When word arrived yesterday that the Ricketts family and the Tribune Co. were close to a sales agreement for the Cubs, Wrigley Field, and a 25 percent stake in Comcast SportsNet Chicago, many saw the news as the culmination of a process long overdue. After all, it had been over two years; it was about time.
But, a closer look reveals that with the sale process nearing its final stages, it’s a complex process. While the Business of Sports Network is not privy to the final details of the sale agreement details forwarded to Major League Baseball, there are enough aspects of the deals to paint a picture of how it is structured and what the future holds for the Lovable Losers once an ownership transfer is completed. Here’s how we got to where we are today.
Two Groups Enter, One Group Leaves
To add a bit of confusion to the mix today, it was reported by Reuters that Tribune has also agreed to the sale terms presented by a group led by Marc Utay, meaning that not one, but two deals have been presented to the court handling Tribune’s bankruptcy. The key is in how the two deals are structured. As reported by Reuters, that an unidentified source said, Utay’s offer is "a higher price but less cash upfront" than the Ricketts bid, which is said to be under the initial $900 million bidding price (more on that in a bit).
"I don't think it's completely over yet," said the source, who asked not to be identified because the sale process is ongoing. "By the same token, Ricketts has a real edge here."
So, why would Ricketts have “a read edge here,” as the source says? The reason is in how much debt is being carried by the two groups (less by Ricketts, more by Utay). That plays into…
The Recession Shakes Things Up
As it was widely reported, when the bidding opened up, 10 finalists were in the mix for the storied franchise with analysts predicting that the sale price would hover at, or in excess of, $1 billion. When the recession’s full weight was felt in September of last year, questions mounted as to whether that record sum would be reached, and how Tribune owner Sam Zell would want it structured.
The biggest problem that came along with the recession was gaining valuable credit needed to reach the lofty sales figure for the Cubs assets. While gaining the credit itself seems to have thawed, the more credit that is involved, the higher the interest rate, and the overall debt being carried in the deal. More debt? Less financial flexibility for player payroll. More cash flow problems. More financial strain which makes renovation to Wrigley Field more difficult.
Why Did the Ricketts Initially Offer $900 Million, but Now It’s Less?
When the Ricketts were initially selected as the exclusive bidder for the Cubs in January, the accepted offering price was $900 million. So, why has the Ricketts offer been lowered, and why is Utay back in the mix, if the Ricketts were involved in an exclusive arrangement with Tribune? The reason is that the Ricketts have pulled back $40-$50 million based upon Tribune paying below market rate on for media rights to the Tribune held outlets WGN-TV, WGN Radio, and Comcast SportsNet Chicago.
Thomas Ricketts was given a 30 day exclusive negotiating window, but that was greatly extended. When lifted, and Utay was added back into the mix, it was viewed two ways: the Ricketts pulling back made Utay’s “higher offer/more debt” look more attractive. And, adding Utay back into the mix acts as leveraging on the Ricketts. Both scenarios seem realistic, and time will tell just how far back the Ricketts offer was initially in light of the broadcast rights issue, and where it landed after Utay was added back into the mix.
How Much Will Zell Retain?
In both offers submitted to MLB and the court to review, Sam Zell will be retaining an ownership equity in a tax avoidance deal – a leveraged partnership. As reported in September of last year by the Chicago Tribune:
[Zell] wants to create what's known as a leveraged partnership between the buyer and Tribune to own the team. The partnership would borrow money to buy the team, and the proceeds from the loans would go to Tribune. The media company would retain a small stake in the partnership, less than 5 percent, giving it some exposure to the loans.
Under the terms of a leveraged partnership, only borrowed money can be distributed tax-free. Consequently, in some of these deals as much as 90 percent of the purchase price is financed with debt to maximize the cash payout, Willens said.
For the Cubs transaction, a new owner also would have another hurdle: The buyer could not start paying down debt until Jan. 1, 2018. That’s the 10th anniversary of Zell’s Tribune acquisition, in which he converted the company to an S corporation from a C corporation. In the 10 years after a conversion, an S corporation must pay taxes on asset dispositions. After 10 years, the capital-gains requirement expires.
