Leslie Alexander, the owner of the Houston Rockets, recently announced his intention to sell the team – marking the 12th time in the past 8 years that an NBA team will change ownership. But the real topic of discussion revolves around the price tag of this transaction. Estimated NBA team values have skyrocketed since Steve Ballmer paid $2B for the Los Angeles Clippers in 2014, and now the entire basketball world is wondering how this sale will compare.
Before valuing the Houston Rockets, the question that needs to be addressed is – “Why sell now?” While part of Leslie’s decision to sell is attributed to his desire to focus on philanthropy, an underlying motivation is to exit the NBA market before the growing bubble bursts.
As shown below, NBA team values are growing at an exponential rate. However, the current growth rate cannot sustain itself forever. As evidenced in other investment markets – like real estate and stock– prolonged periods of above-average growth rates, typically fueled by investor behavior and not financial fundamentals, usually precedes a market correction where prices drop to what the assets fundamentals suggest. And based on the NBA growth rates, it could be assumed that the NBA market will correct itself soon. The state of sports in the U.S., the NBA and the Houston Rockets are all currently doing great which creates optimal timing for Leslie to sell.
Figure 1 NBA Franchise Values overlaid with an exponential trend line (red) with an r-squared of 0.89
Before diving into the valuation analysis, a qualitative assessment of the state of sports, the NBA and the Houston Rockets gives weight to why the bubble is growing so rapidly.
Regarding the state of sports, the consumption habits of young people and the evolution of media distribution are affecting the demand for content. No longer are TV programs viewed when first aired, they are often DVR’d or viewed on streaming services days later without commercials. This trend creates a huge need for content that is consumed when first aired from advertisers – and only sports fits that bill. Thus, the increase in demand coupled with the limited number of sports leagues generates high prices for sports.
Turning to the NBA, the primary determinants of the health of a league are its relationship its players and the security of its revenue. A huge risk in owning a team is the chance of work stoppage due to player discontent. Fortunately, the NBA recently agreed on a new collective bargaining agreement (CBA) with the players’ association securing their services until 2024. And the largest revenue generator of any successful league is its media rights’ contract. Which the NBA has secured by signing a massive media rights’ deal with ABC/ESPN and TNT that will yield over $2.6B a year until 2025. The league distributes that revenue equally among the teams. So, from an investment standpoint, the league is very enticing.
Now let’s discuss what makes the Houston Rockets one of the most valuable teams in the thriving NBA by breaking down some of the key value drivers: market size, arena situation, and corporate landscape.
Regarding market size, Houston is the 4th largest city in the U.S. as well as one of the fastest growing cities. The arena lease with the Toyota Center, contracted through 2033, is favorable as it allows the team to fully capture all revenue streams related to the arena. But the most attractive aspect of the Houston Rockets is its Asian appeal.
Outside of media rights’ deals, the biggest revenue stream comes from corporate partners, and most partners come from companies that have a strong presence in the team’s city. With the headquarters of 26 Fortune 500 companies located in Houston, the Rockets are already well positioned. But, the Rockets strong connection with China – due to Yao Ming spending his career there – expands the pool of potential corporate partners to include most of Asia. Which is evidenced by the number of current Asian sponsors like Toyota (Japanese), ZTE (Chinese) and Peak (Chinese). This potentially creates great upside if the Asian influence is leveraged correctly.
As previously discussed, the industry of sports, the NBA, and the Rockets are all currently positioned well which lays the groundwork for a valuation analysis to determine an estimated price range. Industry experts typically use revenue multiples to value sports teams, with NBA teams usually being valued between a 3-4 times revenue. However, NBA team revenue data is not easily obtained, especially past historical revenue data. Therefore, the valuation method used incorporates the average annualized rate of return on previous transactions.
My research includes compiling available information on all previous NBA team sales where majority ownership changed over the past 50 years. Then, each transaction value was normalized to reflect the implied valuation of the franchise. Analysis of the data yielded an average annualized rate of return and an average holding period of all transactions – which is 14.9% and 12.5 years respectively (My research data can be requested HERE). To put this in context, the stock market yielded a 9.5% annualized return during the same 50-year period.
A not-so-shocking trend was identified in the analysis of transaction data – the longer an investor owned a team, the less dispersed the returns were (see below). In fact, teams held longer than 17 years saw returns between 10.5% and 16.5%, further supporting the average return of 14.9%.
Figure 2 Annualized returns relative to holding period
A current valuation of the Rockets was determined by compounding the original purchase price of $85M by the average annualized rate of return of 14.9% for the holding period of 24 years. This calculation produces a range of $2.3B to $2.4B when including a 5% margin of error. And when factoring that optimal qualitative factors, this deal should be closer to $2.4B
Granted this valuation is high, however, the growing demand for sports content, the booming state of the NBA and the Asian appeal of the Rockets warrant this valuation. But all the research and analyses can have little impact because ultimately valuation is what someone is willing to play. And given the limited number of teams, the demand could push the price even higher.