Wednesday, December 23, 2015

Deal for Nets/Barclays completed, now valued at $1.7B; arena seemingly a loss; Moody's reveals dangerously low debt coverage; Prokhorov pledges community continuity

See my update on arena finances and valuation.

Upon formal announcement of the deal to sell Mikhail Prokhorov's Onexim Sports & Entertainment the 20% of the Brooklyn Nets and 55% of the Barclays Center (operating company) controlled by Forest City Enterprises, the arena deal appeared to be a loss [see below for questions about that] and a bond rating agency revealed that the past year's debt service coverage ratio--the net revenue available to pay back the construction bonds--was dangerously low.

Prokhorov also vaguely pledged community continuity in the wake of local concerns, stating that existing Forest City Ratner staff would remain as interfaces with the public. 

That makes strategic sense, given the difficulty in finding new people, but also means that the Forest City staffers will be conduits, with no clear power to implement policy changes.

The new value

According to the Forest City press release, "The transaction values the team at approximately $875 million and the arena at $825 million, inclusive of debt for each asset." (All press releases at bottom.) Prokhorov must contribute $285 million in cash and notes, with a gentle interest rate of 4.5%, payable in 5.5 years.

That $1.7 billion, Bloomberg reported, is "about 10 percent lower than the $1.9 billion previously reported by Bloomberg." Or the $1.9 billion previously attributed to an unnamed source, a figure one savvy observer, Mike Ozanian of Forbes, questioned.

Arena sale a loss?

The Wall Street Journal's Eliot Brown, who's followed the issue more closely than most, put it pointedly:
The Prokhorov deal marks a loss for real-estate developer Forest City Enterprises Inc.,which banded together with a group of investors to buy the Nets in 2003 in a bid to build the Brooklyn arena and a giant surrounding housing development. While it sold most of the team to Mr. Prokhorov in 2009, it kept a 55% stake in the arena, which it hoped to turn into a cash cow.
Instead, it has been a financial disappointment, trading to Prokhorov at a value of $825 million—well below the roughly $1 billion construction cost. Profits from the various concerts and other events at the arena have proved thin, and last year, it brought in about $40 million a year in operating income, compared with the more than $75 million the company previously projected, according to Forest City securities filings.
The sale came largely because Forest City is converting its tax status to a real estate investment trust—one that requires the bulk of its income come from properties—not teams or arenas.
Here's where the much ballyhooed "$1 billion arena" figure bites back. Forest City in 2012 said the $934 million cited "covers the cost of this building, the transit connection, the site work, etc." So the numbers are somewhat murky.

Then again, $825 million may be close to the value of the arena without transit connection and site work, but the latter don't deliver revenue, so Brown's assessment should stand until it faces more granular rebuttal.

Update: note the commenter who takes strenuous issue with the loss assessment. I agree that the analysis should be more subtle, because there are various slices of financing. Let's see what Forest City says in its next quarterly results.

The revenue was to come from arena profits, but profits have been hard to come by, with operating income--at least until now--offering relatively small clearance above debt service.

Barely making debt service

Indeed, as Moody's reported in a little-noticed release, the arena's "decline in concert and events revenue contributed to the lower debt service coverage ratio (DSCR) of 1.29x in fiscal year 2015," which is well below the "stress case" of 1.5 for an established facility, much less the 1.75 "stress case" for a new facility, according to the 2010 book The Business of Sports, the Fitch ratings agency.

This past February, I reported that the DSCR was originally judged by Moody's at a comfortable 2.85, but had declined to 1.61 in fiscal year 2014.

Now Moody's reports that it went down to 1.29x in FY 2015, itself down from 1.62x in FY 2014, but should go up to 1.7x in the current fiscal year ending June 30, 2016, thanks to the arrival of the Islanders. Now Moody's is not Fitch, but even 1.7x is below the Fitch "stress case" ratio. Oddly enough, Moody's now claims that the initial DSCR forecast was 2.0x.

Nets a gain?

