In the changing world of college athletics, how can we know the true financial value of a football program? Kevin Kaiser, adjunct full professor of finance at the Wharton School and senior fellow with the Harris Family Alternative Investments Program, recently joined the Athletic to help us understand how these programs generate, consume, or sometimes drain value for their universities. In this Q&A, Professor Kaiser offers insights into the distinction between price and value, the rise of trophy-asset ownership in sports, and the financial ripple effects of the House v. NCAA settlement.
You have research that values some college football programs at more than $1.6 billion and others at $0. Can you walk us through why that gap is so large?
Kevin Kaiser: It would be useful to provide a bit of context on what we are measuring. We are seeking to determine the extent to which these programs add value to the university, as measured by the cash flows they generate. This is a very different concept from what others might be interested in studying. For example, we know that other researchers have tried to develop insight into what these football programs might sell for if they were to be purchased by wealthy individuals or private equity companies.
In order to estimate the value as a measure of the present value of the expected future free cash flows generated by these programs, we relied upon historical income and investment numbers provided through various channels. The numbers we obtained were not always easily interpreted, due to the nature of the consolidation of the football program with the overall athletic program of the university, among other complications. However, we did our best to estimate the cash flow generated (or consumed) by these programs for a wide range of universities.
Based upon those cash flow forecasts, we were able to determine that some of the football programs generate cash flows exceeding $100 million annually, whereas others fail to generate positive cash flows in any of the recent years. As a result, we obtained the range you mention in the question, where we have put the lower bound at $0, even though that may be optimistic for some of these programs where the cash flow is negative each year.
How does the “trophy asset” mindset of wealthy team owners affect the valuation of sports franchises — both professional and collegiate?
Kevin Kaiser: As noted in the answer to the first question, the price someone might be willing to pay to purchase something could be very different from the value of that thing as measured by the cash flows it is expected to generate.
When anyone is considering spending money to acquire an item, we can characterize their decision according to whether the item in question is viewed as a consumption item or an investment item. When viewing an item as a consumption item, which provides ‘happiness’ to the owner through its consumption benefits (such as a home, cell phone, or piece of art for the living room), then the price the person is willing to pay is determined by the happiness and joy they expect to experience by owning and enjoying the item. On the other hand, when viewing an item as an investment item, which provides ‘happiness’ to the owner through its investment returns in the future, then the price the person is willing to pay is determined by the cash the item is expected to generate, discounted at an appropriate discount rate reflecting the riskiness of the cash flows. There are some items, such as a property or a piece of art, which can provide both consumption and investment benefits. In such cases, it can be difficult to reconcile the price someone is willing to pay with either set of benefits alone. Rather, we need to know both the expected future cash flows they might realize when viewing the investment benefits as well as the ‘happiness’ they might realize by enjoying their ownership of the item.
By using the phrase ‘trophy asset’ we are suggesting that some assets, such as ownership of a sports franchise, might provide value to the owner by serving as a visible demonstration of their ‘win’ in being able to afford and own the asset in a way similar to how a sports trophy is visible demonstration of the winning of a tournament. In this way, the purchaser is willing to pay for both the expected future cash flows the franchise might generate and the consumption benefit of owning a visible ‘trophy’ which documents their financial success and their interest and ability to own a sports franchise.
This attribute of the franchise will impact the willingness to pay, and thus the price of the asset, even though it may not reflect the ability of the asset to generate cash flow. Therefore, when we value only the future cash flow that the franchise is able to generate, we may underestimate its value to the owner and thus we underestimate the price it may fetch in sale.
What unique challenges and opportunities arise when private equity starts looking at college athletics as an investment opportunity?
Kevin Kaiser: The challenge for PE as prospective owners is that they are stewards of the capital provided by the limited partners (LPs) who invested their money in the fund and to whom they owe a fiduciary duty to manage responsibly and deliver an acceptable return for the risk they assume. As a result, the PE firm might potentially be violating their fiduciary duty to their LPs if they pay a price above the investment value, i.e., the present value of the expected cash flows to be realized through ownership of the asset.
Having said that, it is important to recall that PE owners don’t tend to hold their assets indefinitely. Rather, they typically have an investment horizon of 10 years, so it is expected that they will be selling within 5-10 years. As a result, they can honor their fiduciary duty to their LPs even if they pay a price above the investment value of the franchise if they can reasonably expect to sell the asset at an even higher price when they sell it.
Nonetheless, this still presents a challenge to the PE owner when competing against a wealthy individual who is purchasing to realize the consumption benefits of owning a trophy asset. The PE firm may be able to outbid the wealthy individual, but they must be expecting that they will be able to more effectively monetize the asset than the wealthy individual and/or be able to sell the asset in the near future (3-7 years) at a price which more than compensates for the fact that they paid a price above the investment value.
A final point to be made is that there are many sports-related investments, such as ownership of the parking lots, concessions, etc., whose consumption value is minimal and whose prices therefore will typically only reflect their investment value. For those assets, which are associated with college athletics as well as professional sports, the PE buyers will have many opportunities to purchase at a price below their investment value and earn a very respectable return on investment for their investors.
The House v. NCAA settlement is expected to reshape the economics of college sports by allowing schools to pay Division I players directly. How might this impact the way programs are valued moving into the future?
Kevin Kaiser: The short-term effect of this is to put a hole in the budgets of many programs of approximately $20.5 million, which is the maximum amount that any given university will be able to pay their D1 players in 2025-26 under the ruling, with this amount rising over the next decade.
It is anticipated that universities will reach out to donors to try to fill this hole, and in many cases they may be successful. For those schools, the impact on value will be minimal. However, it is anticipated that for many schools it will not be possible to fill this new hole in their budgets, with the result that their value will be reduced as a result of this settlement. In some cases, some university athletics programs will become consumers of cash instead of generators of cash. Those schools will face the difficult question of whether it is worthwhile to subsidize the activities of the athletic departments, including to cover payments to the student athletes, using the revenues earned from the other activities of the university.
In many of these cases, we can imagine that potential investors, including wealthy alumni and PE firms, might come forward to attempt to ‘help’ the university to monetize and support the athletics activities. Of all of the athletics activities, the most cash generative is the football program. As a result, it is expected that university football programs will become attractive to investors seeking to ‘help’ the university monetize these programs. This may open up creative opportunities for investors to tap into the cash flows generated by ticket sales, media rights, or other revenue streams. As a result, these revenue streams may also be able to benefit from some of the perks of being a ‘trophy asset’ and their prices might deviate from their cash flow values. Additionally, while potential donors may be unwilling to simply donate to the athletic department’s general budget, they may be willing to donate if they know that in so doing they are enabling the football program to recruit, and pay, a very highly sought-after player.
There are many potential impacts on the way college sports programs will be valued as a result of the House v. NCAA settlement, and it is difficult to say whether it will be positive or negative on average. Having said that, it seems to us that it is more likely to be negative on average. As to the impact on the value for any given school, that is much less clear and for some schools it may well be positive while for others it will no doubt be negative.
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