Wednesday, June 24, 2009

The DOOMsday Scenario

As the Cubs sale more and more resembles an episode of 90210, with fewer bikinis, an underlying issue with the process seems to be overlooked.

While there are more potential buyers today than there were a few months ago, the purchase price of the team appears to be falling. Over at (POP!), CCD and gaius marius have discussed this issue on a cursory basis. They note, correctly, that there is no impetus for either the Ricketts Family or Marc Utay to do a fast close as the purchase price for the Cubs that Sam Zell can command continues to drop given the credit markets and the Tribune’s financial distress. Both parties could theoretically wait out Zell and grave dance on him until they get the Cubs for a (relatively) bargain price.

This makes a lot of sense until you remember that there is a group of people outside the Tribune who have a vested interest in seeing the Cubs sold for the highest possible amount. Who are these people?

The 29 owners of every other major league baseball franchise.

Each individual franchise is valued relative to the value of every other franchise. If one franchise sells for X, then every other franchise can determine their value by applying the same metrics to their franchise.

Having the Cubs' "X" equal $1,200,000,000.00 would have been a nice "X" from which each franchise could base their current value.

If the Cubs selling price is falling, as CCD and gaius and other people think, then 29 other owners are seeing the enterprise value of their investment shriveling away all because Sam Zell can't close on a deal.

Fortunately for them, there is another potential buyer of the Chicago Cubs.

Major League Baseball, Inc. and the 29 owners with enterprise values at risk.

Far fetched? Yes. Unprecedented? Hardly.

The story of the Montreal Expos is a precedent for the league owning a franchise. Granted, the background of why the league bought the Expos and why they could buy the Cubs are completely dissimilar. But there is a certain logic for the league coming to the rescue of the Cubs and the Tribune.

The league clearly does not want a replay of the Phoenix Coyote situation on their hands. They want the bankruptcy court to stay as far away from the Chicago Cubs as possible. Why?

Suppose the sale process continues to drag. The Tribune nears the date of needing to make a principal payment on their $12 billion in debt and they are short on the cash. Could a bankruptcy court force a fast sale of the Cubs for a below-normal market cost to help generate the cash? What if the buyer chosen by the court was unacceptable to the other owners?

The 29 other owners could step in and buy the Cubs themselves and hold the franchise until the economy turns and values stabilize. Further, they could buy at a price above the current offers from Ricketts/Utay and provide the Tribune with the cash they need. It would be very hard for a court to reject such a scenario as Tribune creditors would be clamoring for the cash.

Could the clubs swing such a transaction? Perhaps. Assuming the clubs could get the $350 million in bank financing that the Ricketts secured, a purchase price of $785,000,000 would require an equity contribution of $15,000,000 per team. If the Cubs were held for 2 years and then flipped to a Ricketts type group for the original agreed upon price of $900 million, each club would generate an IRR of 12.4% on their $15 million investment (not adjusted for interest expense, fees, etc.). Not only that, but they would defend the value of a cornerstone franchise of the league. In doing so, they defend the values of their own franchises.

Now, is this as a likely scenario? No. But the probability of this occurring is certainly greater than 0%.

And can you imagine how the Cubs could be run with a front office like that that ran the Expos from 2002 to 2006? Clearly, this is a doomsday scenario.

But watching something like this play out would be a lot more entertaining to watch than a Kevin Gregg ninth inning.

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