The Nets' Future - An FAQ

Are the Nets for sale?

In spite of denials and protestations, Bruce Ratner has been trying to sell the Nets for the past nine months, hoping to find a buyer who’ll be willing to pay $400 million for the team, a $100 million premium on what he paid for it five years ago, according to Nets insiders.

Who are the likely buyers?

So far, three investment groups have shown interest in the team, all of whom have been identified previously: those led by Vincent Viola, the former chairman of NYMEX and the team’s second largest investor after Ratner; Terry Semel, the former CEO of Warner Brothers and Yahoo!; and Mikhail Prokhorov, a Russian oligarch who is among the world’s richest men with a fortune between $10 billion and $15 billion. (In addition, a fourth investor, Marc Lasry, a hedge fund manager, has shown some interest, but it has waned recently, according to published reports confirmed by a team insider.)

What the prospects for a sale?

No better than 50-50, according to insiders. Ratner does not want to give up control of the Barclays Center in any sale or recapitalization. Instead he hopes the team’s new owners will be a tenant only in the new arena, pay him a large annual lease in addition to the substantial premium for the team. The insiders say new buyers are unlikely to pay the premium or the large lease, which is significantly greater than the $2.02 million the Nets now pay the New Jersey Sports and Exposition Authority for the IZOD Center.

"In that scenario," said one team insider, "Ratner sells the team, you get control of the team and the right to lose $20 - $35 million a year on the team. Key to the franchise success is the arena, not the team." He explained that whoever owns the arena will be able to book other events—concerts and family shows—on the 220+ dates the Nets didn’t play. "That’s where the money is", he said.

Indeed, internal financials written in 2006 and released in 2008 suggest that the arena could yield a $20 million profit. In addition, the Nets would save money on not having to pay a lease. Conversely, adding a larger lease would put the new owners of the team at a greater disadvantage. With the arena, the Nets become one of the league’s most valuable teams, say team insiders. As the Nets' chief financial officer has said, "everything changes in Brooklyn."

Are any of the investors willing to keep the team in New Jersey?

None of the groups would keep the Nets in New Jersey. Semel and Viola are Brooklyn natives who are committed to bringing the team to the borough. The issue again is the ownership of the arena. The only way to make the team profitable enough to compete for free agents, etc., is to own the arena and reap the profits of the non-sporting dates.

Moreover, the NBA is not crazy about having its teams lease their venues from NHL teams and Newark is not seen as a very attractive location to begin with.

Ray Chambers, one of the former owners, is still pitching Newark. A second insider hinted that Mayor Cory Booker had spoken to some of the owners a while back at Chambers’ request. "If you talk to Ray Chambers and Cory Booker, they'll tell you how good Newark would be", said the insider, but he reiterated that Brooklyn is the better deal because of the arena.

What about the Russian?

The extent of Prokhorov’s interest remains a mystery. He has denied reports he wants to buy the team and in fact his public relations spokesperson two weeks ago called the reports of his interest "untrue and unfounded". In addition, Prokhorov would have to go through the NBA’s detailed vetting process, and it’s uncertain he would pass the test. Insiders and marketing experts point to some unfortunate publicity Prokhorov received two years ago. He was taken into custody by French police in 2007 for reportedly arranging to have seven prostitutes entertain at his villa in the French Alps. Charges were later dropped.

How interested are Semel and Viola?

Semel is very interested and is seeking investment partners in both the sports and media worlds. He is reportedly being helped by Ari Emmanuel, brother of Rahm Emmanuel, White House Chief of Staff…and the model for Ari Gold, the hyper-aggressive agent in "Entourage", the HBO comedy about Hollywood.

Viola appears to be in the lead position, having substantial capital—more than Semel but less than Prokhorov--and enough of the Nets’ preferred stock to thwart either of the other bids if he wants to. Or he simply sell out if their offers are too good to pass up. Viola has made his money as a Wall Street trader and entrepreneur and will wait and see what Semel can bring to the table before he makes his decision says a source close to the Nets. Like Semel, he is recruiting other high net worth individuals to join his group. He has already told Ratner he would not accept an arrangement where Ratner retains control of Barclays Center and he is left with the team.

Does Viola hold the key?

"There’s no deal without Vinny Viola," said one insider, who added the chances of Viola becoming the Nets’ principal owner are no better than "50-50". Another individual familiar with Viola’s thinking said, "Vinny is willing to pay a premium, but he is not going to overpay."

Would Viola accept a partnership with Semel?