It should be noted that the valuation of the team represents a gain of some sort, given that Forest City's remaining share of the Nets was valued at $175 million (20% of $875 million), while Prokhorov committed nearly $450 million for 80% of the team. Wrote Nets Daily:
Tuesday's deal will permit Prokhorov to sell a minority stake, as much as 49 percent, in the team and/or arena. As NetsDaily noted Monday, Prokhorov has been in a buying mode for months. Prokhorov bought his 80 percent stake in the Nets and 45 percent of Barclays Center in May 2010 for $223 million, the assumption of $160 million in team debt and $60 million to cover operating expenses the last two years in New Jersey. He's also lost hundreds of millions since purchasing the team. But if the valuation is accurate, that deal was as good as any he's made since
Community continuity?

As I wrote, both neighbors concerned about arena impacts and local elected officials concerned about community benefits and impacts asked the state agency that formally owns the arena, Empire State Development, to intervene in the sale of the arena operating company. It didn't, and did not even vote, saying that all the deal needed was a staff sign-off.

A press release seemingly responds to those issues:
Under the agreement, Barclays Center will continue to work with the surrounding communities on quality of life issues. It will also continue to implement the portions of the Community Benefits Agreement and other community programs applicable to Barclays Center that were established as part of the development. Select FCRC staff will also continue to serve as liaisons for community and quality of life meetings, and will work with arena staff and Greenland Forest City Partners, the developer for the larger Pacific Park project, to coordinate construction activities.
Of course, "continue to work with the surrounding communities on quality of life issues" does not mean anything specific, and most recently arena-related activities have blatantly taken up public space on Atlantic Avenue and Dean Street for parking and idling.

Also note that the once-named Quality of Life Committee meetings have become developer-driven Community Update meetings, despite requirements in the arena's liquor license.

As to the portion of the Community Benefits Agreement, that likely applies to the distribution of free tickets via the Downtown Brooklyn Neighborhood Alliance, distribution of foundation funds to nonprofits via that group, and, presumably, continued fiscal support for that group, chaired by the Rev. Herbert Daughtry and led by his daughter Sharon Daughtry.

But nothing has been released in writing.

Will Prokhorov invest? Sell team?

In Forbes, Ozanian wrote:
I recently ran into a former employee of the Nets and asked him if he thought Prokhorov would keep the Nets or sell them after he bought out Ratner. His response: “One day he wakes and wants to sell. Another day he wakes up and wants to keep the team,” he said not for attribution.
He then added: “I don’t believe for a minute that he (Prokhorov) is going to bring in $400 million in cash to invest in the team as some have written. Not with what is going on geopolitically. And I can tell you his other businesses are hurting.”
Note that the $400 million referred to Prokhorov's purported investment to get the team and arena. He has to pay $285 million in cash and notes, so he has time--up to 5.5 years--to decide whether to pay in full and/or refinance/sell.

The Brooklyn Nets press release (emphasis added)
ONEXIM SPORTS AND ENTERTAINMENT SIGNS AGREEMENT WITH FOREST CITY FOR FULL OWNERSHIP OF BARCLAYS CENTER AND THE BROOKLYN NETSBROOKLYN (December 22, 2015) – Onexim Sports and Entertainment Holding USA, Inc. today has signed an agreement with Nets Sports and Entertainment, LLC, an entity controlled by Forest City Enterprises, to consolidate a 100 percent equity interest in Barclays Center and the Brooklyn Nets. The transaction was approved unanimously by the NBA’s Board of Governors earlier this month. 
In 2010, Onexim acquired 80 percent of the team and 45 percent of the arena. Since the arena opened in 2012, Brooklyn Sports & Entertainment has managed the team and the arena and will continue to do so under the new structure.

