Buying Shares in an NFL Player? Business Valuation Principles Still Apply

In my last post, I argued that an investor in Kylie Jenner’s cosmetics company was essentially investing in Ms. Jenner’s personal brand, and that the earnings stream for that brand was of a finite life.

The post got me thinking: is it actually possible to invest in the future earnings of a specific, individual celebrity? Has anyone ever done that, and if so, how did it go?

The short answer is “yes” and “not very well”. For the longer answer, keep reading.

Fantex

In 2012, a company called Fantex Inc. was incorporated. Fantex’s business was to invest in minority stakes (typically 10% ) of the future earnings (from both on-field performance and endorsements) of professional athletes. It would raise money from the public in exchange for athlete-specific classes of common shares, and would pay the athletes a lump sum in exchange for the right to a share of their future earnings. Shareholders would receive dividends based on the pro-rata performance of their athletes.

The following table shows a list of some of Fantex’s early investments in National Football League players.

 

How have these investments done? Well, it depends.

The investment in Mohammed Sanu has turned out nicely. Sanu, who earned fairly little on his rookie contract with the Cincinnati Bengals, signed a big contract with Atlanta in 2016 (following his deal with Fantex), earning a base salary of $6M per year the past few years. His tracking stock has already paid out $1.41M in dividends to shareholders (close to the initial $1.63M raised), and he stands poised to earn over $6M per year over the next three years with the Falcons, although none of the money is guaranteed.

 

On the other hand, if you invested in the E.J. Manuel stock issue – well, let’s just say that your investment worked out about as well as every Buffalo Bills quarterback since the Doug Flutie era. The E.J. Manuel tracking stock has issued total dividends of only $0.41M, a mere fraction of the $5.2M that was raised to acquire a 10% stake in Manuel’s future earnings.

Overall, it appears that Fantex’s investments have underperformed; the company had a deficit of $14M as at September 30, 2016, the last published financial statement date before the company was delisted.

 

Valuing Fantex's contracts is really no different that valuing shares in a company: it is a function of three factors: the size, duration and risk of the future projected cash flows of the investment.

Fantex’s public filings make for interesting reading, and they talk about each of these valuation inputs. As part of its financial reporting, Fantex would need to re-value its contracts with its roster of athletes each year, adjusting its assessments of fair market value based on its estimates of future performance in light of how the athlete fared in the previous year; the deficit of $14M is largely a function of the write-down in value of underperforming contracts.

What sorts of assumptions does Fantex apply in its valuations? Here are some of the key ones for NFL players, based on Fantex’s 2015 10-K annual report:

• Discount rate of 4.5% to 20%, with a weighted average of 14.6%.
• Career length (I assume this means from the beginning of the player’s career: 5 to 16 years, with a weighted average of 9.7 years.
• Size of contract: $0.4M to $81.4M, with a weighted average of $23.9M.

My initial sense is that these assumptions seem fairly optimistic, given the average length on an NFL career is only 2.6 years, and has been decreasing recently, although of course once a player becomes more established the expected career length will tend to increase.

Let’s return to the Mohammed Sanu tracking stock. Before, I had presented my analysis without applying a discount rate. What if we apply a 15% discount rate to reflect the risk of the investment in Sanu (who was still a young player when Fantex invested) versus investing in a public company stock? You can see that whereas investors paid $1.4M for Sanu’s stock, the present value of dividends thus far has been only $927,000:

 

 

Based on the above, Mr. Sanu will need to remain healthy and avoid being cut by the Falcons the next couple of seasons in order for his investors to break even.

Conclusion

I'll have more to say about the idea behind Fantex , which more recently has expanded into other sports such as golf and baseball. But given that Fantex is no longer publicly traded, would-be NFL investors may need to suffice with the less expensive option of fantasy football.

 

 

Is Kylie Jenner Really a Billionaire, Or Even Close?

A few weeks ago, Forbes created a social media storm when it proclaimed that Kylie Jenner was poised to become the world’s youngest self-made billionaire. Many thumbs were worn out debating the appropriateness of the term “self-made”, and apparently a GoFundMe page was set up to try to get Kylie over the hump into official billionairedom, although mercifully this was only a gag.

As someone who is only peripherally aware of who Ms.Jenner is, I am perhaps not the best person to comment on all this. But as a business valuator, I do feel I should comment on the basic premise of Forbes' assessment that Ms. Jenner is worth anything close to $1B. So here it goes.

Inputs for Determining Value

In order to value a company or asset, we need four main inputs:

• Current level of cash flows
• Expected growth rate
• Expected capital reinvestment rate
• Discount rate

According to the Forbes article, the following are basic facts about Ms. Jenner’s business.

• Total sales in 2017 were $330M. Revenue growth that year was only 7%
• Production and fulfillment are outsourced to third parties, and overhead is minimal. Forbes estimates the cost of sales at 55%.
• Her mother takes a 10% cut (of profits? Or sales? The article is unclear) as a management fee.

The Forbes article seems to assume that Kylie’s net profit margins are in the range of 40%. This seems quite high, even given her lack of overhead costs. L’Oreal and Estee Lauder both have pre-tax net operating margins in the range of 15% to 20%. Given that Kylie appears to run a leaner operation, let’s assume a net operating margin of 25%.

Revenue growth last year was 7%, which seems very low for a business that started less than 3 years ago. I’m going to assume that growth will simply equal inflation going forward.

Capital reinvestment seems, in this instance, to be zero, given the image-based nature of the business. You would figure that at a certain point her manufacturer would pass along any such costs to her, but let’s ignore them for now.

For a discount rate, I estimate a rate of 10%, based on an estimated cost of equity consisting of:

• Risk free rate of 2%
• Cost of equity of 5%
• Firm-specific risk 3%

If I apply a basic Gordon growth model, I get ($337M x 25%) / (10%-2%) = $1,052M. So far, Forbes looks to be on solid ground.

The Problems

But there are two problems with this analysis.

First, most businesses are valued based on the assumption that they are going to operate into perpetuity.  Thus, L’Oreal has been around since 1909, while Estee Lauder has been in existence since 1946. Of course, when taken literally this is generally not a valid assumption; nothing is "forever". But it is normally valid to assume that a business will be around for the next 20 years. Any projected cash flows after that timespan have a fairly low present value, so the assumption of a perpetuity makes sense.

Will Ms. Jenner’s personal brand persist for the next 20 years? It is difficult to say, given the vagaries of celebrity culture. To give some context, here are the highest earning celebrities from 1998: http://www.wemakethefunny.com/?p=2116

If we assume that Ms. Jenner’s remaining shelf life is 5 years, the present value of her cash flows falls to $347M; even a 10-year forecast gives a valuation of $585M.

There are obviously a lot of assumptions in the above table, and in many ways that is precisely the point.

The more basic problem with Forbes’ analysis, however, is simply the question of what exactly one would be buying if one purchased Ms. Jenner’s company. It owns no physical assets, it doesn’t really have much of a labour force, and it does not seem to own much IP. Its ability to generate cash flows is tied solely to Ms. Jenner’s personal fan base. In theory, Ms. Jenner could sign some sort of contract to guarantee continual promotion of the company, which might tie her compensation to the continued success of her brands. But that is a far cry from being able to liquidate her company, right now, for $1B.