Ding Dong, the Witch is Dead…

by Andrew R on December 1, 2010 in Analysis, Opinion - 260 Comments

The potential sports story of the decade for the city of Toronto, and more specifically, fans of the Toronto Maple Leafs is unfolding right before our eyes.  The legitimacy of the potential sale of MLSE to Rogers should not be easily dismissed.  The rumoured sale simply makes sense for all parties involved.  The recent announcement of the pending retirement of MLSE CEO Richard Peddie now starts to bring the picture into focus and adds significant legitimacy to the Toronto Star report of MLSE share sales from the Ontario Teachers Pension Plan (OTPP) to Rogers Inc.  The fact that the Richard Peddie retirement was announced just before this story broke, absolutely stinks of premeditated public transition planning.  Personally, I must admit, I knew there was much more to the Mr. Peddie pending retirement announcement, but, I simply had no idea how deep this rabbit hole would go.  Speculation and associated questions today, from all corners of the sports and business communities is running rampant.  Why would the OTPP sell off their stake in this cash cow?  What Return on Investment can Rogers Inc garner on a $1.3B purchase of an asset generating an approximate $160M in profit each year, especially considering that the real estate assets are thought to be excluded from the deal?

The best way to examine a transaction like this is to treat it like a normal “hockey” transaction, lets say a trade for example where 2 sides exchange assets with each other.  In an ideal world, as all NHL General Managers will tell you, the best trades are the ones where both parties benefit from the transaction.  Surely there are scenarios where trades are lopsided and there are decisive winners and losers.  However, with a transaction of this magnitude, each side has done their due diligence and both parties have very legitimate reasons for completing this transaction – and as such, I for one am willing to proclaim this a “done deal” which simply needs to play itself out over the next 6-24 months.

The Ontario Teachers Pension Plan (OTPP) is looking at this from a pure shareholder, bottom line perspective.  Having originally bought into MLSE for a reported sum of approximately $50M dollars, as well as some additional option purchases over time from minority shareholders, their estimated total investment in share and option purchases is believed to be in the $75-$125M range.  What this represents is a clean, bottom line profit of significantly more than $1B simply on flipping an asset.  This sort of return on investment is unheard of in the modern business era.  But, this alone is not enough to justify this transaction.

The corporation earns significant bottom line profits from their sports franchises alone (estimated to be in the $160M per year range), has grown their brand into significant holdings in real estate and are sitting on an asset with a proven record of exponential growth in value year over year.  The issue from the OTPP perspective is a very perceived and real plateauing of market value of their sports teams portfolio.  As big and profitable as MLSE is, an apparent ceiling has been reached in franchise value.  After all, they cannot exactly double the seating capacity of the ACC, they feel they are near maximum pricing levels for seating and concessions and it is not like they have 30% seating capacity they can grow into to drive up their profit and shareholder valuation (though it is believed there is still some room for growth with the Raptors in the NBA and the TFC soccer franchise, not too mention playoff revenue if any of their franchises could ever make it there).  This actually isn’t a new reality for MLSE and the OTPP.  They realized this reality many years ago, and began diversifying their brand, expanding into real estate and other ventures in the Toronto area.  It should be of no surprise then to hear that the real estate portion of the corporation is not to be included in this transaction.  The real estate portion now represents the area for the greatest shareholder return.  Combine this with the astronomical purchase price being proposed – and simply put, the OTPP can make more money with $1.3B cash, in a shorter period of time, then the $160M bottom line profit generated from their sports franchises each year.  Lastly, once you add in the very real threat of a 2nd NHL team eventually being added to the Greater Toronto Area, the very real impact to losing their monopoly the Maple Leafs currently enjoy, would certainly force a smaller (or greater) downward trend in their evaluation.  There are whispers in fact that this sales process was stimulated by the realization that ultimately, the GTA will be home to a 2nd NHL franchise.

