Corporate Reorganization and Finances

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T CONCEPTS INTO ACTION

he recent (2017) acquisition of some Fox sport entities by Disney is an example in which economies of scale may be achieved through a merger. Disney and Fox revealed details about the $52.4 billion merger agreement in a massive 455-

page filing with the Securities and Exchange Commission in 2018. Under the agreement, which is expected to close in late 2019, if approved by regulators, Disney would acquire the Twentieth Century Fox film and TV studios, cable networks such as FX Networks and Fox Sports Regional Networks. Not included in the deal would be other Fox networks such as FS1 and FS2. Fox Sports Regional Networks (often referred to as FSN) had numerous rights contracts throughout the United States involving a number of Major League Baseball, NBA, and National Hockey League teams and owned a larger percentage of the YES network—which broadcasts New York Yankees and Brooklyn Nets games. FSN actually was a combination of previously independent sports channels that were compiled into a network. Some original networks that went into forming FSN include SportsChannel Florida, SportsChannel Ohio, Prime Sports Midwest, Prime Sports Southwest, Prime Ticket, and Sport South. It is a perfect example of an entity building a strong network through acquisitions and then being acquired itself.

Another credible justification for a merger in the sport industry is the prospect that a company can save on costs not related to economies of scale. For example, Cablevision, the New York–based broadcasting company, had paid over $40 million annually for the local television broadcast rights of the New York Yankees. The 12-year, $486 million broadcasting deal between the Yankees and Cablevision ended in 2000. In the fall of 1998, Cablevision made a reported bid of $525 million to purchase 70% of the Yankees (King & Brockington, 1998). Part of the rationale for the acquisition was that it would allow Cablevision to save $40 million per year. Instead of paying local broadcast fees to the Yankees annually, Cablevision wanted to purchase part ownership of the team and use the ownership rights to reduce or eliminate the broadcasting payments. Cablevision would have owned both the television outlet and the team. Ultimately, the two sides were unable to agree on some details regarding the acquisition, such as team control, and the deal was abandoned. Ironically, the New York Yankees then decided to begin their own regional sports network, the YES Network. So Cablevision was not only unable to acquire ownership interest in the Yankees but also lost the television rights to broadcast Yankees games.

A merger or acquisition is also a wise financial endeavor if the merged entity can generate revenues that are not possible if the firms remain separate. Two firms may have complementary resources or products that when combined will result in substantial revenues. As a consequence of the merger, the combined company may have a very successful future. For example, the merger of IMG and ISP Sports Marketing that was mentioned earlier has allowed IMG to be involved at a much greater level in collegiate marketing and sponsorship sales. Although IMG had a small interest in these activities before the deal, it became the largest player in collegiate sport marketing.

A corporate acquisition may also be a wise maneuver if a business believes that the targeted company is poorly managed. A business may view the other company as underperforming because of poor management and believe that it can transform the targeted company into a financially successful business. The business believes that, through acquisition, it can improve its own value by instituting more effective management in the underperforming company.

Last, a merger can be the most effective way to invest surplus funds. As mentioned earlier, a successful business with a substantial amount of net income has several options. It can distribute the income to shareholders by increasing dividend payments, or it may repurchase its stock. A third option is for the business to invest its surplus cash by purchasing the stock of other companies. Often, businesses with surplus cash and a lack of good alternative investment choices redirect their capital toward purchasing other companies. The strategy may be wise in that a business that fails to redirect its cash may itself become a target for takeover. Businesses with significant excess cash face the possibility of acquisition because other companies may believe that they can acquire the business and redirect the cash in a profitable manner.

When examining merger and acquisition options, the two interested companies can just decide to fold themselves together. To reduce expenses, some employees in redundant areas might be terminated. For example, if both companies have large accounts receivable departments, then the merged company might lay off some of the people in the new department to become more efficient and save money—one of the key drivers for any merger. Another approach when acquiring a company is to purchase all the stocks so the purchaser becomes the owner. This might seem like a good idea, but if the acquired company has any potential legal liability, then the acquiring company will be responsible for any such payments. To avoid this potential liability concern, some acquiring companies will just purchase the assets of the company they want to acquire.

Just as there are numerous strategies to grow, there is an equally large number of strategies that might need to be explored to reduce costs if they reach a critical level.

