In the previous couple of articles, we have already seen what securitization is and how it is used in the context of sports. We also know that there are various types of securitizations that take place in the sporting industry and that the popularity of securitization has increased over the years.
It must be understood that the increasing popularity of securitization is not without any reason. This method of raising funds offers several advantages to the sporting franchises as compared to other methods. This is why it is being widely adopted by the sporting community.
In this article, we will have a look at some of the main advantages that are offered by securitization.
- No Dilution of Control: The first and the most important aspect that differentiates securitization from other modes of financing available to a sporting franchise is that securitization does not lead to a loss of control for the management. This is not the case with other financing methods.
For instance, if a sporting franchise sells an equity stake in order to raise more funds, then there is a chance of loss of control. Also, if a sporting franchise raises debt, then the bank or financial institution imposes some covenants that impose restrictions on the management. There are some restrictions imposed by securitization as well. However, they are very less as compared to other means of financing. As a result, there are many franchises that prefer raising money using securitization.
- Lower Cost of Capital: Securitization appears to be the best option available to sporting franchises with regard to raising long-term debt as well. The sale of equity is easily the most expensive way to raise capital.
On the other hand, the sale of debt can also be quite expensive for sporting franchises since they are known to have unpredictable cash flows and hence are perceived to be quite risky. This is not the case as far as securitization is concerned.
Securitization provides finance to the special purpose company which has been created from the main sporting franchise. This special purpose vehicle is supposed to have predictable cash flows and hence lower chances of bankruptcy. This structure lowers the risk for investors who are then willing to buy debt for a lower cost of capital.
- Tranching: The cost of capital related to the funds received from securitization can be further lowered with the use of credit enhancement techniques such as tranching. Tranching allows the risk of default to be lowered. This is because the risk of default is first absorbed by lower tranches. Only after a certain level of default loss has been reached do the losses spread to higher tranches.
It is common for sporting franchises to hold on to the lower tranches themselves and sell the low-risk higher tranches to investors. Since the threat of default is further reduced, it is possible to raise finance at very attractive interest rates using this technique.
- Wider Range of Investors: Sporting franchises are able to raise funds from a very limited pool of investors if they follow traditional means. Hence, sporting franchises do not have much bargaining power since they do not have too many options.
However, when securitization is used, the sporting franchise is able to access a much wider range of potential investors. Also, they do not need to raise funds from one or a few investors. Theoretically, they can sell their debt on the bond market and can raise funds from a multitude of investors. This increases the bargaining power of the franchise and also helps maintain a lower cost of capital.
- Surplus Cash Retained: The process of securitization is generally set up in such a way that the investors only have rights over a certain amount of cash. For instance, a certain dollar value is assigned to the expected gate receivables or digital rights contracts.
For some reason, if the amount falls short, the franchise generally has to make good the loss. Conversely, if the gate receivables are higher than expected or more revenue has been generated from the sale of digital rights, then the sporting franchise is also entitled to these excess funds.
- Residual Value Retained: Also, the securitization contracts are for a certain period of time. Ideally, the intangible assets should get completely amortized during that time.
However, if that is not the case and there is some residual value present in the asset, then such residual value belongs to the sporting franchise which has the right to once again take possession of the asset and realize this value.
- Portfolio Diversification: Last but not least, the sporting industry is not heavily correlated with other industries.
The amount of money flowing into the entertainment industry generally doesn’t correlate with other industries such as manufacturing or information technology. Hence, the addition of securitized debt to the balance sheet of such investors helps them diversify their portfolios and increase their overall returns.
As a result, it can be said that securitization is one of the cheapest and most convenient modes of financing available to sporting franchises. As a result, the popularity of this financing approach has been skyrocketing. However, there are some disadvantages to this method as well which will be discussed in the next article.