"No," said an insider "Only one guy gets to call the shots. You can’t have two owners that don’t know each other at all. It doesn’t work."

Of the prospective owners, Viola is the most savvy basketball wise. He is a long time season ticket holder and currently owns eight season tickets 10 rows off the court, notes a Nets’ official. According to filings he made with the SEC on another matter, Viola spends 20% of his working time on issues related to the Nets. As has been reported, he attends practices, draft workouts, etc. As one Nets insider noted, "Viola follows the NBA and the Nets like he follows the markets; he doesn’t miss a thing and has an eye for talent." He is a member of the Nets Chairman’s Council, which passes on major financial decisions, including those related to roster moves, i.e. trades and draft picks. He reportedly gets along quite well with Ratner and with the senior executives at Forest City Enterprises as well. He also serves with Jerry Colangelo, the former Suns owner on the board of directors of the National Italian American Foundation. Colangelo is presumably advising him.

One hint of his long term commitment: his investment vehicle in the Nets is JMT Athletics, according to the SEC documents. The three initials represent the first letters of his three sons’ first names.

Prokhorov was a major investor in Europe and Russia’s best team the last five years, CSKA Moscow, but he recently severed his relationship with CSKA, according to reports. Prokhorov, who is 6’9" tall, played the game as a youth and is very knowledgeable about it. An associate of another Russian oligarch says Prokhorov suffers from "boredom and $7 billion in cash". Semel is an avid fan of the game.

Ratner, who Lawrence Frank tutored in the game’s intricacies, is more of a fan now than he was back in 2004, when another insider noted he thought the NBA game was divided in halves, not quarters.

How close is a deal?

"Things are tight," said the insider referring to the schedule. The Court of Appeals hearing is Oct. 14. A decision is not expected til November. In addition, bond rating agencies have to approve the financing and then the bonds have to be sold. Ratner has already met with bond ratings agencies and two investment bankers, Goldman Sachs and Barclays, are marketing the financing package. "The ownership will have to be settled by November."

Ratner would like to have firm offers in early September as a result.

Why does Ratner want to sell now?

Ratner’s desire to sell is tied to the team’s increasingly desperate finances—the Nets have lost $70+ million the past two years, according to filings made by Ratner’s parent company, Forest City Enterprises, with the Securities and Exchange Commission. Forest City owns 23% of the team and has increasingly funded team losses, going from 38% to 100% over the past four years, as the filings have noted. It has agreed to fund this year’s losses as well, but reportedly has told Ratner after this year "we’re done".

Overall, Forest City has lost $119.1 million and all investors $353 million, according to a New York Times analysis of team finances.

There’s also the urgent need to find a significant amount of capital to construct the $774 million Barclays Center in downtown Brooklyn. Ratner or whoever owns the team must put up at least $200 million in cash and show prospective financiers they have substantial revenue streams—like the lease—in order to obtain tax-exempt financing. And he must do that by year’s end, if not sooner. Whoever owns the team will lose the ability to use tax-exempt financing if there’s no deal in place by December 31. In addition, Barclays Bank has set December 31 as a deadline for the Nets to break ground or it can reneg on its $400 million naming rights deal…although Barclays CEO Bob Diamond said last weekend, "we’re not going away". The proposed lease and the naming rights are the biggest proposed revenue streams tied to the arena. The other sponsorship deals Brett Yormark has arranged—reportedly worth another $100 million--are also part of the collateral the Nets’ investment bankers are using to justify that financing.

What about debt? Aren’t the Nets heavily in debt?

According to one insider, half the $400 million would go towards the down payment on the Barclays Center and half towards reducing team debt.

The team’s debt is more than $200 million, says Forbes Magazine. That, reports Forbes, makes the Nets’ debt-to-value ratio the highest in the NBA, if not professional sports, at 71%. The Nets have three large creditors, J.P. Morgan Chase; GSP Capital, owned by Sal Galatioto, a New York sports financier; and the NBA itself. Forest City recently restructured a lot of the Nets' debt.

In addition, a second insider says Ratner and Forest City has paid out more than $150 million in upfront costs on the arena, including property acquisition, legal costs to defend critics’ litigation and architects’ fees for both Frank Gehry, who was dismissed earlier this year, and his replacement, Ellerbe Becket. The "love affair" with Gehry, as one insider described it, led to architectural costs of just over $12 a square foot for the project, according to the internal Forest City documents. That’s roughly three times the industry average and while that might have been viable in 2005 or 2006, "it’s not financially viable…period", said an insider.