Mikhail Prokhorov, owner of Onexim, said, “Today’s deal brings the ownership structure of the Brooklyn Nets and their state-of-the-art home in line with NBA guidelines and comes at an opportune time for all involved. We have enjoyed a wonderful partnership with Forest City and Bruce Ratner and worked together to open one of the most successful arenas in the country and to bring professional sports back to Brooklyn. We will continue to support arena management to provide a high level of service to our fans and the best sports and entertainment experience in the world. We also remain fully committed to community programs that were created as part of the arena. We believe a successful arena must be a destination, but also be part of the communities that surround it and more broadly the collection of neighborhoods that represent Brooklyn.” 
Bruce Ratner, Executive Chairman of Forest City’s New York subsidiary, Forest City Ratner Companies (FCRC), added, “The development of Barclays Center enabled the return of major league professional sports and world-class entertainment to Brooklyn, and in just over three years of operation, it has become one of the top-grossing arenas in the country. As an anchor for the continued development of Pacific Park Brooklyn, Barclays Center stands as an iconic landmark for the borough.” 
Under the agreement, Barclays Center will continue to work with the surrounding communities on quality of life issues. It will also continue to implement the portions of the Community Benefits Agreement and other community programs applicable to Barclays Center that were established as part of the development. Select FCRC staff will also continue to serve as liaisons for community and quality of life meetings, and will work with arena staff and Greenland Forest City Partners, the developer for the larger Pacific Park project, to coordinate construction activities. 
“It’s a seamless transition due to the incredible partnership between Onexim and Forest City over the years,” said Brett Yormark, Chief Executive Officer of Brooklyn Sports & Entertainment. “Exciting times are ahead for our fans, partners, and employees as we continue to improve and grow all of our businesses.” 
The parties expect to complete the transaction either late this year or early in 2016.
The Forest City press release

Forest City reaches agreement with Onexim for sale of Barclays Center, Brooklyn Nets
- Onexim to become 100 percent equity owner of arena, team 
CLEVELAND and BROOKLYN, N.Y., Dec. 22, 2015 /PRNewswire/ -- Forest City Enterprises, Inc.(NYSE: FCEA and FCEB) announced today that its subsidiary, Nets Sports and Entertainment (NS&E), has executed a purchase and sale agreement with Onexim Sports and Entertainment under which Onexim will become the 100 percent equity owner of the Barclays Center arena and the Brooklyn Nets basketball team. The NBA's Board of Governors unanimously approved the transaction earlier this month.

The transaction values the team at approximately $875 million and the arena at $825 million, inclusive of debt for each asset. NS&E currently owns a non-controlling 20 percent equity interest in the team and a 55 percent equity interest in the arena. Forest City owns approximately 62 percent of NS&E. NS&E expects to receive proceeds from the transaction in a combination of cash and notes receivable of approximately $285 million at closing. The notes receivable are expected to approximate 75 percent of the total proceeds, bear annual interest at 4.5 percent, and be payable in three to five-and-one-half years from the date of closing. 
"As we continue to focus our portfolio on core retail, office and apartment assets in strong urban markets, and transition to REIT status, this transaction is a significant milestone," said David J. LaRue, Forest City president and chief executive officer. "I want to thank the NBA for their support and I salute our New York team, led by Bruce Ratner, MaryAnne Gilmartin and David Berliner, as well as our partner and our associates and advisors involved in making this deal a reality." 
Bruce Ratner, executive chairman of the company's New York subsidiary, Forest City Ratner Companies, added, "The development of Barclays Center enabled the return of major league professional sports and world-class entertainment to Brooklyn, and in just over three years of operations, it has become one of the top-grossing arenas in the country. As an anchor for the continued development of Pacific Park Brooklyn, Barclays Center stands as an iconic landmark for the borough."
The parties expect to complete the transaction late this year or early in 2016. Evercore ISI advised Forest City and NS&E on the transaction and provided a fairness opinion.
The Moody's press release
Moody's affirms Barclays Center Project's Baa3 with stable outlook
Approximately $537 million of rated debt outstanding 
New York, December 22, 2015 -- Moody's Investors Service affirmed the Baa3 rating with a stable outlook on the PILOT Revenue Bonds, Series 2009 (Barclays Center Project) issued by the conduit Brooklyn Area Local Development Corporation. Original bond proceeds were used to partially fund the construction of the Barclays Center, an approximately 18,000 seat capacity arena in Brooklyn, NY. The arena is the home facility of the NBA's Brooklyn Nets and the NHL's New York Islanders, and is a venue for other live entertainment and sporting events. The arena opened in September 2012. 
RATINGS RATIONALE

The rating reflects the cash flow predictability supporting the debt that comes from contractually obligated income (COI) in the form of medium to long-term contracts for naming rights, sponsorships, premium seating, minimum team rents, and concessions. The rating also reflects the security afforded by the PILOT bond structure, the strength of New York City as a media market, the non-relocation agreement with the Nets, the Owner's Operating Support Agreement, the large equity component of the financing structure and the strong liquidity. The rating also considers the challenges presented by the demand risk associated with concerts and other events, which declined in the fiscal year that ended June 30, 2015.

