Home Analysis Don’t let the door hit you on the way out…

Don’t let the door hit you on the way out…

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Photo Credit: The Star

Back on December 1st 2010, the Toronto Star broke a story which, if accurate, was poised to change the sporting and business landscape in this city and country forever. It would also represent the largest sporting transaction in Canadian history and will likely represent the most significant indication of the inevitable merging of the telecommunications, media and internet industries of our generation. This transaction will play a huge and direct role in transforming the way business in these sectors is done moving forward in this country.  The story literally broke out of thin air.  The concept that the Ontario Teachers Pension Plan (OTPP) would be selling out of their cash cow that is MLSE was nothing more than a fantasy which most Leaf fans would not allow themselves to even consider as a possibility. Now, several months later, and despite repeated denials by everyone involved including the OTPP, MLSE, Rogers, etc., the matter has gone purposefully and strategically public and what was once only a whisper and a rumour has now become a verified fact. The OTPP are mercifully on their way out and will be selling off their ownership stake (66%) of the MLSE sporting empire.

With the public announcement of the OTPP hiring investment banking firm Morgan Stanley  to manage the process of the sale, as well as find additional suitors, the sale of the 66% OTPP ownership in MLSE is now a certainty.  It is simply a matter of when and to whom, rather then an “if”.  The most obvious match for the OTPP is still Rogers Inc.  If the rumblings were true, Rogers was prepared to dramatically overpay for the 66% ownership in MLSE, were prepared to buy out the remaining significant minority owners on a massively inflated valuation and were also prepared to exclude the real estate holdings from the transaction.  The proposed purchase price was thought to be $1.3B for the OTPP’s 66% ownership stake, as well as an estimated $500M-$800M or more to buy out the other significant stakeholders. Allowing the OTPP to maintain the real estate holdings which are expected to yield generous returns from associated revenue streams and flat valuation appreciation in real estate was thought to be a slam dunk move for the OTPP.  Rogers of course, was looking to generate a Return on Investment by leveraging their media, internet and telecommunications channels to drive profitability high enough to justify the almost absurd purchase price for an asset that reportedly generates approximately $160M/year in profits. From The OTPP’s perspective, they were looking to sell at an absolute peak valuation, well above real market value, while still maintaining the assets which represent the greatest potential for future profit, as it’s widely known at this point that revenue streams are near capped for the OTPP with respect to their sporting franchises.

Taking this matter public, and opening up the auction block for this asset is a massive gamble on the OTPP’s part. For my money, they should have cut the deal with Rogers, pulled up the armoured car and got away like gangsters with $1.3B cash and a significant real estate portfolio on a measly $75M-$125M original investment.  Not bad for a mid termed investment like this.  The OTTP are absolutely convinced that “this is the Leafs” and a public bidding war will drive the price up even further.  They may be right when its all said and done, but they may also get burnt here. Morgan Stanley has obviously made a sales pitch that got the OTPP drooling, and for their sakes, I hope they can pull this off.  The commission Morgan Stanley stands to make on this transaction will not be worth the millions and millions of dollars it will cost them in reputation alone if they do not close a deal that is worth significantly more than what the OTPP already had on the table with Rogers.  The OTPP fully understand that Rogers would be willing to pay more for this asset than their previous offer if they had to, and are gambling that they can force this to happen with a strategically placed and very public price war. Rogers meanwhile are not taking the bait, and have already proclaimed they have no interest in pursuing this transaction any further.  If one was to rationally translate this statement, it simply means Rogers is going to see how low this auction goes and then step in to save the day; or, if a legitimate price war does take place which drives the valuation higher then they anticipate, they will step in at the end, with a superior offer and will likely take over the real estate holdings as well in order to offset the costs.  Regardless of what is said for public consumption, Rogers is the best poised to offer up a larger amount than anyone else is.  They are hoping this strategy backfires on the OTPP, but at end of the day they could pay double the proposed price and still come out on top.  By removing themselves from the equation at this point, they are removing the inflation affect they would have on the bidding process and will allow for an organic market valuation of the asset.  Whether it’s higher or lower than their original offer I do not believe matters to Rogers, as ultimately, I would speculate that they will be the owners of MLSE.

Having said this, everything and anything is possible here and should not be summarily dismissed. Proposed bidders for the blue chip MLSE holdings would not only include Rogers, but, also other telcom players such as Bell, Telus and Cogeco as well as Globe and Mail media mogel David Thomson, Blackberry Billionaire Jim Balsillie and of course, the existing stakeholders being TD Capital (13.5%) and Larry Tanenbaum (20.5%).

