Valuation of a Sports Franchise: Market Approach

In the previous articles, we have already come across a couple of methods used for the valuation of a sports franchise. However, we know that both of those methods have certain shortcomings which make them unsuitable for the valuation of a sports franchise.

In this article, we will discuss a third approach called the market approach. The market approach is the most widely used approach when it comes to the valuation of sports franchises. The details of the market approach as well as the pros and cons of this approach have been discussed below:

What is the Market Approach?

The market approach towards the valuation of a sports franchise means that the value of the franchise will be derived based on arms-length, third-party sales, or transaction data regarding the various assets owned by the franchise. This means that the value of the franchise will be calculated as the sum of its parts.

Instead, of valuing the entire sporting franchise as one unit, the market approach advocates breaking down the assets and liabilities of the franchise into its component parts such as player contracts, brand value, stadium leases, etc.

The logic behind this approach is that the valuation of the franchise as a whole is quite difficult. However, it is possible and even convenient to accurately estimate the sum of the parts that create the franchise. Hence, the value of each part can be found out and it can later be summed up in order to derive the valuation of the franchise.

For example, the financial value of any team is largely influenced by the players who play for the team. Now, even though transactions regarding the sale and purchase of sporting franchises do not take place every day, it is common for players to be transferred across teams.

Hence, the market value of an individual player can be found by obtaining such data and then using mathematical analysis. It is common for the analysis to include the price of a rookie player and then make adjustments for experience, fan following, and brand value.

Similarly, it is possible to estimate the financial value that each and every player brings to the overall team by making adjustments on top of an already determined base value.

The fundamental premise is that it is easier to derive the market value of the component parts and then sum it up. Let’s have a look at some of the pros and cons of this approach.

Benefits of Market Approach

The benefits of using the market approach for the valuation of a sporting franchise are as follows:

1. High Degree of Accuracy: First and foremost, it needs to be mentioned that the market approach is the most accurate approach when it comes to deriving the valuation of sports franchises. This is because the biggest problem with the valuation of sporting franchises is the lack of available data. This is because sporting franchises do not publish their information publicly.

   Also, it is not common for sporting franchises to be sold and bought regularly. However, when it comes to players or the contracts signed by franchises, there is an abundance of data available. It is possible to use this data as a marker for the overall valuation of the firm. This is the reason why the market-based valuation approach is the one that is followed by franchises around the world.

2. Cash Flows as Well as Assets are Considered: The shortcoming of the income approach is that the value of fixed assets is not considered. On the other hand, the shortcoming of the replacement cost approach is that the cash flows are not considered.

   In the case of the market approach, both cash flows as well as the valuation of assets are considered. It can be viewed as a hybrid method that uses either a cash flow based or replacement cost-based approach to derive the market value of individual assets which are then combined.

3. Relative Value is Considered: The valuation parameters in the sporting industry are generally different as compared to the other industries. This is because investors buy sporting franchises for non-financial reasons as well. This makes the data from other industries incomparable to the sporting industry.

   However, when it comes to a market-based approach, the data from the sporting industry itself is used for valuation. Hence, this data can be considered to be more accurate and reflects the relative valuation based on the norms of the sporting industry.

Disadvantages of Market Approach

The disadvantages of using the market-based approach are as follows:

1. Mathematical Complexity: First and foremost, the data available regarding individual assets is quite muddled up and has a lot of influencing factors. This data needs to be broken up in such a way that the financial factors can be segregated into a baseline rate which is then adjusted to come up with a financial value. This is possible after complex calculations which are not easy to understand.

2. Valuation of Individual Assets: Last but not least, the market-based approach considers the sporting franchise to be a collection of assets and not a portfolio of assets.

   We already know from portfolio theory that a simple mathematical sum cannot be used to determine the financial value of assets. Correlation as well as other factors also need to be taken into account which is not done in such cases.

The fact of the matter is that the market-based approach is the best mechanism when it comes to the valuation of a sports franchise.