Tuesday, May 17, 2005

Power Play Opportunity for the NHL

In March, shortly after the NHL cancelled its 2004-2005 season due to the lack of a collective bargaining agreement (CBA), a group led by Bain Capital Partners approached the league with a $3.5 billion buyout offer. The immediate reaction of NHL owners and the media was lukewarm, and the deal was put on the league’s back burner. Two months have passed since then, however, and the league and its players union (the NHLPA) continue to make little progress towards a new CBA. As negotiations continue to stall, and the resulting decline in fan interest shrinks the league’s potential revenue base, we argue that the structure proposed in the Bain offer deserves a second look – if not the deal itself.

Advantages of Single-Entity Ownership

While the opportunity to buy assets at a reduced valuation was a large part of the motivation behind the Bain offer, NHL owners need to consider the other aspect of the deal – its structure. If the deal had occurred, all 30 teams would have been owned by one entity, with each team’s hockey operations run locally under a budget set by the new owners (essentially making them corporate subsidiaries). All revenue would flow to the corporate parent, and while that would provide some opportunity for revenue enhancement, the key change would be in the leverage each team holds with the players.

Indeed, under the old contract, bidding between teams had rapidly escalated the average player salary (from $700,000 to $1.8 million over the last 10 years), and player compensation accounted for roughly 75% of the league’s revenue at the time of the lockout (a far higher number than any other sport, or just about any industry period). In economic terms, the league’s suppliers (i.e. players) had too much power for the NHL to be a profitable business, and that is what forced owners to take a hard-line stance in negotiations and insist on a salary cap. While the NHLPA has been extremely reluctant to agree to a cap (unless it included terms very favorable to the players), single-entity ownership would accomplish the same goal. In essence, each team’s budget would serve as a cap, and the league would set the budget.

While the NHL’s current lockout strategy could eventually force the players into accepting a salary cap that favors the owners, in the long-run it would not change the balance of power between the two groups. The next time the CBA expires, owners would be back in the same position -- as powerless, small buyers of a good (talent) that is in limited supply. Conversely, with single entity ownership, the league will have turned the table on its players. The NHL needs only to look to the retail sector to see how effective this strategy can be, as consolidation in the retail sector (led by the emergence of Wal-Mart) has turned the table on previously powerful suppliers like Procter & Gamble. In this scenario, a salary cap could very well be the means through which salaries are kept reasonable, however its presence would merely be a symptom of a more important result – an increase in the league’s leverage with its players as a result of consolidation.

Potential Problems

Although the advantages of single-entity ownership are clear, the following three issues would need to be overcome before such a strategy could be implemented.

Competitive Nature of the Product

While there is aesthetic entertainment value in an NHL game (even though years of 1-0 scores may cause some to argue otherwise), we contend that more than anything else, hockey fans come to the arena to support their team and see if it wins. Under that hypothesis (which few would argue against), a league with one owner presents a problem: where is the competition? If not addressed properly, fans could easily come to the conclusion that the league is giving one team the best players, and that the outcome is predetermined.

That being said, we believe that the Bain proposal addresses this concern adequately – with each team managed locally, the single entity owner’s only input into a team’s success would be the budget that it allocates to each team. As long as all budgets are equal, each team’s local management would have one goal – to win as many games as possible. In fact, given the current disparity in team salaries, this could even result in superior competitive balance.

Antitrust Concerns

A concern of greater substance is that players would stop a move to single-entity ownership by claiming that it violates federal antitrust laws. The Bain proposal attempted to address this issue by offering equity in the league to players, and while that may have helped, we doubt it would have been sufficient to stop the NHLPA from crying foul. Indeed, a league with a single owner dramatically alters the balance of power between teams and players, and not in favor of the players.

However, there is reason to believe that the NHL would prevail on this issue even without player cooperation. First, a single-entity owner would likely have a larger war chest than the NHLPA to finance a superior legal team (especially after a year of lockout). More importantly, there is precedent for single-entity ownership in other leagues, such as the WNBA and MLS. We are not lawyers, but it appears that prospects of a battle on this front are not dim enough that they should deter the league from looking into a single-owner strategy.

How to Compensate Current Owners

While the benefits of single entity ownership are clear, how does the NHL get from here to there? This is undeniably a significant roadblock, and is probably the biggest reason why the Bain deal didn’t happen. Any prospective single-entity owner (even if it was just a corporation formed by current NHL owners) would need to convince every current NHL owner to sell. While the present state of the league (with the lockout and losses of $500 million over the last two seasons) definitely creates a compelling case for owners to sell, not all teams are losing money. In fact, some (such as the Rangers and Maple Leafs) have been consistently and highly profitable, and would clearly demand and deserve more than the average team.

However, with the help of consultants or investment banks, the valuation problem does not appear to be insurmountable – until you factor in two other issues, that is. First, many hockey owners are not in it for the money. They own their team for prestige reasons, and it would be extremely difficult for a financially-motivated buyer to get these owners to sell. Second, even if all owners are financially motivated, there is a prisoner’s dilemma problem. Even though all owners would be better off agreeing to a deal, each individual owner has an incentive to hold out and be the last to agree (where he could conceivable command a higher payment). As a result, the negotiations involved in making the strategic shift to a single owner would be quite complex and difficult.

Conclusion

Clearly, any attempt to transform the NHL to single-entity ownership will have to overcome some serious obstacles, none greater than the issue of motivating 30 different individuals to sell simultaneously. Nevertheless, we believe the NHL and most members of the media have dismissed this idea too quickly. The single-owner structure is the dominant model in second-tier sports leagues such as the WNBA and MLS, which is strong evidence that it is the best approach to control costs. That should make it attractive to any league, but particularly to the NHL – which faces the imposing task of generating revenue in a mildly popular league that has alienated its fans by missing an entire season (and possibly more). Convincing every owner to sell at a fair price will not be an easy task, but as the lockout drags on it will only become easier. At some point, NHL owners would be wise to take advantage of the opportunity and permanently switch the balance of power in their sport.


Authors: Pat Goff, Nathan Kieffer, John Morrison

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