As a result, the best way for the OTPP to increase their bottom line, have the largest positive impact on their shareholder value, and avoid a potential decrease in market value of their sports franchises once a 2nd team is added to the GTA area, is to complete this transaction.  The fact they found a suitor who is interested in paying an amount high enough to make $160M guaranteed year over year profits insignificant, while also willing to forego the real estate portion of the business, makes this an absolute match made in heaven for the OTPP.

The benefit to Rogers in this transaction is much more transparent, and their approach is absolutely brilliant.  Already owning the Jays, already owning a large share of the broadband, cellular and sports television industries in the Toronto market, they are primed to own an absolute sporting monopoly with this transaction.  The revenue generation from granting themselves exclusive television and associated marketing revenue is almost inconceivable.  They will literally crush competitors in the market and force full compliance with their will.  Any competitors remaining in the market will be squeezed of all profit and all leverage.  Advertisers will also be bent over a barrel, likely leading to a steady increase in revenue generation from radio and TV advertising alone.  This is a pure and simple check mate move on their part.  No wonder they are willing to pay almost double market value for this transaction.  It makes the transaction an absolute “can’t say no” scenario for the OTPP, turns the $160M revenue the OTPP currently generates into an insignificant dollar amount, and frankly, it is a zero risk transaction for Rogers.  They could likely afford to double their offer and still make this work long term for them.  Obviously due diligence was done here, as the offer amount, reported to be $1.3B, is high enough to force the OTPP out without a fight, and is high enough to avoid any competition, as no other individual or organization is capable or matching this offer as they would be lacking the complimentary market presence Rogers enjoys.

Rogers is now able to continue where the OTPP left off.  They feel (and rightfully so), that leveraging their channels, they will be able to force the valuation of the organizations they are purchasing higher then the $1.3B they are going to pay.  They also feel (again, rightfully so), that they will be able to increase the revenue, by leveraging their channels and assets, well beyond the $160M in annual profit currently being generated.  Rogers also feels that they are better equipped to run sports franchises and will be able to significantly increase bottom line profits simply by managing their sports assets better.  After all, the Leafs for example leave anywhere from $20M to $60M (or more once merchandising, etc are considered) on the table simply by failing to be a contender year in and year out (something that was not lost on the OTPP, but, more on this below).  From a Rogers perspective, this is a no lose scenario, and the purchase price, almost doesn’t matter – as pretty clearly indicated by the extremely generous proposed purchase price.

Lastly, and most importantly – what does this mean for the fans of MLSE sports product lines?  Personally, as a fan of the Maple Leafs and Raptors, I simply cannot tell you how excited I am about this transaction.  I knew this sort of monopolization and sporting empire was ultimately inevitable, not only in Toronto, but, in all big sporting markets.  I simply did not expect to see this for another 10 years or longer in Toronto.  Obviously the fear of a monopoly in any industry is a very real concern.  The common sentiment that an individual owner with a passion for winning is preferred over a faceless corporation worried about nothing except profits.  Although I agree with this sentiment and opinion, the reality is, the OTPP would NEVER, in our lifetime, have sold these assets to an individual.  The sporting assets were so profitable, that they would never be able to justify selling the assets to someone paying fair market value.  The only reason something like this works is because Rogers is able to pay significantly more then fair market value, forcing the OTPP out.  This of course is only possible because they are able to extend the profit margins via their established and complimentary channels.  So, from my perspective anyway, I would certainly prefer a passionate, rich, hobbiest owner.  However, I will happily accept a corporate ownership like Rogers who require long term, sustainable and winning organizations in order to realize a prompt return on investment and valuation growth in their asset.