CONTRACTION Contraction refers to the process of either shutting down (possibly closing a division) or closing the entire company a business or business unit. Sports organizations sometime face significant financial issues and cannot solve them. That is what happened to The Sports Authority, and the company had to file for bankruptcy protection. Strategy comes into play when a sports organization starts facing pressure from various sources such as competition, government entities, changes in laws, or changes in markets. It could be as simple as a fad. For example, some readers of this text might remember when inline skating was popular in the late 1990s and the turn of the century, but that seems to have been a fad. According to the Sporting Goods Manufacturing Association, there were 22 million people in 2000 who went inline skating at least once that year. By 2010 that number had declined more than 64%. Such a quick rise and subsequent fall is a classic example of a fad. Similarly, trampoline parks were popular through the 1960s, and then they were basically sued out of existence. More recently, trampoline parks have popped up again, but the number of injuries and resulting suits might once again jeopardize this industry segment.

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NASCAR was facing issues with a decline in viewership and sponsors. In 2017, multiple teams moved to reduce costs by hiring younger drivers or renegotiated contracts with veteran drivers. Changing drivers or contract terms was one of the first steps at shedding costs as a driver could represent one-third of the annual budget for a team (Stern, 2017). It used to be that star drivers were the primary focus for sponsors, but sponsors are focused now more on return on investment. Top driver salaries can range from $5 to $10 million a year compared with junior drivers who might be closer to $500,000. A base salary is complemented by a portion of race winnings and a portion of sponsorship dollars. With some sponsors leaving the field or reducing their sponsorship amounts, teams are now fighting for the sponsorship crumbs (Stern, 2017).

While financial planning has previously been discussed, such efforts normally focus on trying to achieve a positive result such as launching a new business unit or trying to increase sales. Sometimes planning has to focus on another goal—avoiding going out of business. Such a scenario requires different analysis and strategies. When exploring possible financial hardships, a sport business has several options. The organization can reduce salaries, delay paying some bills, ask for additional funds from lenders, slow production, sell a business unit, sell some assets, or sell the business. Most organizations attempt one approach and see if it makes any difference. Then it can explore other efforts or a combination of efforts. Sometimes the efforts will work and the organization can get back on its feet. At other times, all these efforts to stay alive might not work. If efforts do not work in reducing expenses, an organization might need to liquidate or file for bankruptcy (or be pushed into bankruptcy). Even nonprofit organizations can face bankruptcy protection when their assets are not enough to cover debts. That is why it is so important to identify signs of trouble and then to act quickly to prevent further harm.

Red Flags Before deciding to terminate operations, a business needs to know when it is in trouble. Most businesses cannot just decide to close their doors; they usually have financial obligations such as accounts payable, long-term labor contracts, long-term lease obligations, repayment to equity investors, and debts. The decision to close is neither an easy one, nor is it made without significant managerial forethought. Most executives take pride in their managerial skills and would not want to be remembered as the person who lost a business.

Fortunately, a number of indicators can help signal financial trouble and provide adequate warning to an executive. For example, if orders start declining significantly, a business can examine the reasons and take corrective action to avoid losing market share. If a new competitor comes into the market with a more advanced and cheaper product, then the business needs to adjust to stay competitive. Key factors associated with business failures include economic weakness, industry downturns, poor location, too much debt, too little capital, and countless others. These concerns can lead to temporary cash flow problems that can often be worked out. Sometimes, however, the concerns indicate a permanent problem.

One sign of trouble is a lender’s request for early repayment of a loan. A bank or other lender may call the loan under certain conditions; the primary reason is poor financial performance. If a sport business has been losing money steadily for several years, banks may feel uncomfortable with their loans and demand immediate repayment. The following are other conditions under which a bank might call a loan or not renew a line of credit (Broni, 1999):

Loan covenants have been repeatedly violated. The bank is losing money on the relationship. New bank managers favor a different loan mix or institute new policies. The bank does not understand or is uncomfortable with the industry segment. The bank’s credit exposure in the industry segment is too great. A loan guarantor’s financial condition has deteriorated. The bank has lost faith in the business’ management team.

If a bank or lending institution pulls the plug, the business needs to establish a policy to deal with the lost cash. The first step is often to negotiate a short-term extension to try to resolve any problems or secure new funding. If the business is on strong financial ground, approaching another bank might be easy. If a problem caused the bank to call the loan or pull the funds, asking the bank what the problem was might be worthwhile. If the problem is one that can be fixed, such as untimely reporting, then the business owner can explain this to another potential lender and take measures to correct the problem.

