Harsh Goenka, RPG Group

July 30, 2010 - PRLog -- “Price is what you pay, value is what you get,” wrote the fabled investor Warren Buffett, popularly known as Oracle of Omaha, in his annual letter to his shareholders some years ago. Buffett’s statement holds true for commercial transactions of any kind and when applied to the current state of affairs of the Indian Premier League it takes on an ominous resonance.  

The foundations of the current mess don’t lie in the inflated egos, wild allegations and counter allegations of financial misconduct alone. That would be an oversimplification of matters. An important question that needs to be asked at this juncture is whether IPL has dug itself into a hole thanks to a greed- driven, bloated financial estimation of itself, or what as some in the world of business would term as valuations based on irrational exuberance. Would IPL have been spared the blushes if the financial stakes during the second round of franchise auctions had not been raised to the levels of around $370 million? Would a relatively poorer, yet cleaner IPL model have helped long-term sustainability and profitability? Several teams in IPL seem to have nebulous ownership structures. Are some of the owners with less-than-squeaky-clean antecedents in the game to ride the shortterm valuation gravy train? IPL raises several uncomfortable questions, and it’s absolutely vital for all stakeholders, including investors and the paying public, to have greater clarity and understanding of its finances.  

At the best of times, putting a price tag on even the most conventional businesses and brands is fraught with risks, which is perhaps the reason why investment bankers and consultants are paid the kind of money they are! In the business of sports, that task becomes trickier given the fact that there are so many more intangibles. When the likes of Mukesh Ambani and Vijay Mallya forked out in excess of $111 million (Rs 500 crore) for the Mumbai and Bangalore teams, respectively, what were they getting in return? At the time, IPL was an untested model. Franchisees were essentially buying the branding and participation licences for teams based in their city, with a promise of profitability sometime in the future.  

To put things in perspective, in 2006, Randy Lerner, an American businessman who owns the NFL team Cleveland Browns, purchased Aston Villa, the fourth most successful club in English football with a 135-year history, for $115 million—or roughly the same amount his Indian counterparts spent in IPL. Lerner’s acquisition bought him a readymade fan base (Aston Villa is the biggest club in English midlands), an established tradition and tangible assets that included nearly $50 million worth of real estate in Birmingham.  

Intrigued by the plethora of franchise valuations figures thrown at us every day, I did some detailed workings with data collated from various sources I consider reliable. The biggest component of revenue for the teams is the income from TV Rights, which on an average began at around Rs 31 crore per team in Year 1 and will fall for next three years to a low of Rs 19 crore due to induction of two more teams and variable sharing rates. Theatrical rights and internet rights are expected to earn about Rs 3 crore, respectively, with an upside potential. Central Sponsorship is a key ingredient that will bring in Rs 12 crore every year for the first five years and will double for the next five years. Added to these are inflows like advertisements between overs, ground sponsorships, aftermatch parties and even the share of the blimp ad revenues.  

That is not the end of the story. There are attractive earnings at the local level comprising team and shirt sponsorship, gate receipts, boundary ads and merchandise sale that will together rake in about Rs 50 crore to start with and will overtake Central revenues by the third or fourth year.

An interesting aspect of costs in the IPL is that you have a fairly well known and predictable cost structure. This feature by itself mitigates risk to a high degree, barring national and global risks, which is a factor applicable to virtually any business. Franchisee fee is the major component of cost at around average of Rs 36 crore per annum. The cap on player salaries ensures that player costs remain within a range of Rs 30 crore to Rs 60 crore over the ten year period. The only other area of significant cost is media promotions.

It is relevant to mention that I have still not factored trading of players which is presently a nascent activity, and can be considered a bonus in future. Nevertheless, what we are about to see is an incredible set of numbers that will make it amply clear why there are so many interested people scouting around for even a small fraction of IPL share! Neither should the government be unhappy, the tax revenues are growing too. The important part of the profit numbers is in its stability and its sustainability and not just the quantum. ( See Table 4)  

There are not too many methodologies you can apply in valuing this business given the high upside potential. Hence I did not consider using any of the multiple based methods.Instead, the tried-and-tested DCF (discounted cash flow) valuation I felt was clearly the right way to put a number to this extravaganza. To make the valuation as comprehensive as possible,a ten-year net cash flow was used. The terminal value, a critical component, was determined assuming a terminal growth rate of 5% and weighted average cost of capital of 15% and 12%. The result did not leave me too surprised and throws up a few insights into the values that lie beyond the numbers. The financial valuation range based on these lies somewhere between $83 million and $133 million (Rs 370 crore and Rs 600 crore), a far cry from the $370 million (Rs 1,665 crore) bid the Pune team finally attracted. However, I do have use with this number. It can be argued that there is significant value appreciation to the parent’s brand. But whichever way you look at it, apart from UB group no other corporate owner is extracting significant branding. Reliance is not the face of Mumbai Indians. Anyway, to advertise you don’t need to own the team—you can instead buy the space. What then is the real value proposition? I can see only the “Ego Quotient” remaining to be valued. Let me attempt to value it. If I subtract $133 million, the peak DCF value, from the recent $370 bid, it leaves a balance of $237 million. Discount this over a ten-year period and you get $132 million (about Rs 600 crore) . What does this 600 crore represent? I could break this up as

Obviously there is a cost to it. Based on present assumptions, the Kochi and Pune teams will break even in the 11th year. If a pure financial investor was to buy the Kings XI Punjab Team, he should be paying about $133 million (Rs 600 crore). If some of the clever and cash-rich Indian entrepreneurs are looking at sports as an investment opportunity, they’d do well to take a look at Liverpool Football Club that’s been put on the block by its American owners. If they could double the money Pune’s new owners shelled out, they could be the proud owners of 100 years of unadulterated football history and tradition, a truly global brand and fanbase, and the ability to rub shoulders with the richest men from Russia to Hong Kong to the Middle East. As the dotcom bust has shown us in the past, a manic obsession with valuation is dangerous. IPL is an innovation that deserves every bit of the applause it’s getting from the people of India. It is indeed a product of New India. But greed, and short-term profit motives are hazardous in any business. And cricket is no exception.

(The writer is the chairman, Mr. Harsh Goenka
RPG Group)