Professional sports are the definition of feast or famine. While some athletes like the Lebron James and Peyton Manning's of the world routinely bring home salaries between $50-100 mm per year, most pro athletes barely bring home more than $300k the few years that they do play; which generally vary between 1 and 5 years. In this sense Fantex's decision to securitize cash flows for professional athletes shouldn't come as much of a surprise. Athletes now have a mechanism to both hedge against injury and to be provided risk capital to immediately serve the needs of their families before displaying on-field production (many athletes come from situations of poverty). In the eyes of Fantex, this is an excellent opportunity for the general public (not merely owners and agents) to gain access to these remarkable cashflows and make bets on something they can understand, (1) the CF derived from a players on field performance (ie contract) and (2) the marketability of the athlete (ie endorsement deals). This is in stark contrast to corporate securitizations which are subject to complex accounting rules, capital structures, and growth opportunities. Ultimately, however, no one except for the most novice investor buys a security merely to tell others that they own it (Facebook anyone?). Fantex's first securitization is the $10 mm / 200,000 share (ie $50 a share) IPO of Houston Texans RB Arian Foster. The share promises a yearly return (adjusted for % ownership) akin to 20% of Foster's cashflow.
How profitable is the recent securitization of Arian Foster's cashflows? In order to answer this question I built a full scale financial model to forecast CF and provide reasonable projections of the equity value.
Anyone who knows anything about finance understands that the theoretical value of a share is the present value of all future cashflows. FUTURE, is particularly important here as Foster's likely balloon salary payment to avoid the "Cap Hit" sustained by the organization has largely already been exhausted. As such the model projects Foster's production into the future using a general comparable case and the average decline of an NFL running back. Here it is:
All cells highlighted in yellow a assumptions provided by the user. In this case I assume or use current values of the following:
(1) Depreciation = the average yearly depreciation in endorsements offered to the athlete as a function of his aging and inability to produce on the field. I assumed that starting at age 30 (the historical average point of dramatic decline in NFL RB production), Foster's endorsements would decline by 25% a year until reaching a value of 0. I assumed endorsements would lag his actual retirement by a year as his retirement is unlikely to be pre-planned. That being said, Foster is no MJ or Kobe so its unlikely he will continue to receive endorsements far past his prime.
(2) Balloon Endorsement = the unexpected increase in an athletes endorsements as a function of popularity and/or production up through his theoretical decline (30). Though Foster is currently receiving ~$1.75 mm from current endorsements, its possible that he could obtained additional endorsements over the next 3 years of his prime. This value is the yearly estimation of additional endorsements over the present year (so in this case $1.75 mm + $ 2 mm).
(3) Tax Rate. Pretty standard, the tax rate charged on Foster's CF. In reality this is probably quite complex.... but in this case its better to give a relatively high estimation (aka fnce 100).
(4) Contract Salary. This is the most difficult projection to make, and once evaluated in context of the model the most important aspect of Foster's expected equity value. While Foster has an agreed upon 5 year ~$43.5 mm deal, the Texans have discretion on how to allocate the cashflows in order to benefit their own financial situation. http://www.spotrac.com/nfl/houston-texans/arian-foster/
provides a decent breakdown of how the Texans will likely excise Foster's contract. This has to do with the teams desire to stay under the luxury tax when possible and take the penalty in certain years when the mentality is "win now" as opposed to the Oakland A's moneyball. The current year is considered a "cap hit" year with Foster's salary ballooning to $13.25 mm. Unfortunately for the investor, much of this salary has already been paid off as the season is nearly half over (I assumed 25% of the salary may not be paid off by the time of the IPO). Next year is assumed to be another balloon payment at $7.5 mm. This is VERY IMPORTANT because the issuers of the IPO note that Foster's average salary remaining on his contract is ~ $4mm a year.... which would be true if you didnt deduct for recent payments.
(5) Endorsements. Similar to contract salary the first year is assumed to be partially excised.... I assumed 65% remained. The next three years are a sum of the initial per year + balloon payment, the next three years are the previous year depreciating at the user defined rate (25%) until 0.
(6) Risk Free. Rate earned by investing in treasuries of the given maturities based on the current yield curve. Obviously this could change over time, but its worth noting that given dovish Fed policy, rates are likely to remain near 0 through at least the end of 2015/ mid 2016. Dramatically rising rates wont be an issue until the end of 2016.
(7) Decline = assumed decline in salary of the player after the age of decline (30). I also assumed that he would get paid with 100% certainly only the guaranteed portion of the contract (assumed at 30%). I based this number off a similar RB LT's production after age 30 and the contract offered to him by the NY Jets. I think LT is a great comparison because he is a similar workhorse back who is both active on the ball and off as a screen playmaker... as such he's on the field a large percentage of downs and plays with more finesse than the brute Brandon Jacobs type of back.