The carrying costs are high and a second insider noted, "if he had just waited (on the property acquisition), we could have waited forever" on the critics lawsuits. Now, however, they have the carrying costs, including mortgages, taxes, etc. on the property he bought…not to mention the legal fees.

Like many in the construction business, Ratner has been hurt by the economic downtown. Much of his net worth has been in the stock of Forest City Enterprises. He restructured most of his real estate holdings with Forest City, his parent company, in return for stock in August 2006. The stock was hovering around $50 at the time. Since then, it has plummeted, dropping to under $4 a share a year ago. It is still below $10.

Are the Nets in danger of bankruptcy like the Phoenix Coyotes of the NHL?

No. The team is fully funded through this season.

Other than the lease, what is the biggest impediment to a sale?

Complicating any deal is the capital structure of the Nets, the arena and the larger project known as Atlantic Yards. There are three separate corporations with three separate if somewhat overlapping groups of investors: Nets Basketball, which owns the team; Brooklyn Sports and Entertainment, which is the arena holding company; and Atlantic Yards Development, which would develop the commercial, retail and housing at the Brooklyn site. Overall, nearly 100 individuals, partnerships and corporations have invested in the three entities.

"You have Forest City Ratner (Ratner’s parent company), Vinny Viola and his associates, remnants of the Secaucus Seven (a previous ownership group), and a variety of dogs and Katz," said one insider, referring to Lewis Katz, one of the owners who sold out to Ratner (and still sits on the NBA Board of Governors as the Nets representative.)

Ratner’s original plan called for Nets Basketball to operate the team for no more than three years, then sell it off as the arena was completed, said the insider. In the original plan, Atlantic Yards would have been built in a single phase, not stretched out over many phases and years, as it is now, he added. The unanticipated delays caused by the critics’ litigation ruined that plan. Then, the recession intervened, further complicating matters, but the capital structure remains.

"The capital structure isn’t conducive for long term operations. It was more in-and-out," said one insider.

How critical was the critics’ legal strategy?

Two insiders offered begrudging praise for the critics’ legal plan, noting that they first took it to federal court, then state court. Even without a victory, that sequencing slowed the legal process to a crawl. It was "brilliant", said one insider.

As delays stretched out, investors were asked to help fund team losses. Each June, investors were presented with a "capital call", a bill for their share of the team’s projected losses for the coming season. In the first few years, 90% of the investors met their call, but as the losses mounted, more and more investors defaulted on their commitments. In 2006, the Nets went into the capital markets and borrowed $60 million from Galaitotto to shore things up. Still, delays with Brooklyn continued and losses mounted. Forest City Enterprises, Ratner’s parent company, agreed to fund all of the losses, including those anticipated for the upcoming season.

"You have to give them credit for stepping in, but now they’re saying ‘we’re done’" said a team insider who added that if for whatever reason Atlantic Yards fails, Forest City faces big problems. "For them, this is their key development opportunity. " They have invested a gigantic amount of capital into the project according to Forest City Enterprises public filings and there would presumably be a significant write-down of a good portion of that investment if it fails."

Will the critics succeed in derailing the whole project?

The top brass still believe, in the words of Brett Yormark, "Brooklyn is inevitable". They believe they will prevail in the Court of Appeals decision and will be permitted to move forward, that the Empire State Development Corp. will approve the "master closing" and begin condemnation proceedings as quickly as possible.

They are also convinced the financing will be available. "Goldman Sachs is confident the team will get the financing," said an insider.

Still, they admit, all the delays have made them gun shy. "Bruce would like to break ground in October," said another insider, expressing skepticism at the same time.

Why are the Nets in such financially distress?

The Nets’ inability to attract fans to the IZOD Center is the biggest reason for the team’s escalating financial problems. "Attendance is the issue", said one insider.

As CBS Sports reported, the Nets ticket revenue dropped 29% between 2007-08 and 2008-09, even though official attendance dropped only 3%. Specifically, two seasons ago, the team brought in $45 million in ticket sales. Last season, it dropped to $32 million and could go even lower again this season. Already, season tickets for next season are being discounted as much as 30% less than last season’s. (In 2006 financials, the Nets projected they would net $44.5 million in ticket sales in 2008-09, then jump to $67.4 million in Brooklyn in 2009-10.)

"The Knicks make twice that," said one NBA insider, referring to the $32 million figure.

