Investors pursing global investment opportunities across the sports industry should be aware of the key considerations likely to apply to the M&A process amid the coronavirus (COVID-19) pandemic.
As governments around the globe continue to assess the effectiveness of travel restrictions and social distancing measures to contain COVID-19, opportunistic investors are eyeing prized sports assets. Collapsing broadcast, gameday, and commercial revenues have forced sports federations, leagues, and organizations into survival mode.
Investors, led by private equity firms, are swooping in. CVC Capital Partners is canvassing investment opportunities across European football, having recently offered financial assistance to the German Football League (DFL), and is currently weighing an investment in the Italian Football League (Lega Serie A). Similarly, Silver Lake is reportedly in discussions to acquire an interest in New Zealand Rugby, which administers the All Blacks.
As other investors join the hunt for undervalued opportunities, this LawFlash discusses some of the key considerations for investing in sports amid COVID-19.
One of the obvious effects of COVID-19 on the M&A process is accelerated transaction timelines while facing logistical limitations. This requires investors to prioritize the scope of due diligence exercises. Accordingly, specific emphasis should be placed on the following:
- Identifying how the target is structured: Understanding the corporate structure and legal status of a target will assist investors to identify the necessary regulatory and third-party approvals required for completion. The “owners and directors” test is an obvious example for investors considering investment in English football. The English Football League is currently conducting a review into the adequacy of that test following the insolvency of Bury FC, one of England’s oldest football clubs.
- Assessing the continuity of business performance: This requires careful examination of termination, material adverse change, and force majeure provisions in material and revenue generating contracts. We are seeing sponsors and rights holders beginning to delay or cancel payments as many sports competitions remain indefinitely suspended. Bistro Regent, a French restaurant chain, recently announced its suspension of sponsorship payments to football giant FC Girondins de Bordeaux. This may cause investors to seek greater assurance of business continuity, which could see a resurgence of comfort letters or other forms of assurance.
- Understanding litigation risk: As sponsors, broadcasters, and other rights holders reconsider contractual relationships, understanding the litigation risks post-acquisition will inform effective risk mitigation strategies. An example is how Liverpool FC will transition its kit sponsorship from New Balance to Nike, given the recent challenge by New Balance in the High Court of England to Liverpool’s termination of the existing kit sponsorship. Liverpool’s new deal with Nike was set to begin following completion of the Premier League season, in which Liverpool was expected to be crowned champion while wearing New Balance kit. However, the indefinite suspension of the Premier League season means Liverpool will need to consider the competing expectations of New Balance and Nike when the Premier League resumes play.
- Evaluating employment and labor issues: The implications of recent or planned furloughs and pay cuts should be carefully evaluated, particularly in countries that have well-developed employee protection regimes. For example, the Rugby Players Association of England has reportedly been providing legal advice to its more than 700 members, including a recommendation to reject Championship Rugby’s proposed 25% pay cut. While pay cuts affect all players and athletes, those coming off contract are likely to be most resistant, especially if they do not expect to receive contract extensions.
KEY DEAL TERMS
Investors may want to consider how to structure the transaction to mitigate ongoing uncertainty of business performance. This may include the following:
- Formation of an investment consortium: Investing as a consortium allows investors to allocate risk, pool capabilities and expertise, and leverage networks. Arctos Sports Partners is a recent example, having raised more than $430 million to invest in sports franchises and teams across the United States and Europe. It was launched by David “Doc” O’Conner, the former president of Madison Square Garden Co., and Ian Charles, a veteran private equities secondaries investor.
- Acquisition in tranches: This will allow an investor to increasingly assume risk over time. A call option may be preferable because it gives an investor the right, but not the obligation, to acquire additional tranches of shares in the future. Farhad Moshiri and his company, Blue Heaven Holdings Ltd, is a recent example. Moshiri has increased his ownership in Everton FC over time. He initially acquired a minority interest in 2016 and became majority owner in 2018. In 2019, he further increased his majority ownership to 77.2%.
- Alternative forms of capital: Convertible loan notes, convertible preference shares, or other convertible instruments will give an investor the right to acquire shares in the future on presently negotiated terms. In 2018, US hedge fund Elliot Management assumed control of AC Milan by converting loans totaling approximately €300 million ($328 million) to equity after then owner Li Yonghong defaulted on loan repayments.
- Introducing an earn-out: An earn-out clause allows an investor to defer part of the purchase price until specific post-acquisition milestones are achieved. These types of clauses can be effective in breaking price negotiation deadlocks. During uncertain times, an earn-out mechanism allows investors to mitigate risk by deferring part of the purchase price and conditioning deferred payment(s) on the achievement of future earnings and/or commercial milestones.
- Use of material adverse change (MAC) clause: A MAC clause typically allows an investor to renegotiate pricing terms or terminate a transaction if the financial performance or value of the target materially deteriorates before completion. In practice, MAC clauses are heavily negotiated and can be an obstacle to agreement by the parties. We are seeing intense scrutiny of MAC clauses during COVID-19. Therefore, the drafting and overall circumstances of a transaction are important in determining its effectiveness.
- Examining pre-completion covenants: If pre-completion covenants are too restrictive, they may prevent the target from acting prudently to address unanticipated business challenges. However, pre-completion covenants should restrict the target from making decisions that could be detrimental and irreversible.
VALUATION AND PURCHASE PRICE ADJUSTMENTS
Valuations are becoming more challenging because of the global disruption caused by COVID-19. In recent years, the locked-box mechanism has become increasingly popular because it creates price certainty. The purchase price is determinable by a set of historical locked-box accounts and is not subject to post-completion adjustments. However, investors are likely to abandon the locked-box mechanism in favor of a purchase price adjustment mechanism. This allows an investor to seek price adjustments through a set of completion accounts if the financial position of the target at completion is different to what was expected. While traditional adjustments have been net debt and working capital, investors are likely to seek adjustment based on revenue or earnings to completion.
CONDITIONS PRECEDENT AND COMPLETION MECHANICS
The period of time to the long stop date for satisfaction of conditions precedent should be carefully considered, specifically because there may be delays to obtaining the necessary regulatory and third-party consents. This has been the case with a Saudi-led investment consortium that continues to experience regulatory delays to approval of its £300 million ($366 million) acquisition of Newcastle United FC. Further consideration should also be given to how ongoing disruption to government services and business operations could adversely affect the completion timeline and mechanics. Disruption should be expected in jurisdictions where the administration and processing of company incorporations, share transfers, and/or regulatory filings have recently been transitioned online.