The decline in concert and events revenue contributed to the lower debt service coverage ratio (DSCR) of 1.29x in fiscal year 2015, which was below expectations and down from 1.62x in fiscal year 2014. This one year decline is viewed as temporary as management forecasts an improvement in the DSCR to 1.7x in the current fiscal year ending June 30, 2016, which Moody's views as reasonable due to higher event revenues year to date and greater revenue certainty with the addition of 44 known hockey sporting dates with the New York Islanders, which are new in the current year. Moody's believes new management forecasts are relatively more conservative compared to past forecasts that included growth. There is some certainty around the near-term forecast as COI is anticipated to comprise approximately 85% of 2016 fiscal year revenues.

For further details on the ratings rational and the structure of the deal, please refer to our credit opinion on Moodys.com, which will be posted separately.

The stable outlook reflects our expectation of more stable financial performance with DSCRs in the 1.7x range for the next couple of years due to the significant portion of contracted and more predictable cash flows.

What Could Change the Rating -- Up
The rating could face upward pressure if actual performance exceeds forecasts with higher annual DSCRs closer to the initial forecast of 2.0x on a sustained basis.

What Could Change the Rating -- Down
The rating could face downward pressure if anticipated DSCR improvements in the revised forecast do not materialize and the DSCR continues to fall below 1.45x on a sustained basis, or if the financial state or performance of the Nets and Islanders were to negatively affect premium seating or sponsorship revenue.

7 comments:

  1. Anonymous5:13 PM

    This is out of my pay grade and knowledge level, but to suggest a loss by comparing construction cost versus sale price potentially ignores the various tax benefits that go along with construction and ownership of property and buildings, which includes depreciation. It's far more complicated than my simple mind can understand, and you're way more knowledgeable on the various intricacies and promises (written and unwritten), along with option agreements and rights of first refusal in the various other properties (meaning the arena was built but there are other business interests that exist). But all this is to say that for the tsuris that it took to build the damn thing, and all that press about Ratner being so wonderful, to walk away with an on the surface loss would be very surprising.

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    1. I hear you. And I think that more will surface about this. But this was Eliot Brown's conclusion first, and he does write for the Wall Street Journal.

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  2. Anonymous5:28 PM

    You’re relying on the same press coverage that you ridicule for making so many errors? Like Hollywood films, real estate profits depend heavily on accounting sleight of hand. You, almost better than anyone else, should know that a simple sale-purchase price does not equal profit/loss, especially in NYC where there are so many different revenue pools and tax breaks. Depreciation alone moves the needle, and when other tax breaks got paid (ie upfront lump sum credit versus a long term payout) also makes a difference and I'd almost bet Nets season tickets you're headline is materially misleading and there was no loss.

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    1. Actually, nearly all the press coverage merely parroted the press release. On arena revenues, Eliot Brown of the WSJ has done more analysis than most. I take your point that it's complicated, and that the different parts should be disaggregated.

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  3. Anonymous5:58 PM

    I know most of the press simply copied the main parts of the press release, but that's why I tend not to read the rest of the press and why I click on your blog when I see your link. You tend to dig beneath what's given, which was why I called you out on it, and you know the ins and outs of the various promises and financing arrangements. It's your blog so you can do what you want but if you're not doing that anymore, I'll move on and stop clicking on your pieces when I see the link (typically on Brownstoner).

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    1. Hm, that's rather a large threat regarding one area of dispute. That said, I am revisiting the issue--stay tuned. And if you're going to chide, you should ID yourself.

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  4. Here's my update on arena finances and valuation: http://atlanticyardsreport.blogspot.com/2016/01/barclays-center-bombshell-arena-lost-9.html

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