Those same 2006 financials show that like many NBA teams, the Nets have two attendance figures, the official number and the "turnstile" number, a closely guarded corporate secret. In 2005-06 the Nets’ turnstile number was 15,475. That's 1,411--or 8.3%--less than the official number, which was 16,886…and that was a very good season for the Nets. Same thing is true with the turnstile number vs. the official number in 2004-05. The turnstile number was 13,300. Official number was 15,089. That's an 11.8% difference. So the official numbers can reflect a double-digit inflation in attendance.

What about other sources of income?

The Nets have done well in sponsorships, "but you can only hang so many logos around the IZOD Center," said an insider. Despite that, "Yormark has done a fantastic job of selling" said the insider. The Nets regularly bring in about $15 million in sponsorship revenue annually, according to the 2006 financials. That’s triple the $5.4 million they got in 2004-05. The Barclays naming rights alone will bring in $20 million. By comparison, the IZOD naming rights, minus a fee paid to the Nets, go directly to the New Jersey Sports and Exposition Authority. That deal pays only $1.4 million per annum.

The Nets are also at a disadvantage in another big revenue stream, local television rights. YES, which is owned in part by the Nets’ last set of owners, will pay out only $9.6 million to the team this coming season, according to the 2006 financials. The Nets believe that’s about 40% of fair market value for a team playing the nation’s largest television market. The YES contract runs through 2013-14, said an insider, although the Nets can reportedly go to an arbitrator in the final year.

With the team in Barclays Center and a good product on the court, the team hopes it could set the television rights’ price at between $20 and $26 million in the next contract, more that double what it will get in any year of the current contract. YES has also indicated a willingness to reopen negotiations before that, believing Brooklyn will make the Nets more marketable, the insider said.

The other big revenue stream is what the Nets and all the other 29 teams get from the NBA in equal measure: a percentage of national television and merchandise rights. That amounts to about $35 million a year. (Even though the Nets will have nearly all (if not all) their games broadcast in China this season, none of that revenue goes to the Nets. Instead Chinese broadcasters pay the NBA, which puts the money in the TV rights pool. The Nets do make money on selling Chinese companies advertising on the revolving signage below the scorers’ table.)

Are Nets smaller investors happy with the state of things?

No. Insiders say there’s been increasing dissension among smaller investors for the past two years and now that’s coming to a head (and thus their willingness to talk.) They’re not likely to walk away with any additional money.

"No one’s going to make money out of this," said one insider, noting the huge amount of capital—approximately $600 million--already sunk in the team, the debt, etc. "There will have to be a recapitalization." What’s likely to happen is that whoever wins the auction will get a big chunk of the team (and presumably the arena) with smaller investors having their percentage ownership cut substantially. But with that will come the likelihood of future profits.

Where’s Jay-Z going to end up in all this?

Like everyone else, his ownership percentage will be reduced, but there’s no indication any of the new owners would want him gone…or in a reduced role. Viola and Semel are, like Jay-Z, local Brooklyn guys who did well, even if in different ways or under different circumstances. Don’t be surprised to see him at a press conference announcing the team’s sale.

What might new management look like?

Think "Money Ball" if it’s Viola. His companies are built on algorithmic trading of commodities. He believes in slicing and dicing data and he has the talent on hand. One insider says don’t be surprised if Viola sends one of his more hoop-savvy traders to the Nets for an apprenticeship…or more.

Also expect a significant reduction in the pay of top management no matter who the new owners are. Rod Thorn, Kiki Vandeweghe, Brett Yormark and Lawrence Frank make more than $12 million a year combined. Thorn and Frank are on the last year of their contracts. Yormark is under contract til 2013. Some investors are reported to believe that Thorn and Frank in particular make too much money. David Stern has told teams they should be reducing coaching salaries.

What about the arena?

As reported, it will not look like the preliminary design published in the New York Times, but it "will look like a field house" with a Brooklyn theme, said an insider. The interior, as has been reported by Sports Business Journal, will be tight, like Madison Square Garden, but unlike the Garden, there will be no hockey option. While that may limit revenue potential—no Islanders—it will get fans closer to the action since a hockey pad is much larger than a basketball court. Suites have been downsized to take into account the suite glut in the New York area. The Nets will now be marketing a wide range of suite sizes.

Suppose it doesn’t work. What happens then?

"The team will be sold to whoever can pay for it," said an insider. "They could wind up in Seattle or St. Louis." A sports marketing expert agreed, suggesting that Brooklyn gets less and less likely every day.

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