Latepost Valuing Athlete Earning Potential? Tracking Arian Foster!

In a calendar week during which both Google together with Netflix striking all-time highs, yous would hollo upwardly I would pick 1 of these high fliers for special valuation attention. While I notwithstanding invention to facial expression at these companies, I am going to pass this calendar week on a quirky valuation challenge: valuing tracking stock on a star athlete’s futurity income. Last week, a fellowship called Fantex filed an S-1 (prospectus for a forthcoming safety issue) alongside the Securities Exchange Commission, making world its intention to issue tracking stock on Arian Foster, a star running dorsum for the Houston Texans inward the National Football League (NFL). In the filing, Fantex reported that it had paid $10 meg inward early on Oct to Mr. Foster inward provide for 20% of all contract together with endorsement income that he volition earn later on Feb 28, 2013. The S-1 also specifies that Fantex plans to heighten to a greater extent than or less $10 meg (thus roofing its outlay) from the issuance of 1.055 meg Arian Foster tracking shares to the public, together with usage its portion of Mr. Foster’s income to pay dividends to these shareholders. The motion-picture demo below captures the initial laid up: 

Fantex intends to usage its platform to attract to a greater extent than athletes together with celebrities into the mix, thence creating a portfolio of tracking shares that tin locomote traded past times investors. 

Arian Foster: Background 

Arian Foster was born on August 24, 1986, together with is a running dorsum for the Houston Texans. He played college football game at the University of Tennessee together with was signed every bit an undrafted gratuitous agent past times the Texans inward 2009. In 2010, he had a monster year, leading the NFL inward rushing, yards from scrimmage together with touchdowns. He continued alongside impressive performances inward 2011 together with 2012, every bit tin locomote seen inward his career statistics page. 

Arian is also clearly a self-promoter (in the best feel of the word) together with has aspirations beyond the gridiron. He has his own website, where he characterizes himself every bit an all-pro running back, entrepreneur, philosopher together with father. 

On March 5, 2012, Arian signed a five-year contract alongside the Texans worth $43.5 million. The contract had a guaranteed payment of $20.75 million, including a signing bonus of $12.5 million, his get-go twelvemonth salary (2013) together with $3.25 meg of his instant twelvemonth salary (2014).  He is also entitled to bonus payments, based on surgical physical care for inward games, of upwardly to $5.25 meg inward 2013, $5.75 meg inward 2014, $6 meg inward 2015 together with $6.5 meg inward 2016. He is a gratuitous agent inward 2017. 

Claim together with Contract details 

To value the claim on Arian Foster’s income, yous bespeak to interruption downwards the cash flow claims that yous have got on the income. Note that patch Fantex has a contractual claim on 20% of Foster’s futurity income, investors inward the tracking stock don’t have got that direct claim. Instead, they are subject on the dividends that Fantex chooses to pay out from that income. 

As noted inward the figure, in that location are at to the lowest degree ii expenses that Fantex volition incur that volition create the dividends paid less than the income that they instruct from Foster. The get-go is that a portion volition locomote laid aside to encompass the expenses associated alongside managing together with maintaining the Fantex platform. The instant is that Fantex views its purpose every bit non but a contractual intermediary but also every bit a create edifice organization. Effectively, that implies that Fantex tin together with volition usage some of the Foster income to marketplace seat him amend (and hopefully increase endorsement income). 

To value the Foster tracking stock, nosotros volition locomote through 3 steps. In the first, nosotros volition lay out broadly the risks faced past times investors inward the tracking stock. In the second, nosotros volition value the cash flow claim that Fantex has on Foster’s contract together with endorsement income. In the third, nosotros volition evaluate the claim that investors inward the Foster tracking stock have got on the dividends they have from Fantex.

The Risks 

The S-1 goes to smashing lengths to emphasize the indicate that this is a speculative investment, but since that should have got been obvious to anyone thinking close the investment, it is of import that nosotros interruption downwards the risks at each phase of the process: 

Working the risks through the pipeline, hither at the layers of risks that nosotros see, starting alongside risks to the earning current together with and then moving on to risks inward the intermediary together with ending alongside risks at the investment level.

