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Saturday, March 29, 2014

How An Islanders Sale Can Fall Through

There is talk out of Canada that the New York Islanders hockey club may be up for sale. Fans of the team are generally happy about the prospect (see the vituperative comments to this article). However, a sale is far from a done deal and this article explains some of the common ways a possible deal can fall apart. I base my thoughts on my knowledge of the desires of a reasonably intelligent potential purchaser, knowledge gained through years as a former corporate mergers and acqusitions lawyer turned corporate due diligence lawyer.

First off, this is a legal, policy and economics blog, not a hockey blog. Dissertations of what's wrong with the team (the players) itself are left elsewhere.

As for a deal, the primary buyer concern is valuation. What is the right price?  A buyer does not want to overpay. This calculation is a function of revenues.  As the Islanders franchise is leaving its present arena (Nassau Coliseum) for the recently opened Barclays Center 30 miles to the west, historic revenues do not bear much on future revenue potential.  The word "potential" needs to be emphasized and this is a wild card.

A prospective buyer should be looking at an Islanders deal as buying, in essence, an expansion club moving into a virgin market.  The New York metropolitan area is obviously a historic hockey market, hosting not one but three teams (the New York Rangers since 1927 and the New Jersey Devils since 1982).  The market itself does not need to be conditioned but the ticket base and sponsor base need to be expanded.  As the team is moving far enough from its soon-to-be-vacated venue to its new home, historic revenues should not mean much (a plus given that recent revenues such as attendance have been subpar, a fact owing almost entirely to the team's on-ice product being regularly among the worst in the National Hockey League for most of the last 25 years).  The flip side and not necessarily a positive one is that the new home carries uncertainty as to both performance and potential.  

Attendance-driven revenues have a ceiling imposed by the ticket prices the market will bear, and the seating capacity of the building.  Attendance drives sponsorships and other ancillary revenue streams such as licensing and merchandising. Sponsors do not care about the sport, they care about the size and disposable income of the audience.  Therefore, a buyer has to get a grip on the audience potential, the fan base, meaning tickets sold.  The media audience (i.e., television) is more of a known quantity although the move to Brooklyn by itself will get publicity for the "new" venture.  Anything "new" gets an initial pop in attention. Whether it can be sustained over time is a big and valid question.

Other pitfalls to a deal are far less obvious. There may be issues with current debt obligations or ambiguous legal liabilities that would be discoverable only upon careful due diligence.  These liabilities cut into profitability and can reduce the probability of making a profit.  Who does your due diligence may determine whether the deal gets done.

Many large law firms do corporate due diligence and offer their clients the reassurance of using "name brand" lawyers. In reality, large law firms use very junior lawyers for vetting deals, contracts and the like. This means you have very smart but often just as unmotivated, bored and exhausted young men and women looking -- and you hope, attentively and passionately -- at contract details which could determine whether you as the owner make or lose millions of dollars a year. The firms will assure clients that partners and other experienced, mature lawyers are "supervising" the junior lawyers.  If you're the buyer, you hope you're right.

On the sale side, you care only about the sale price. But it's not as simple as you think. If it's a straight cash deal that's one thing; it's just the number. But if you are getting paid in part with a percentage of revenues going forward, you will want assurances (these are called "covenants") as to the team's operations after the sale. If you are getting paid in debt, meaning you are getting a promissory note, you are getting the equivalent of mortgage payments, interest payments from the buyer, with a lump sum payment at some future date.  If that is the case you will want to see how creditworthy the buyer is.  Even wealthy team owners default on loans and other obligations, and sometimes, they are more likely to do so because they view nonpayment as an acceptable business tactic. So, seller beware. 

And with any of these purchase price components, the questions and debate will revolve around their valuation.

This is just a short explanation of how and why a simple deal is anything but simple.

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