I think its worth noting that LT's dramatic decline in performance is standard across NFL running backs. Very few backs have even been able to put up the numbers LT did after turning 30... and lets just say no NYJ fan remembers Tomlinson as fondly as a Chargers fan.
Takeaways:
(1) Foster is by far and away the winner from issuing equity if we view his decline as standard course for NFL running backs. It is extremely unlikely that he will reach anywhere near the $50 mm breakeven rate necessary to justify the IPO price on a theoretical basis. Foster benefits even more in present value terms as he receives a ballon financing payment at year 0 as opposed to investors who are hoping they will receive anything 5 years down the line.
(2) Cap Hit is the largest factor in determining the dividend and consequent return on equity of the given share. While Foster may be averaging an "x" salary over the duration of his playing time, investors will receive 20% of future cashflows on an annualized basis. This means returns will vary widely based on how the team decides to exercise Foster's contract. In this case the dividend yield on a share of Arian Foster would be 14.53% in year 2, 4.59% larger than the CAGR of the S&P500 over its history (9.94%). Unfortunately as time passes, the dividend yield falls sharply as Foster's projected income depreciates. Also after receiving a balloon salary payment, Fosters remaining salary is amortized at a much lower rate meaning the yield simply cannot reach previous highs.
This leads us to the main question....
Is it worth buying stocks in pro-athletes?
IMO:
Questions still remain about liquidity and market participants. Most likely professional investors will only buy these stocks as a joke to gauge potential growth opportunities (especially at this stage). The market will likely be supersaturated with hardcore sports fans who know next to nothing about trading. The market maker (Fandex) will likely make a killing hosing newbie investors the bid/ask spread. More likely than anything the market, with only 200,000 total shares, will be as slow as they come and liquidity will be hard to come by. This will make it hard for the savvy trader to buy equity, collect the cap hit dividend yield (year 2), and exit the market without slipping on share price.
First, in the case of a deep value purchase following a terrible potentially career ending injury such as Adrian Peterson's ACL/MCL tear, Kobe Bryant's Achilles tear, or Peyton Manning's four consequent neck surgeries. In this case, an athlete could prove the critics wrong and investors could position themselves on the athletes comeback wagon. This would also work best with high profile athletes like the above as I could easily see a broker issuing 2,000,000 shares instead of 200,000 simply due to the athletes popularity. There would definitely be risk of moral hazard with an athlete like an Allen Iverson or Terrell Owens, but with someone with a lot of pride like Kobe or Peyton it could be a win-win.
Second, in the case of a talented fringe athlete needing some guaranteed money to feed his family while spending time in the D league.
From wikipedia: " Many former NBA draftees, waived players and undrafted players have played in the NBA D-League. Some of the called-up D-League players that went on to have successful NBA careers include Rafer Alston, Louis Amundson, Chris Andersen, Kelenna Azubuike, Matt Barnes, Devin Brown, Will Bynum, Matt Carroll, Eddie Gill, Stephen Graham, Jason Hart, Chuck Hayes, Anthony Johnson, Dahntay Jones, Jamario Moon, Mikki Moore, Smush Parker, Bobby Simmons, Ime Udoka, Von Wafer, C. J. Watson, and Mike Wilks.[17] Aside from these players, there are several successful NBA players who were assigned to the D-League in their first and second season, such as José Juan Barea, Brandon Bass, Andray Blatche, Avery Bradley, Aaron Brooks, Jordan Farmar, Shannon Brown, Marcin Gortat, Ramon Sessions, Jeremy Lin, Danny Greenand Martell Webster"
D league salaries are pathetic so the incentive is there for small time players. Investors would likely have to pay a very low initial investment given the probability of payoff. The risk for moral hazard would also exist in this system, but with low share volume this would be more like angel investing than anything else.
Third, in the case of high profile phenom athletes looking to hedge themselves from injury and receive a higher PV contract, and use the investment to further build brand. This is probably the least likely to occur as someone like Andrew Wiggins (who was offered a supposed $180 mm shoe deal) probably has no need to finance and its unlikely that his brand can get much higher if he actually plays well.
In conclusion, I'm intrigued by the concept but I'm also quite wary of the idea of investing money in a young person who has no idea what they are signing all to make a quick buck. May of these athletes lack financial literacy... look at the number of former pros who ended in debt. Much of this occurs because they are surrounded by greedy people who all want a piece of the pie as soon as possible. It may be too difficult for athletes to ignore the idea of "free" money now, even though it could critically hurt them over their career. Imagine if investors could have bought shares in AI at the current deal (20% of future earnings) at a notional value of even $100 mm. AI would have lost HUGE on that type of transaction from an investment standpoint. With educated athletes like Arian Foster, I give the benefit of the doubt he knew what he knew what he was getting into.
In any case, I digress.
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