Earnings Risks

1. Player Risks

The most immediate impact on instrumentalist net comes from the athlete alongside ii large risks to earnings: injuries that are career ending or a drib off inward surgical physical care for skills, either every bit a resultant of historic catamenia or before injuries.

1.1. Player Skills/Longevity

A. Player Injuries: If yous are laying claim on a professional person athlete’s futurity earnings, yous are exposed to whatever injury/event peril that impedes his or her capacity to perform on the field. Part of this peril tin locomote mitigated at the contract level, if yous have got guaranteed income (that volition locomote paid fifty-fifty if the athlete is injured) but it volition notwithstanding touching on the athlete's net mightiness inward price of getting contract renewals & bonus income.

Arian Foster shares: Foster's guaranteed income on his contract has dwindled downwards to $3.25 meg together with almost all of his remaining income volition locomote at peril if he is injured. While Foster has been durable through his early on years, in that location are ii reasons to worry. The get-go is that he but hurt his hamstring this season, an injury that may maintain him out for a portion of the flavour together with may locomote a harbinger of things to come. The instant is that injuries tend to climb every bit athletes age, together with specially so for running backs whose bodies have got meaning penalization on the field. 

1.2. Player performance

While a player’s electrical current contract may locomote unaffected past times declining performance, in that location are ii reasons why it volition feed through into the net claims. First, if in that location are bonus payments, every bit is the illustration alongside Arian Foster, they volition clearly locomote position at risk, if surgical physical care for deteriorates. Second, to the extent that yous are counting on a continuation of net from a contract renewal (from the electrical current squad or some other team), futurity net volition locomote lower, if the player’s surgical physical care for deteriorates. 

Arian Foster shares: Age has to locomote factored into the equation since he is 27 inward a sport where running backs seem to historic catamenia faster than everyone else inward the field. One assessment of running dorsum output based on historic catamenia yielded the next graph on production for running backs (and quarterbacks): 

Note that output for running backs peaks early on (24-25), levels off until close 27 together with starts deteriorating later on that age. Foster may rattling good locomote the exception to this rule, but it is unsafe to bet against history. 

2. Macro Factors

There are ii macro degree peril factors that tin touching on a player’s earnings. 

2.1. Collective Bargaining Constraints

In most sports, in that location is a players’ matrimony that negotiates alongside squad owners on both contract rules together with constraints. While private players may negotiate on their ain behalf alongside teams, the constraints imposed past times collective bargaining agreements may touching on net potential for private players. For instance, the hard caps on squad payrolls imposed inward the NBA together with NHL together with fifty-fifty the soft caps inward the MLB (soft, because they tin locomote over the cap every bit long every bit they pay the penalty tax) have got affected instrumentalist negotiations together with contracts. 

Arian Foster Tracking stock: The NFL’s electrical current salary cap is $123 meg per squad together with each squad is required to spent to a greater extent than than 95% of that cap. Both teams together with players, though, have got instruct practiced at evading the cap constraints past times loading to a greater extent than of the payment into futurity years. With Arian Foster, I am going to assume that this volition locomote a shaver factor. 

2.2. Economic factors

The magnitude of a player’s net may locomote affected past times the overall economy, specially if a large proportion comes from endorsement income together with that income is expected to grow over time. The growth inward the aggregate economic scheme tin also touching on revenues to a sport inward the aggregate together with thence indirectly touching on how much tin locomote paid out inward contracts to players. 

Arian Foster Tracking stock: Since exclusively a pocket-size portion of Foster’s electrical current net (less than 1 million) came from endorsements inward 2013, the impact of the overall economic scheme on his net is probable to locomote small. 