If the business has assets, the assets could help secure needed funds. Asset-based loans, as the name implies, can be obtained on the basis of the existing inventory or accounts receivable. If the business owns a valuable asset such as buildings or land, these could be pledged as collateral to secure more funds. If these options are not available, the business might need to approach a commercial finance company that specializes in unbankable loans. Because these loans are riskier, they entail a higher interest rate. The business may also need to report earnings frequently to keep the lender abreast of financial conditions. After the business can show sustained success and compliance with loan terms for one to two years, the owner can usually apply again for conventional bank loans.

Losing a bank loan is just one sign that a business is in trouble. A business that cannot pull itself through the hard financial times may have to resort to informal or formal attempts to satisfy debt holders. Debt holders can be satisfied through informal reorganization or liquidation, bankruptcy, removal of assets, or selling the business.

Informal Reorganization Informal reorganization allows a business to recover and reestablish itself after facing a temporary financial crisis. These voluntary plans, in which all parties try to come to an agreement, are often called workouts. Workouts are successful only if the debtor is a good moral risk, if the debtor can show the ability to recover, and if the general business conditions are favorable for recovery (Brigham & Gapenski, 1994).

The informal reorganization process comprises extensions and composition. Extensions allow additional time for repaying a debt. If a debt is owed and due in one year, an extension could be worked out for the borrower to repay the debt in two years instead. Composition is the process

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A

of asking to repay a lower amount. A debt holder would rather receive $900 from the company versus only $500 in bankruptcy proceedings from a $1,000 debt. Most often a workout involves a combination of these two methods.

CONCEPTS INTO PRACTICE ssume that Under Armour (UA) owes several lenders $10 million. The company might be able to develop a workout in which it pays 25% of the debt immediately and 20% a year for the next three years. Thus, in four years, UA will have

repaid 85% of the original debt, and the debt will be discharged. Although lenders might not receive the entire amount they are owed, most lenders would be happy to recover 85% of the original loaned amount versus possibly nothing, or a much smaller amount, if the borrower goes bankrupt.

Not all banks are willing to engage in workouts, but most understand the value of negotiating the best deal they can to receive the largest possible share of their initial loan. The lenders might demand interest payments during the payback period to help cover the extension and might also demand additional security, such as personal pledges or asset-backed pledges.

Informal Liquidation Informal liquidation is effective if the company can turn around, but some companies cannot fix their problems. If the company’s debt is larger than its net worth, the company will probably need to go through bankruptcy protection (discussed later). But if the company has more assets than debt, it is “worth more dead than alive.” Assignment is the term used for the informal liquidation process. Lenders normally obtain a greater return through assignment than through bankruptcy. For that reason, lenders should focus on encouraging informal reorganization or liquidation rather than trying to force a company into bankruptcy.

Banks and other lenders are not the only options available when times become rough. When financial concerns arise, a business can sometimes look inside itself to find an answer. One such answer lies in liquidating assets such as stocks. If no such assets exist, the business might have to sell other assets such as property.

Removal of Business Assets A business owner might decide to condense a business by removing assets. Selling assets can reduce business costs or raise cash. Such transactions are often highlighted on annual reports as a footnote indicating a one-time write-off. Otherwise, the transactions would appear to boost the company’s income when there is no likelihood of ever generating those levels of funds again. Selling assets, or downsizing, occurs frequently. The Boston Celtics once owned their own television and radio stations but sold them because those assets did not fit into the team’s business plans.

Owners can use several techniques to downsize a business and remove assets so that the new business will be smaller. The primary reason that a company would want to downsize is reduced expenses, which will hopefully generate future higher profits. Instead of closing the business, a business owner might wish to downsize and hope that at a later date it could grow again. The first technique is taking out profits as dividends. Owners can also pay themselves more, sell assets, give bonuses, or effect other strategies to right the ship. All these efforts, though, can take a toll on a business owner, and they might decide to exit the game by selling their business.

SELLING A BUSINESS Any business goes through ups and downs, but owners are sometimes not willing to accept the stress associated with such cyclical patterns. Business owners may decide to sell their businesses for a number of reasons, including the following: