Acpevans' BLE 4 Blog: The Pros And Cons Of Investing In A Sports Franchise

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Investors in these uncertain economic times are looking for stability and predictability when they decide to invest extra dollars. Consider this investing proposition: You have a chance to invest in businesses that have been around since the 1920s and are growing in popularity. These companies have an intensely loyal consumer base; in some areas of the country, there is a waiting list of years to purchase products. Most rational investors would argue this is a compelling value proposition.

The industry that I am referring to is professional sports, particularly its franchises and ancillary businesses. This seems like a slam dunk of an investment theme; however, to quote ESPN football analyst Lee Corso: "Not so fast, my friend!" It is true that professional sports leagues, with its derivative businesses such as athletic apparel and media conglomerates, have become a multi-billion dollar industries, but these businesses are not risk-free and in many ways can be more risky than traditional corporations. Today, we will look at the pros and cons of investing in big-time sports.

See: Value Investing

Pros

In economics, demand or "final demand" is defined as the ability and the desire to purchase goods and services. Professional and college sports programs strike a strong emotional chord with their audiences. There aren't a lot of companies that can claim a higher brand loyalty to their businesses, than big-time athletics. Typically, this means their dollars will follow their hearts. The National Football League (NFL) tends to market toward a more affluent or "able" customer base; an affluent family of four can easily spend over $1,000 while attending one sporting event. If this family attends 10 events per year, well, you get the picture.

Likewise, people spend serious money renovating entire rooms of their homes to show support for their alma mater. Professional and collegiate sports have also successfully adapted to the ever-changing technological landscape that is part of our daily lives.Viewing of live sporting events on mobile devices is growing rapidly, as well as on satellite radio and pay-per-view showings. All of these distribution channels are revenue drivers for these businesses.

In fact, the NFL started its own television network where it can realize more of the advertising revenue, instead of sharing with traditional networks (FOX, CBS, NBC and ESPN, to name a few). The networks charge premium prices that their loyal customers and sponsors are willing and able to pay. How many people thought there would ever be a golf or tennis channel around the clock?

Another tremendous advantage these major sports leagues have is lack of competition. It's simply a tough nut to crack or as economists would claim: "There are too many barriers to entry" to compete with Major League Baseball, European soccer or the National Football League. There have been some attempts to challenge these leagues, but all have failed. Some sports leagues are also protected legally by anti-competition legislation.

The NFL in the U.S. has a special antitrust exemption. How many businesses can make a similar claim? One would suspect that is a very short list. Finally, these businesses enjoy repeat business; most people don't just own one t-shirt of their favorite team, they own several. Many families pass down season tickets to their children, instilling further brand loyalties for future generations.

Cons

Sports teams and leagues are not immune from economic shocks. Demand for sports entertainment depends on the overall economic climate. The recent, prolonged weakness in the economy has hurt attendance at many sporting events. Some NFL towns struggle with mandatory blackouts due to low season ticket sales, as most average Americans view sports as good entertainment that can be enjoyed when there is extra income to spend.

From an economist's perspective, demand for attending sporting events is elastic. In other words, a change in someone's income (downward) or a change in the products costs (ticket prices upward), will have a material impact on final demand (ticket, merchandise and pay-per-view sales). These are the hard economic facts about why sports investments can be risky, but perhaps less apparent are the exogenous or human factors that investors should be attuned to that present at least equivalent business risk. (For related reading, see Why We Splurge When Times Are Good.)

It seems that every day we hear about a sports scandal more sensational or unbelievable than the day before. Make no mistake, these scandals hurt business and at times present irreparable damage to reputations. Tiger Woods' extramarital affairs caused NBC's golf ratings to take a significant hit, that the network has yet to fully recover from. Recent allegations of sexual abuse at Penn State University not only hurt its reputation, but apparel sales dropped significantly as a result. Incidents such as the one where NBA players jumped into the crowd and brawled with fans (or "customers"), harms the reputation of the NBA brand.

Furthermore, greed is everywhere in these businesses: Stars in these leagues make much more annually than the average consumer. The point here is that these businesses present risks to investors that are not traditionally part of business. If employees of a major corporation went on strike, the company's stocks would most likely get hammered in the short-term. If the CEO of a blue-chip company decided he wasn't going to report to work for months, or hold out for more money, these companies would face serious repercussions from investors. (For more information, read Stocks Basics: What Causes Stock Prices To Change?)

The Bottom Line

Investing in companies that benefit from the multi-billion dollar sports business can be an appealing and profitable proposition. High consumer demand, pricing power and lack of competition, are critical success and survival advantages that big-time sports leagues and teams command. It is also important to realize that these businesses have unique risks. So, the next time you are at a sporting event, look at the ancillary businesses that support your favorite team and see if they make sense in your financial playbook.

Also realize that sports entertainment is generally considered a "luxury" and subject to the economics laws of elasticity. The same human or emotional factors that attract us to spend our dollars on their product, can quickly sour due to unforeseen events.

This post originally appeared at Investopedia.

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