3. Player Default 

Even if the athlete inward enquiry generates high earnings, the net current to investors is subject upon that athlete carrying through his side of the contractual understanding together with delivering the promised portion of net to investors. If the athlete defaults on that obligation, your net downwards current are at risk. You could, of course, seek legal recourse but given that an athlete who defaults is also probable to have got other fiscal problems, it is unlikely that yous volition instruct much of your promised payback. 

Arian Foster shares: We have got petty testify on Arian Foster’s default history. The strongest illustration that tin locomote made for him is that he is ambitious together with hopes to parlay his pro career into entrepreneurial ventures. Presumably, that volition hateful that he volition non locomote cavalier inward defaulting on contract obligations. That does non hateful that in that location is no default peril but nosotros volition assume depression default risk. 

4. Intermediation Risks

Investors don’t have got a direct claim on Arian Foster’s earnings, since those net volition locomote get-go collected past times Fantex, which volition together with then determine how to much of these net volition locomote returned to investors every bit dividends. Consequently, in that location are 3 additional risks to constituent into the assessment: 

4.1. Poor create edifice investments

Fantex views itself every bit a create builder for the athletes who determine to usage it. That would imply that some of the net collected from the athlete volition locomote spent inward trying to increase net inward the future, primarily from endorsements. There are no guarantees, though, that this merchandise off volition locomote a positive one. Thus, it is possible that Fantex volition expend 20%, 30% or fifty-fifty 50% of Foster’s earnings, trying to increase his marketability, alongside no discernible lawsuit on endorsement earnings. 

4.2. Spillover risks

 One of the stranger features of the Arian Foster stock is that investors inward the stock may locomote called upon to comport losses incurred past times Fantex on other athletes that it may have got inward its portfolio. Thus, if Fantex makes a large upwardly front end investment inward a potential superstar (Andrew Luck) together with that star suffers a career ending injury, investors inward the Foster stock may have got a hit. 

4.3. Corporate governance risk

The nature of tracking stock is that holders of the stock are onlookers when it comes to corporate governance, since they have got no mightiness to alter or fifty-fifty influence managers. This is going to locomote a constituent on ii levels. The get-go is that Fantex volition have got a portion of the collective revenues it gets from instrumentalist net to encompass administration expenses & fees; if it keeps “too large a portion” of the net for these expenses, in that location is petty recourse for yous every bit an investor. The instant is that Fantex is non required to pay the residual net (after create edifice expenses, administration expenses together with other portfolio charges) to investors) every bit dividends. While this is ever a work alongside publicly traded fellowship stock, investors inward conventional shares instruct a claim on the cash residuum which may compensate (at to the lowest degree partially) for the unpaid dividends. There is no such compensating claim alongside tracking stock. 

5. Investment Risk

If yous are an investor who decides to purchase Arian Foster tracking stock, in that location is 1 finally peril that has to come upwardly into the picture. Since in that location is no create marketplace seat (yet) for these shares, it may locomote hard together with expensive to liquidate these investments. In valuation, that is by together with large a argue for either charging a “illiquidity premium” inward your discount charge per unit of measurement (increasing the discount rate) or attaching an “illiquidity discount” to the value. The extent of the lawsuit volition depend upon how much yous value liquidity every bit an investor together with how easy/difficult it is to merchandise these shares. 

Arian Foster tracking stock: Since this is the get-go laid of tracking stock, I volition assume that in that location is substantial illiquidity risk. That peril may pass upwardly over fourth dimension every bit to a greater extent than athletes instruct listed together with the Fantex trading marketplace seat becomes to a greater extent than liquid, but neither is a reality yet. 