As the report notes, the deal is technically not a “sale”
The question is, Zell retain less than 5 percent, or possibly more? By structuring the deal as such, Zell will dodge somewhere under $400 million in taxes by not making the deal a straight sale, which would involve capital-gains taxes.
Just How Much Debt Can the New Owners Carry?
Utay, and to a lesser extent, the Ricketts family, both are caught in a sandwich play between Zell’s leveraged partnership structure and baseball’s rules regarding how much debt clubs are allowed to carry.
The most current collective bargaining agreement details debt as follows using a formula based upon a club’s Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) (see pages 192-194 of the CBA – PDF). The formula involves the amount of debt against the amount of cash flow the club has. As the CBA reads:
No Club may maintain more Total Club Debt than can reasonably be supported by its EBITDA. A Club’s Total Club Debt cannot reasonably be supported by its EBITDA if Total Club Debt exceeds the product of the average of that Club’s EBITDA over the most recent two years multiplied by the Cash Flow Multiplier applicable to that Club
The CBA then continues to explain the Cash Flow Multiplier
Cash Flow Multiplier. “Cash Flow Multiplier” means the number to be multiplied by the average of a Club’s EBITDA over the most recent two years … in order to determine the maximum Total Club Debt that reasonably can be supported by that Club’s EBITDA. The Cash Flow Multiplier shall be ten (10), except that any Club which incurs (or has incurred within the last ten years) stadium-related debt to finance construction of a new ballpark or the major renovation of its existing ballpark may use a Cash Flow Multiplier of fifteen (15) for the first ten (10) fiscal years after that ballpark’s opening or re-opening
Since the Cubs are not currently involved in stadium renovation, they are not allowed to carry more than 10 times the average EBITDA over the last two years.
There is some wiggle room in the Debt Service Rule when it comes to club sales as outlined in Section 6.5 – Sales Transactions:
In all transactions involving the sale or transfer of a control interest in a Club, the Commissioner must certify to the Clubs and to the Players Association that the level of debt undertaken in connection with the acquisition or transfer will not create a persistent inability of the Club to comply with the requirements of the Debt Service Rule.
So, how much cash flow do the Cubs have? According to the September Chicago Tribune story, “Sources have pegged the Cubs’ 2007 cash flow at $31 million, which implies a debt ceiling of $465 million.” Could the Ricketts family and Utay have pulled together a staggering $400 million or more in cash? For one, the Ricketts family sold 34 million shares of TD Ameritrade Holding Corp. (NASDAQ:AMTD) stock in Feb., which was founded by Joe Ricketts, Thomas Ricketts father. Total value of the stock sale? $403 million. The reported total equity being available for the deal by the Ricketts is said to be $450 million. When factoring in Zell’s retention of some ownership equity, and the lowered offering price, the structure of the deal will have some cushion under the Debt Service ceiling.
The next steps will be for the bankruptcy court to look at both sale agreements and sign off on one or both of them. That could take 30 to 45 days. It will then be up to Zell to determine which deal to sign off on. Based upon the debt laden structure and the larger cash component, if the Ricketts deal passes the courts muster, expect that sale agreement to be finalized.
From there, it will need MLB’s approval with 75 percent of the owners voting in favor of the ownership transfer. With the 30 to 45 day approval window for the bankruptcy court, the vote by the owners would most likely occur during their next quarterly meeting set for August.
If the approval is consummated (something that seems near certain), the Cubs would at least not be rudderless in the off-season at the ownership position based upon lame duck ownership. Whether the steep price being paid for the Cubs and its associated assets will hamstring the organization in terms of free agency, time will tell.
Maury Brown is the Founder and President of the Business of Sports Network, which includes The Biz of Baseball, The Biz of Football, The Biz of Basketball and The Biz of Hockey. He is contributor to Baseball Prospectus, and is available as a freelance writer. Brown's full bio is here. He looks forward to your comments via email and can be contacted through the Business of Sports Network.
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