Monday, February 23, 2015

Barclays Center profit some 63% behind expectations; key debt service statistic drops 43%

Projected income/expenses, Official Statement, December 2009
The Barclays Center's gotten much notice for its awards and its high rank nationally in tickets sold and concert revenues.

That has not translated to profit.

In fact, the arena--according to the most recent 12-month report--is about 63% behind its profit goals, reaping just $17.5 million (after expenses and bond payments) in the year ending June 2014.

Its debt service coverage ratio--the net revenue available to pay back the construction bonds--was originally judged by ratings agency Moody's at a comfortable 2.85.

It's now at 1.61--a 43% drop.

No wonder Forest City Ratner CEO MaryAnne Gilmartin told the Commercial Observer recently:
Of course, it’s not yet stabilized financially. If you were to look at the numbers and research it, you would learn it’s still a work in progress. It takes awhile to get an asset like that to its stabilized, operating income.
From Official Statement; see debt service coverage ratio
Sure, but the "work in progress" lags well behind projections, which casts doubt on Forest City's pledge to stabilize net operating income by 2016. And it surely has raised questions among those considering buying the arena company. (The arena is technically owned by the state.)

Falling short

As the Wall Street Journal pointed out 2/12/15, "the aggressive investment in top-name artists, along with the learning curve of a new building, means that expenses for operating the arena are more than $12 million above original projections, while revenue is lagging."

No wonder Forest City Ratner/Forest City Enterprises is selling its 55% share of the Barclays Center operating company. (Russian billionaire Mikhail Prokhorov, who's selling his 80% of the Nets, is also likely to sell the 45% of the arena he owns.)

Yes, the main driver of the sale is Forest City Enterprises's plan to convert to a real estate investment trust (REIT).

However, Forest City is selling while the arena's buzz--major awards, high-profile events--obscures the poor financial performance, one that significantly trails the projections to bondholders and in media interviews.

Previous predictions

The December 2009 Official Statement (excerpted top right) for the Barclays Center bonds predicted net income of $47.2 million by the second year, with steady increases.

That was over-optimistic, since, 16 months later, then-CEO Bruce Ratner dialed back the projections. A 5/1/11 Real Deal profile quoted Ratner:
He estimated the arena will generate annual net income of about $110 million to $120 million, cost $30 million to operate, and require about $45 million to $50 million a year to pay off financing, leaving the company with about $35 million a year in profit...
(Emphases added)

That didn't quite make sense. The arena has cost far more to operate--which Ratner arguably didn't know--but also required additional financing costs that would cut into and seemingly eliminate Forest City's profit.

New document shows shortfall

Now, as noted in the 2/12/15 Wall Street Journal, "For the year ending June [2014], Barclays Center earned $17.5 million in income after debt-service payments, according to company filings, compared with projections of about $48 million."

The $48 million projection comes from the bond document at top, while the other figures come from a Barclays Center Financials document recently circulated to arena bondholders, which I've posted at bottom and excerpted here.

It is far more granular than Forest City's quarterly corporate filings.

From December 2014 report
As shown in the graphic at right, the 2013-14 net operating income (NOI)--revenues minus expenses--was $46 million, as opposed to $78.7 million projected in the bond document above left.

Then came $28.5 million in payments in lieu of taxes (PILOTs) to pay off construction bonds.

That left $17.5 million in profit, presumably to be split 55%-45% between Forest City and Prokhorov.

But not really. The document indicates $3.9 million in additional interest expense, paid in escrow toward the financing lease obligation, or the option to purchase the arena at the end of the 37-year lease.

(Does anyone think the arena will still be around at that time, or be called the Barclays Center?)

The document also indicates an additional $12.7 million in interest paid to a "related party," Prokhorov's company Onexim, for a loan needed to fill out arena financing.

Details are at left. That loan, issued at a bruising 11% interest rate (the arena bonds were at 6.48%) was initially for $75.8 million but has since grown to $122 million as of last June 30. (Seems to me the buyer of Forest City's shares will take over that obligation.)

Those two interest payments suggest the arena isn't providing any return to Forest City. (Also, if you count depreciation, it's taking a loss, but that's a typical accounting move.)

However, the minority owner, Prokhorov, seems to be gaining something thanks to those loan payments.

(Update: Yes, Prokhorov gained, but that is additional debt service, as I wrote regarding the next year's results, so that puts the arena in the red, as far as I can tell.)

2014 results: first nine months

According to a 10-Q filing last November with the Securities and Exchange Commission, the Barclays Center earned $85 million over the first nine months of 2014, compared with $76.3 million in the first nine months of 2013. See graphic below, with 2014 stats outlined in purple and 2013 stats in green.

Operating expenses dipped to $55.4 million from $56.6 million. Interest expense went to $30.1 million from $27.8 million. (That interest expense includes the PILOTs, plus, I believe, the payments to Prokhorov.)

That suggests that, over the first nine months, the arena had net operating income of $29.6 million ($85 million-$55.4 million), but then spent that surplus on interest.

The recently reported $17.5 million figure--which comes after paying the PILOTs but before payments to Prokhorov--splits results from the second half of 2013 and the first half of 2014.

The need for increased profit

It's important to raise profit, because the bond payments will increase to $50 million by 2035.

To bond investors, documents (top graphic at left) indicated net income from operations would start at $76.7 million in the first full year, and keep rising.

In quarterly reports to investors, Forest City long projected $70 million, but 2013 dialed it back to $65 million, a figure they say should be reached in 2016. (That year, debt service hits about $33 million.)

That $65 million goal seems like a significant stretch, because arena expenses are much higher than projected. That $29.6 million figure over nine months but the arena on the path to less than $40 million in net operating income, though a strong fourth quarter would boost that number.

Full 2014 financial results should be released tomorrow.

From The Business of Sports
Surely the arrival of the New York Islanders will help. But there have to be question marks.

A declining debt service ratio

Another concern surely is the debt service coverage ratio (DSCR), the amount of cushion available to pay back the bonds.

According to the 2010 book The Business of Sports, the Fitch ratings agency sets a minimum DSCR for a new facility at 2.25, in the "base case," when the arena appears operationally sound.

(In a "stress case," when there are more question marks, the minimum pledged revenue for a new facility is 1.75.)

The Barclays Center figure is 1.61, according to the most recent report. That's slightly above the "stress case" for an established facility, where a DSCR of 1.5 is sufficient. But the Barclays Center, despite its buzz, is still establishing itself.

The number is down, remember. On 12/1/09, the Bond Buyer reported:
Moody’s expects the senior bonds will have a 10-year average debt-service coverage ratio of 2.85 times and stressed that even without being in operation, the existing sponsorship deals and naming rights deal would provide 0.95 times coverage on the bonds.
Today, it doesn't look like the arena's ability to pay off the bonds is threatened.

After all, as the screenshot at right indicates, there are significant reserve balances, including more than a year's worth of debt service.

But the cushion is much lower.

Note that by April 2013, ratings agency Standard & Poor's projected a stable outlook for the bonds, saying the arena had come in on budget and had many sponsorships, but also saw flaws, including a lower DSCR. (S&P presumably estimated the DSCR at the time, but the figure is not specified in the excerpt made publicly available.)

The document does disclose that S&P--unlike Moody's--had previously "expected likely senior DSCR to be 2.11x...." That figure was more conservative than 2.85, but still higher than the current 1.61.

(The Louisville arena has a more dramatic DSCR of 1.1, which concerns ratings agencies.)

A brief history of projections

Forest City has steadily urged caution and backed off projections. In a Q1 2012 Earnings Conference Call, on 6/8/12, executive Matthew Messinger estimated it would take two years to stabilize net operating income, or NOI.

In a Q4 2012 call, on 3/28/13, after the arena had had its well-publicized debut, CEO David LaRue pointed to stabilization in 2015-16. "We have projected that $70 million stabilized NOI number to occur once the Islanders are in... we are on track."

In a 7/23/13 press release, the Barclays Center noted that it was reported as "the top-grossing U.S. venue for concerts and family shows." (Note: gross, not net.)

In a 7/24/13 Investor Day conference call, LaRue said they were focused on that $70 million stabilization when the Islanders moved. "So the revenue coming in is great. It's not so great if you have to spend it all."

In a 9/5/13 press release regarding Q2 2013 results, LaRue said "the arena has received excellent market acceptance and performed well from a revenue standpoint." He repeated such statements in a 9/9/13 conference call, saying the Barclays Center had "done very well from a revenue standpoint." 

In a Q3 2013 call, on 12/9/13, CFO Bob O'Brien said they "reduced the projected stabilized NOI for Barclays Center arena to $65 million," down from $70 million, given "a better understanding of the revenues and expenses."

In a 2/27/14 press release on 2013 results, Forest City cited "Underperformance of the Barclays Center arena."

In a Q4 2013 call, 2/28/14, La Rue said they'd save money on staff at the arena, and predicted the $65 million NOI would be achieved after the Islanders move.

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