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Prokhorov filled arena financing gap not by buying bonds but offering a loan; he could end up owning 80% of arena operating company

Well, Russian billionaire Mikhail Prokhorov, who as of yesterday owns 80% of the Nets, also filled the financing gap for arena construction, thus leading ratings agency Standard & Poor's (S&P) to affirm its investment grade (BBB-) rating on $511 million in tax-free bonds and removing them from the potential downgrade announced in March.

Prokhorov offered a $75.8 million loan rather than, as reported, buying $106 million in taxable bonds.

And Prokhorov--who put down $200 million for 80% of the Nets and 45% of the arena, and agreed to fund some $220 million in losses and debt--apparently drove a hard bargain with Forest City Ratner and Forest City Enterprises.

With relatively little additional cash, Prokhorov, according to a report issued yesterday by S&P, could end up owning 80% of Brooklyn Arena LLC (BALLC), the company operating the Barclays Center.

If so--and S&P didn't call it likely--that would mean that the government assistance and eminent domain for the Atlantic Yards arena, the first building in the project, would have benefited most directly Russia's second-richest man.

Had that been announced during the approval process, it surely would have generated much more concern.

The financing scheme

The arena will be nominally owned by the Empire State Development Corporation and leased for a dollar to the Brooklyn Arena Local Development Corporation (BALDC). The lease to the arena operating company requires payments in lieu of taxes (PILOTs) directed not to the public coffers but to pay off construction.

In other words--and this is an issue in dispute--it's a no-risk arena or, at least, the only risk is paying for construction, not rent or taxes.

Winding road to arena financing

The tax-exempt arena bonds only go so far, so more money was needed. Last December, $146.8 million in taxable arena bonds were rated B, or "very speculative," by S&P. After the preliminary rating was withdrawn, a smaller amount of taxable bonds, $106 million, was announced in early February.

In March, S&P issued a report withdrawing its rating for the taxable bonds, citing “uncertainty” about the financing plan.

Yesterday, S&P reported that Prokhorov's $75.8 million loan to the Brooklyn Arena Holding Company (BAHC) "has certain equity like characteristics, the financing structure allows this loan and any accrued interest to be refinanced by debt."

In other words, there likely will be future debt issuance; the report estimates $96.2 million of refinancing debt. S&P reports:
FCRC stated that there is currrently no intent to incur additional indebtedness at BALLC. Should debt rise (excluding the possible refinancing debt), we may lower the rating.
Keep in mind that Forest City Ratner has often said it "intends" or "aims" to do things, but then things change. In May 2008, Bruce Ratner said in a Daily News op-ed that "Our first goal is to break ground on the Barclays Center later this year" and "We anticipate finishing all of Atlantic Yards by 2018."

Land costs are uncertain

S&P notes that BALLC (parent of BAHC) and Atlantic Yards Development Company (AYCD) are parties to the Land Acquisition Funding, Property Management and Relocation Agreement, which means exposure to non-arena costs, including compensation yet to be paid for properties in Phase 1 of the condemnation and properties in Phase 2 that have not been condemned.

Translation: Forest City Ratner and the state will drive a hard bargain for the last major pieces of property needed for Phase 1, a large building and adjacent lots owned by Henry Weinstein at the southeast corner of Pacific Street and Carlton Avenue.

Prokhorov can gain

According to S&P, in "the absence of AYDC's obligation to fund any shortfalls (in excess of the letter of credit posted to secure such obligations)," Nets Sports and Entertainment, controlled by an investor group led by Bruce Ratner, could see its 55% equity position in BALLC diluted.

Then what? Prokhorov's company, Onexim Sports and Entertainment (OSE) can fund shortfalls in exchange for equity. That could lead to a downgrade in the ratings for the tax-exempt bonds.

States S&P:
If the $75.8 million loan were to be converted to equity and OSE to cover a shortfall of about $38 million of mandatory costs, OSE could end up with 80% of the equity. Based on our analysis, the likely risk of OSE paying more than $38 million is commensurate with the rating level.
That sounds like a pretty good deal--keep in mind that Prokhorov in March lost a $53 million deposit on what is reportedly the world's most expensive home.

So there's some risk--remember, the rating level is the lowest investment grade--that Prokhorov would pay more than $38 million.

What are the chances of Prokhorov taking over? "Based on our analysis of the documents, the greatest risk of equity dilution is likely during the construction period," S&P states.

S&P doesn't clearly estimate this risk. It does say, however, that Forest City Ratner "is generally a buy and hold developer of core assets" and thus "will likely remain an interested member with blocking rights in BALLC."

That's plausible. But if FCR doesn't come up with enough cash--and can't get government partners to do so--look for the billionaire with deep pockets to come up with a check that, to him, represents little more than chump change.