Bell, Telus and Cogeco are interesting cases. To varying degrees, they lack the national and regional media capabilities enjoyed by Rogers, which would lead one to believe that they would be unable to go as high in a bidding war as Rogers would. There appear to be extensive conversations between these companies and current minority owner Larry Tanenbaum who holds some sort of first right of refusal on the transaction. Ultimately however, it is believed that Rogers could anti-up a price high enough, where the other telcom’s would not be able to justify the purchase price. One possible strategy is for these organizations to drive up the purchase price on Rogers to a point where it will stretch out their ROI and possibly hinder their efforts in other markets. This could grant them a competitive advantage in another strategic market, while Rogers is using up their resources to corner the sporting market in Toronto. Of course this strategy carries the inherit risk of leaving them holding the bag on a purchase they cannot really justify if Rogers chooses to walk away from the transaction completely rather than coming in with a higher offer.

The existing stakeholders (TD Capital at 13.5% and Larry Tanenbaum 20.5%) are not as important to this process as most are reporting.  The concept of first right of refusal is more than likely being blown out of proportion, or at the very least not completely understood. It does not appear as though anyone has been able to actually verify the terms of these clauses, but it would be highly unusual to just be a blanket first right of refusal clause. Typically, with clauses like this, they are bi-directional. Meaning that a first right of refusal exists, except under specific terms. Traditionally, this is done as an uplift of purchase price. For example, if the controlling shares are sold for $10/share, the owners of the first right of refusal clause would be able to match that price and purchase the shares. However, there is almost always a clause where the first right of refusal is negated, and the existing minority owner must sell their shares, if the purchasing party pays a sum of $x/share + y%. So, in this example, if Rogers for example purchases MLSE shares from the OTPP for $10 a share, Rogers has the option of buying out the minority shareholders by anti’ing up $15/share for example. Another common clause usually involves the minority shareholder holding the right to refuse being bought out at the uplifted price while maintaining their existing minority holdings. The actual percentage uplift, and actual terms and conditions around such things certainly vary, but the essence is almost always the same. TD Capital specifically is taking a “show me the money” approach and will happily cash out of this holding at absolute peak value. They are obviously hoping for this sale price to go as high as possible. Larry Tanenbaum is one who reportedly would love to own a controlling or absolute ownership in MLSE. Working out a financing arrangement, or finding investors that will allow him to maintain control on a purchase that is certain to go well above “fair market value” for the asset, will not be easy. Once you factor in the scenario that is more than likely – his first right of refusal clause carries stipulations which would allow the current majority shareholder (ie the OTPP) to sell the asset to whomever they desired and provide the buyer with a mechanism to take over the existing minority stakeholders – it is quite unlikely that the existing minority share holders will play a role in the future ownership of the organization. Their role in the actual sales process however should be quite interesting to watch as the maneuvering starts to take shape.

The most interesting group of buyers of course are the independent billionaires. The two that are most often mentioned are Globe and Mail’s billionaire owner David Thomson (who according to Forbes is worth an estimated $23B) and Blackberry Billionaire Jim Balsillie. There is also the possibility that other billionaires will surface during this process. Billionaires are certainly a wildcard in any transaction. They have enough money to do whatever they want, and if their heart desires to own MLSE – regardless of whether the purchase price is too high and egardless of whether it is a smart business decision or not – they could simply make the purchase. There is no way to predict what a person like this will do, and as such, they are complete wildcards in this process. I am certain however, that the OTPP would like nothing more than a few billionaires to get involved in the bidding process. The most interesting person on this list is of course Jim Balsillie, who has an established and controversial history with the NHL. Out of any potential billionaire bidder, Balsillie is likely the only one we can really get a handle on. Many feel the NHL would try and block any purchase of MLSE shares by Mr. Balsillie. This is simply not the case. For one, the legality of the NHL blocking a share purchase of a company like this simply does not exist. The NHL would need to take franchise ownership rights away from MLSE for the Leafs if they seriously intended on blocking Balsillie from owning the NHL franchise once he, in theory, purchased the shares. They have zero ability to dictate who owns what shares of a company like MLSE. I could not even imagine the lawsuit which would ensue if the NHL tried to take the Leafs franchise rights away from MLSE if Balsillie purchased the shares. All of this however is in actuality irrelevant, though, it is always entertaining to discuss “what if’s” scenarios like this. The truth of the matter is the NHL would love nothing more than having Balisillie and Blackberry as a majority or sole owner of MLSE. This would be absolutely welcomed with open arms, along with elaborate press gatherings and gallas, likely involving Jim and Gary, all smiles, sharing a stogy and a bottle of expensive champagne. The issue the NHL has with Balsillie is that he is trying to take $1B out of the pockets of NHL owners. The NHL intends on adding a second team to the South Western Ontario (SWO) market. The proposed asking price for a franchise fee in this market is reported to be in the $1B range. This money will be split evenly amongst the NHL owners (with apparently some “special” compensation to go to Toronto and Buffalo). The LAST thing the NHL wants is for Balsillie to purchase a struggling southern US franchise for next to nothing, and then move that franchise to SWO. By doing so, Balsillie spends significantly less than $1B dollars to buy a team, move them, build an arena, etc.  That is money Balsillie has spent and not one single penny into the pockets of the other NHL owners. Conversely, Balsillie has a franchise in SWO for a fraction of the actual cost of doing so, which has obviously been his motivation all along.  If I were to wager on this, Balsillie plays no role in this MLSE transaction as his agenda seems to be to vulture on a struggling southern US franchise and bully his way into the SWO market at a bargain basement price. Certainly, with so many struggling US franchises, other opportunities will surface for him to try this again. Again though, billionaire wild card factor in effect, maybe he just decides he wants in, wants to own the Leafs and simply will not care if it costs him double this way. Very difficult to predict what a gentleman like this will do when the chips are down.

