia needs to re-engage with its supporter base to shore up its financial position.
The need for private equity (PE) investment
There are not a lot of financially successful sporting organisations in the world. Breaking even over a cycle of good times, and not so good times, is rightly considered to be not a bad result for sports.
Consequently, most sports organisations spend most of their lives chronically short of cash. Even successful professional clubs will have balance sheets heavily weighted towards long-term and intangible assets, mostly the right to future revenues.
Some years ago a globally respected forecaster predicted that major global sports had hit a revenue ceiling around 2015, coincidentally around the time of record NRL/AFL/RA broadcast deals. Right or wrong at the time, I suspect in a post-COVID world, he is now right.
Irrespective of cause, the liabilities for FX exposures on 2020 revenues, Israel Folau and an advance against 2023 World Cup revenues have resulted in a big hole (I guess around $25 million) over the next World Cup cycle. This is compounded by likely reduced revenues and uncertainty over what expenses can be effectively reduced.
RA’s need for cash now is somewhere between urgent and desperate.
What is Australian rugby worth?
Pretty much zero right now, I guess.
I would argue that both rugby codes in Australia had built significant intangible value since 1900 based on the blood and sweat of their players. Super League and professional rugby arrived in 1995 and in the last 25 years players and administrators have largely monetised that value.
While rugby union might be going gangbusters globally, the commercial reality is that if you take out the value of the World Cup, the Six Nations and the Lions tours, then the total economic value of global rugby is probably less than zero.
We all mostly understand the general structure when PE invests in a traditional business. Usually they pay for an equity share in the whole business, assets, liabilities and future cash investment obligations in return for its share of profits and the proceeds from the eventual sale of the business.
With the equity value of Australian rugby being negligible, and with its only valuable asset being future cash flows, a PE equity investment transaction does not help RA because the sale price would be low. PE would not want to invest time in managing rugby and it would be years before they could take a cash dividend from profits. It would be difficult to find a buyer when they want to exit.
RA’s only real asset is future revenues and it is most likely that any transaction would take the form of an acquisition of a share of future cash flows. From the scant reporting I can locate, these are the types of deals done by CVC with the English Premiership and under negotiation with the Six Nations.
There are only two numbers that need to be negotiated:
1. How much money does Rugby Australia need?
2. What future share of revenues is required to ensure that the PE investor receives back over time all its principal and achieves the desired rate of return?
Rugby Australia is in a very weak negotiating position as it needs a relatively large amount of money and it has not yet secured future deals or been able to identify what games will be played in the future. There is a serious risk that the future PE share of income is too high for RA to meet its liabilities and operating expenses in the future.
English Premiership and Six Nations
It is difficult to find any detailed analysis of the so-called PE investments. While sports journalists are not great financial analysts, I also suspect there will not have been a lot of detail shared with them by PE or the unions either.
CVC apparently offered £275 million ($487 million) for a 51 per cent share of the Premiership, which was refused by the clubs, who then sold 27 per cent for £230 million ($408 million). The apparent discrepancy (27 divided by 51 multiplied by 275 equals 146) is compensated by CVC becoming entitled to 45 per cent of revenues over an agreed ratchet revenue level. The tension between the capital sum desired by the clubs and the revenue share they could afford to give away is balanced by giving away a greater revenue share in the future when revenue grows.
The involvement of CVC must therefore increase total revenues by 37 per cent just for the clubs to maintain their current level of income. Thereafter their increased share of net revenue must exceed increased costs. If revenues go over the ratchet threshold and the 45 per cent revenue share kicks in, it will become more difficult as operating costs rise and players push for a larger share of the additional revenue.
The desire was for the clubs to invest the CVC proceeds into assets such as facilities, which would improve the ability of clubs to generate future revenues. Maybe some did, maybe debt was repaid, or funds were otherwise used. Any balance left over would now be likely to have been absorbed by COVID. Not only has COVID hit this year’s financial performance but significant revenue increases in the medium term look unlikely.
Some other potential drawbacks will include:
• CVC will have significant influence of future revenue opportunities
• CVC could now be in a position to influence availability of players contracted to the clubs
• CVC would be a major beneficiary of future revenue windfalls, such as entry of new content providers like Amazon
Prior to COVID CVC was in negotiations with the Six Nations to acquire a one seventh share for £300 million ($532 million), which is now stalled due to uncertainty about the international program. The main sticking point is CVC’s desire to move the tournament to a pay television platform.
Retaining a free-to-air presence with an audience of millions is important to the home unions as a critical entry point for supporters, but that will result in CVC reducing its offer.
How this plays out with significant losses in the current year and no November internationals remains to be seen. It is rumoured is that the offer has been reduced to £200 million ($354 million) with further concessions to PE if more games are cancelled. However a windfall right now could be the difference between financial survival and going under, irrespective of the potential loss of interest with no free-to-air TV broadcast.
With investments in the Premiership, Top14 and the Six Nations, CVC will be in a powerful position to challenge World Rugby for effective control of the elite global game.
Advantages of PE investment
We are currently in the softening up period as aspects of the advantages of PE are floated out through the media and press conferences. These have been positive messages:
• There are several PE interests enquiring about investing in the game
• Rugby will benefit from the PE expertise in contributing to strategy and efficiency while rebuilding value
• PE are very smart at identifying opportunities to increase RA revenues
• RA can pick and choose what parts of rugby are sold to PE
The rugby supporter base is hearing the messages it wants to hear:
• All is not lost, there is still value in the Australian game, recognised by sophisticated business people and investors
• Immediate solvency and liquidity problems will be solved by PE investment
• Equally comes with that an underlying reassurance that if things do not go well, more investment will be available
• After years of poor administration, there will be smart successful people running rugby whose interests are aligned with building its value
• Wallabies and clubs are untouched, and PE will only invest in the unloved SR and NRC competitions
Ultimately it is also incredibly positive for the current administration:
• Immediate perception that they are an improvement on previous administrations, hobnobbing with PE high flyers and providing sophisticated solutions to rugby’s problems
• Potentially fixes the current solvency and liquidity problems and appears to underwrite operating costs for the next broadcast cycle
• Defers obligations and liabilities some years down the track, possibly after they have retired or left the game altogether
Risks to Australian rugby of private equity investment
This is not akin to an investment in a private business with a return to PE dependant on improving efficiency and growing the value of the business. PE and rugby interests are not aligned at all as this is the purchase of an almost guaranteed income stream, which transfers wealth away from rugby into PE pockets and threatens the future of the game.
If revenues are significantly increased over time, irrespective of whether it is attributable to the efforts of the PE investor or RA, then it is more simply described as a loan with an extremely high interest rate. Either the loan will never be repaid, or RA will be forced to borrow again to buy out the PE investor so it can regain control of its own revenues.
If revenues simply do not increase, then RA will have insufficient funds after PE takes its share to operate rugby and will eventually go broke. Even then, the PE investor will have received some revenues to reduce its losses and will walk away to its next investment elsewhere, leaving the rugby support base to put the pieces back together. A worse outcome could be if the original agreement gives the PE investor further rights and controls if RA becomes insolvent.
Part 2 will make a more in-depth look at the risks to rugby and how they could be reduced, as well as ways of adapting this investment structure so that more patient and less avaricious investors can earn a reasonable rate of return at minimum risk, while not placing the future of rugby in the line of fire.