Valuing the Fantex Claim 

To value the claim on Arian Foster's earnings, I began past times forecasting aggregate net to Arian Foster. In making these forecasts, I assumed that:

1. Expected playing time: I volition assume that Foster volition play for nine to a greater extent than years, until the historic catamenia of 36, at which indicate both his contract income together with his endorsement income volition end.
2. Current contract: The electrical current contract would deliver on the remaining $23.5 meg due betwixt 2013 together with 2016. On average, that plant out to $5.875 meg a year. During the electrical current contract period, I volition also assume that he volition earn to a greater extent than or less $2 meg inward bonuses each year, to a greater extent than or less a tertiary of his overall potential bonus payments.
3. Contract renewal: At the destination of the electrical current contract period, I am assuming that Arian Foster volition instruct resigned to a novel contract for the relaxation of his, worth $4 meg a year, assuming that his historic catamenia (31) together with the production pass upwardly that comes alongside historic catamenia alongside touching on his earning power. I volition also assume a pace downwards inward bonus income to $1 meg a twelvemonth for the relaxation of his career.
4. Player fines/penalties: Given Foster's create clean history together with the seat he plays, I volition assume no dollar penalties volition locomote imposed on his during his lifetime.
5. Endorsement Income: Arian Foster's endorsement income inward 2013 was $687,750 (though some of it is contingent on performance). I volition assume that in that location is substantial growth potential (10% annual growth rate) inward this income.

To value the cash flows, I have got to create assumptions close instrumentalist together with default risk. For instrumentalist risk, I volition assume that in that location is a 5% probability of a career ending injury each year, resulting inward cumulative probabilities that volition increase over fourth dimension (to 37% past times the finally year). For default risk, I volition assume that Arian Foster's history & wishing for commercial success volition maintain default peril depression (a default spread of 1.50% together with a discount charge per unit of measurement of 4.1%). volition locomote added to the peril gratuitous rate. For endorsement earnings, I volition assume that in that location is depression exposure to macroeconomic risk, resulting inward an equity peril premium of 3% (and a discount charge per unit of measurement of 5.60%). The tabular array below captures the cash flows, discounted value together with the value today (with the link to the spreadsheet).

The value of the claim on Foster's net to Fantex, based on these assumptions, is $10.06 meg (before accounting for expenses together with injury probabilities).  Fantex paid $10 meg to instruct these claims, this looks similar a interruption fifty-fifty grapple for both sides of the transaction, alongside Arian Foster having the slight edge.

Valuing the Tracking Stock

To value the tracking stock, I have got to constituent inward the drains on the cash flows from administration expenses together with branding investment, every bit good every bit the additional risks from non getting a direct claim on the earnings. For the first, I volition assume that administration expenses volition eat 5% of the flow through net (as specified inward the S-1) together with branding investments volition work organisation human relationship for 15%, leaving 80% of the net every bit residual earnings. While I volition assume that all of the residual net volition locomote paid out every bit dividends, Fantex has no history (good or bad) inward this honour together with I volition add together an extra 3% to my discount rates to capture my absence of whatever corporate governance mightiness (over either expenses or dividends). Finally, I volition contain an additional premium of 3% inward my discount charge per unit of measurement for illiquidity, since it is unclear to me how I would instruct out this investment, without bearing meaning costs. The value of my claim is illustrated below (with the link to the spreadsheet):

Specifically, I volition locomote willing to pay $6.11/share for the Adrian Foster tracking shares, alongside my assumptions. There is a conversion characteristic on these shares, but it tin locomote exercised exclusively past times the fellowship to convert these tracking shares into Fantex platform shares; that selection volition create my claim less valuable, non to a greater extent than so. Consequently, I would non locomote a buyer at the $10 portion cost that Fantex has tentatively tagged the shares every bit worth inward the S-1 filing.

Update: In both the Fantex together with tracking stock claim valuations above, I did non contain the injury probabilities. Since I have got an estimated probability that Foster volition locomote playing inward futurity years, I decided to contain that probability into the value together with non surprisingly, it brings both numbers down:

Note that in that location is exclusively a 63% peril that Foster volition locomote playing inward twelvemonth nine together with the value of the Fantex claim drops to $8.2 million, giving Foster the clear border on the deal, together with the value per claim drops to $5.07. 

Arian Foster Tracking Shares S-1 filing

My valuation of Fantex claim/ Tracking Stock

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