Watching the changes this inevitable ownership sale is having on the organization’s sporting products is probably the most interesting aspect of this entire process. The OTPP have clearly shifted their focus towards reducing operational costs and increasing organizational market value. In previous years, the OTPP only had one avenue with which to increase their bottom line, and that was playoff revenue. Nothing more, nothing less. Seat pricing, seat capacity, concession pricing – all effectively maxed out. The OTPP had already diversified their brand to generate additional revenue streams via real estate and other avenues. Ultimately though, and what is driving this sale process to begin with, is the fact that their only remaining avenue to impact their bottom line, was for their core sporting assets (Leafs and Raptors) to make the playoffs. With the decision to sell off their sporting assets, a fundamental shift became evident in their strategy and it has obviously filtered down to their sporting assets as they began to involve their business unit executives in their plans. Their focus shifted towards increased share valuation versus what would now be considered “petty” cash that a few playoff games may yield (though, they certainly would be happy to collect that as well if by some miracle the Leafs and/or Raptors made the playoffs this year). It is of no surprise that both the Leafs and Raptors have reduced their payrolls (ie increased short term cash flow for the OTPP), both the Leafs and Raptors are playing with very young rosters and have both moved towards accumulating picks and prospects vs the win now approach that was so evident as recently as last season and even parts of this season with respect to the Leafs. The short term cash savings are most beneficial for the OTPP today while they still maintain responsibility for day to day operational costs. Simultaneously, young rosters with an accumulation of young assets, significant cap flexibility and extensive (and for the first time ever, complete) management teams offering seamless plug and play business continuity are thought to be much more valuable to potential new buyers. New owners can now immediately take over these organizations and can more easily establish and create a sustainable winning organization required to realize their ROI and justify the purchase price the OTPP is demanding. This becomes apparently obvious once you consider what time and costs would be involved to tear down and rebuild an older franchise full of difficult, limiting and expensive contracts. With both clubs General Managers being expensive, high profile, proven leaders on expiring contracts, it is of no surprise to see them aligning their respective organizations in such a manner as to accommodate their current ownership group as well as better position themselves for beefy contract extensions with the new ownership group.

The OTTP still have their foot firmly planted over the throats of fans of the Leafs and Raptors. Their reign is almost over, and better days are clearly ahead. I find it ironic and almost amusing that once the OTPP looked to sell out of MLSE, the way they ran their organizations dramatically changed, as their focus shifted to overall franchise valuation versus maximizing year over year shareholder return. It is completely perplexing how they never made the connection, until such time that they looked at selling. Running your organization in a manner which would increase immediate franchise valuation, would also consistently, over time, provide the highest possible year over year shareholder return against your direct bottom line is business 101. What the OTPP always failed to realize is they could have done both all along, but they were far too short sighted to realize this. The end result is they ended up costing themselves millions and millions of dollars in revenue over the last 6-8 years and did a complete and utter disservice for all of their paying customers – the best and most loyal fans in the world. At the end of the day though, they are still selling out for absolute maximum dollars (which they would have done anyway), and the only solace we as fans have is to know that the reign of terror is finally and mercifully coming to an end.

Thank you OTPP and please don’t let the door hit you on the way out….