Many will ask how Rogers ownership will differ from the OTPP ownership.  Their primary concern was certainly to generate additional revenue and no better way to accomplish that then create a winning product, generate playoff revenue and additional merchandising revenue, etc..  The answer is sadly obvious, and at the same time, quite a painful reality for Leaf fans.  The OTPP is a pure shareholder corporation based on year over year returns.  They had pretty well maxed out their profit several years ago with the Maple Leafs.  Unlike Rogers however, they lacked the ability to significantly expand their profit margins via their on ice product and instead turned to alternate ventures (ie real estate) and leveraged their brand elsewhere to drive up overall profit.  The only way for them to increase their profit for the Maple Leafs on ice product was to make the playoffs.  Pure and simple.  This was their sole objective each and every year.  It needs to be remembered, unlike Rogers, the OTPP does not own the media outlets.  Short of the handful of games shown on Leafs TV, they were cut out of the majority of advertiser revenue, settling rather on selling off television rights packages to the major networks at a fraction of their actual worth.  This was and is the proverbial cement shoes they attached to their general managers right before pushing them into Lake Ontario and feeding them to the fans.  The OTPP certainly provided a budget (usually generous) for each General Manager, and they were free to do with that budget whatever they wanted – but, whatever you do, make the playoffs.  This was and is the corporate mantra.  Granted, there was some room to grow the bottom line with the Raptors, TFC also represented an opportunity to improve the bottom line – but, end of the day, the biggest impact to their bottom line from their sporting franchise was going to come from the Leafs being in the playoffs.  Each playoff game is significant, clean and straight cash against the bottom line.

Watching general managers like Pat Quinn, John Ferguson Jr and most recently Brian Burke absolutely bury themselves as General Managers by trying to win now, make the playoffs now, and at all costs has been the most frustrating part of being a Leaf fan.  Obviously it is not the general managers fault.  They absolutely must follow the corporate mantra.  Each general manager however approached this a different way.  For the most part, Pat Quinn simply ignored the future and continued to sell off assets as required in order to remain in the playoffs each and every year.  He actually took the young, playoff team he inherited, and slowly replaced the youth with veterans that would give him the best chance to be in the playoffs each and every year.  As the team began its inevitable decline, the OTPP began to panic and wanted long term sustainability of this revenue stream.  Enter John Ferguson Jr, who sold them on a hybrid approach.  He felt he could draft well enough to stockpile the future, and maintain and acquire enough veterans to keep him in the playoffs until his draft picks came around.  He may have actually been able to pull it off if he ever had goaltending.  He tried twice to fill that hole (Raycroft and Toskala), and both times paid a dear price for goaltending in the hopes of pushing the Leafs into the playoffs now – which, of course, never materialized – yet, his teams were “oh so close” to making the playoffs.  He was eventually replaced for being too inexperienced to play the politics properly, and for being an easy political target due to his inexperience.  An absolutely perfect fall guy for the OTPP – but, ultimately, make no mistake about it – he was fired for missing the playoffs and causing his superiors to miss their projections to the shareholders they report to.  Brian Burke is probably the most interesting of the bunch, as his mandate was the same, but, packaged a little differently.

“I’m in a hurry. I believe this team can be successful, I don’t think you don’t need to do a classic rebuild, I’ve said that since the day I got here.”

The same old mantra remains, not even slightly disguised to protect our intelligence.  To Burkes credit though, he has attempted to build using young assets, acquired via untraditional methods.  Unfortunately though, the same pressure of “playoff revenue now” is hanging over his head, and just like those before him, the strategy to date has failed.  How does a brilliant man like Burke approach things the way he has?  Nothing more complicated then a mandate from the corporation he works for and the shareholders they report to.

So, will this change with Rogers owning the Leafs instead of the OTPP and if so, how?  My personal opinion here is that Rogers has a vested interest in not only making the playoffs, but, long term and consistent success of their sporting products.  Once this transaction is completed (which I think is inevitable now), Leaf fans can expect to hear the same message Jays fans have been hearing in recent years.  Patience, long term sustainability, no short cuts, no gambles…  The reason I am so confident about this?  well, as much as I would like to believe its because Rogers has the fans best interests in mind, I would simply be foolish to believe that.  But, what I do believe is that it is in Rogers best financial interest to proceed as such, as they are now able to exponentially impact their profit margins where the OTPP was not able to do so.  As a result, the best financial ramifications for Rogers just happens to fall in line with my own personal wishes and expectations for the Leafs – good enough for me.

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