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Moody's: Sale of Nets to Tsai rescued Barclays Center finances, bolstering bonds above "junk" despite negative outlook

The recent blockbuster sale of 49% of the Brooklyn Nets by billionaire Mikhail Prokhorov to fellow billionaire Joe Tsai—a deal valuing the team at $2 billion-plus and which is expected to lead to Tsai’s full control of the Nets by 2021—didn’t just represent a big payday for Prokhorov.

It also provided a crucial backstop to the uncertain finances of the Barclays Center operating company, now owned by Prokhorov’s Brooklyn Sports & Entertainment (BS&E), which has consistently reaped far less of a profit than expected, due in part to a bad deal with the New York Islanders.

Though the $1 billion transaction with Alibaba tycoon Tsai did divert additional revenues from the arena to the team, as ratings agency Moody’s explained May 14, it also allowed Prokhorov to create a $345 million reserve fund to deliver supplemental revenue and ensure that bondholders are repaid.

That cushion safeguards BS&E against a downgrade of the bonds, from the lowest rung of investment-grade—a common ranking for local sports facility projects--to “junk,” which could trigger sales by investors and would require Prokhorov’s firm to pay higher interest on any future bonds. (Last month, the Crain’s New York Business headline was “Barclays Center Bonds are just about junk.”)

Bonds have had “negative” outlook since October 2017

This was the third ratings announcement in the past eight months with a “negative” outlook toward the bonds issued by the Brooklyn Arena Local Development Corporation (BALDC) and repaid by the arena operator. (The BALDC is a state entity that enables tax-exempt financing for a nominally state-owned building.)

Each announcement has added new reasons for strain on the arena bottom line, which contrasts with the typically sunny portrayal of the arena, such as when, in January 2018, Billboard (in a mini-profile of Brooklyn Sports & Entertainment CEO Brett Yormark) hailed Barclays as “the third-highest-grossing U.S. venue.”

Gross revenue does not equal net revenue, and several factors have contributed to lower profits. Last October, before arena operators renegotiated their unusual license agreement with the New York Islanders—guaranteeing the team a payment in exchange for game-related revenue—Moody’s revised its ratings outlook to negative, warning of lowered attendance and ticket sales at hockey games. (See my coverage in The Bridge.)

Indeed, the Islanders and the arena in December began to revise the once “ironclad” 25-year license agreement, with the Islanders’ owners planning to build a new arena at Belmont Park in western Nassau County. Over the expected three years of construction, the Islanders will play both at Barclays—which has luxury suites but an awkward layout—and at the team’s longtime home, the renovated but downsized Nassau Coliseum, which has no public transit access and few suites. (A lucrative TV contract and a core of committed fans made it unlikely the Isles would leave New York.)

BS&E operates the Coliseum, with no anchor tenant, and was eager to have the Islanders play there, if only briefly. Gov. Andrew Cuomo helpfully offered $6 million in state funds to further renovate the Coliseum, a payment that the Long Island newspaper Newsday, generally a Isles-move enthusiast, called “troubling.”

Arena cash cushion shrinks

The Moody’s ratings action last October, plus follow-up actions by Standard & Poor’s (S&P) last month and Moody’s last week, all indicate a shrinking debt service coverage ratio (DSCR), a common metric used to describe the revenues available to pay off construction bonds. The bonds are repaid via payments in lieu of taxes, or PILOTs, an arrangement that comports with tax-exempt financing, which has a lower interest rate.

Back in 2009, when the arena bonds were first issued, Moody’s estimated a robust DSCR of 2.85x, meaning that net revenues were nearly triple the payment obligation. By December 2015, though, Moody’s noted that ratio had declined to 1.29x in the past fiscal year, from 1.62x the previous year.

After Prokhorov in 2016 bought the remaining 45 percent of the operating company and 20 percent of the Nets from original owner Forest City Enterprises (parent of Brooklyn-based Forest City Ratner), the state agreed to refinance the bonds at a lower interest rate. That significantly lowered annual payments and bolstered a shaky DSCR.

In August 2016, Moody’s predicted that, given that Prokhorov would pay less each year, the DSCR would reach a solid 1.9x, or nearly twice the money needed. That didn’t happen. The ratio last year sunk to 1.31x, and Moody’s last October warned of a further decline to 1.07x, barely enough to cover the debt.

We don’t know the ratio yet, but Islanders’ attendance—one factor in the Moody’s warning—has continued to suffer, dropping 8.4 percent, to a league low of 12,002, according to ESPN. (The arena holds 15,795 for hockey, with a good fraction of seats with poor or obstructed views, and typically reported attendance exceeds gate count.)

Nets deal resets finances

The Islanders’ troubles, interestingly enough, did not trigger rival ratings agency S&P’s first negative outlook. Rather, S&P, which rated arena bonds BBB- (its lowest for investment grade), cited the Nets’ sale, because the arena would now collect just 30 percent of food and beverage sales from NBA games, down from the prior 100 percent. (NetsDaily said that the new allotment was the league standard and, indeed, other evidence is that this was required by the league.)

“To bridge the gap in revenue loss,” S&P said April 20, “a reserve account was established with a portion of the sale proceeds (estimated to be $345 million).” S&P warned, though, that “our preliminary calculations suggest that these features are not sufficient to support the current credit profile.”

Moody’s raised more warnings, but ultimately expressed more confidence. Its May 14 affirmation of its previous negative outlook blamed not just the Islanders contract and the Nets transaction, but also a “several year decline in attendance at the Nets' home basketball games (although this may have stabilized),” as well as lower revenues from sponsorships, premium seating and concessions.

However, Moody’s was more optimistic than S&P regarding the new reserve fund, saying it would mitigate the “financial underperformance. expected to continue for at least the next several years.” Thus the arena should be able to meet a minimum DSCR of 1.38x.

Last year, the arena operating company reported $174.9 million in revenues and $146.9 million in expenses, leaving $28 million. (It’s unclear how Billboard calculated the $83.7 million in revenue.)

While that $28 million could cover the $22.8 million in arena debt, it could not cover the $34 million required in PILOTs, with the overage placed in a fund for operating and maintenance expenses.

The new reserve account must be invested in high-grade fixed income securities; if, say, the $345 million fund earns 3.5 percent a year, that would deliver more than $12 million a year, a healthy sum.

The deal history

Prokhorov in 2009 agreed with Forest City to buy 80 percent of the Nets and 45 percent of the arena holding company for $200 million in cash, absorb $60 million in losses before the Brooklyn move, and assume 80 percent of the team's $207 million debt.

With the Nets, Prokhorov absorbed significant losses--for example, $44 million in 2017, according to ESPN, and $144 million in 2014, according to Grantland-- but in 2016 was able to buy the remaining 20 percent of the Nets in a deal valuing the team at only $875 million. That should translate into a significant profit today, given the Tsai transaction.

That recent deal, according to news outlets including Bloomberg and Reuters, valued the team at $2.3 billion, a record sale. (Other teams not on the market, like the New York Knicks and Los Angeles Lakers, are worth far more, according to Forbes.)

The Moody’s announcement left wiggle room, stating that the 49% sale was “for approximately $1 billion.” That could mean the full deal is not much over $2 billion. Or not. It depends how much they're rounding, since 49% of $2.3 billion is $1.127 billion.

Not only does it seems that, as Jay-Z once said, NBA teams are like “paintings for billionaires,” with their rarity a spur for spectacular pricing. Also, the U.S. Supreme Court’s legalization of sports betting unlocks new potential revenue sources for NBA owners, as the New York Post reported. So maybe Tsai will earn some profits, especially since he has an entree into the world's largest regional gambling market, in Asia.

Today Prokhorov’s company focuses on operating venues, including Barclays and the Coliseum, along with the under-renovation Brooklyn Paramount and Webster Hall.

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