AEG Changes The Tune

Only eight short years ago, Anschutz Entertainment Group (AEG) was playing a much different tune then they are today. Back then, the owners of the Kings were complaining in the newspapers about how much money they were losing on the team and why the Hockey business model was unsustainable. In fact, Tim Leiweke even told season ticket holders that the team could not compete for the top talent as long as salaries, and hence costs, continued to escalate well beyond revenues. Yet today, in an era where neither team nor arena revenues have appreciated significantly, we see the Kings spending close to the salary cap of $64.3 mm and well beyond that when one considers that many of the current player contracts are heavily front-loaded. Despite what has to be significant and growing operating losses at the team level, we are hearing nary a peep from ownership about how much money they are losing or how difficult it is to operate a hockey franchise. So, what gives?

I believe there are several intersecting factors that have resulted in a changed environment from eight years ago and are resulting in AEG significantly loosening their purse strings even to the point where huge losses on the Kings are acceptable. Let’s take a closer look. While season ticket prices have not risen appreciably over the past eight years, the NHL finally has gotten a meaningful national television deal from NBC/Versus, not large enough to stop losses for the Kings but certainly sufficient to mitigate them. In addition, there are no more player buyouts or deferred compensation payments left over from deals negotiated by previous owners. Put another way, the team’s income statement is becoming healthier even as player salaries escalate.

This alone does not explain AEG’s new willingness to spend money to improve the roster. For this we have to look at the company’s other business interests. The primary investment AEG has in Los Angeles is the real estate the company owns in the downtown business district. Much of this has been developed into apartments, condominiums and retail, most notably the company’s 27 acre LA Live project. Success here depends greatly on the amount of foot traffic that comes downtown for the various entertainment events. While visiting Fleming’s, one of the restaurant tenants three weekends ago, I asked the waitress how they could make it with ¾ of the tables empty on a Saturday night. She answered that the wait for a table was two hours on evenings that the Lakers play at Staples. Given that some of the retail tenants may be on percentage leases, AEG has to be enormously motivated to add over 40 (including playoffs) additional busy nights through a hugely successful Kings team. Revenues generated as a landlord have much higher margins than running a hockey team, and, best of all, are recurring with very little effort required to retain them. As a private company not answering to shareholder pressure, AEG has the ability to use the Kings as a loss leader in order to provide economic synergies to their more profitable businesses.

This is before we even discuss the elephant in the room, the NFL. AEG has already received preliminary approval to build a football stadium adjacent to Staples Center. With financing already in place, the only contingency remaining before the stadium can be built (other than the formality of an environmental impact study) is having an NFL team that is committed to move downtown in 2015 when the facility can be completed. While convincing an existing team to move here is a possibility, this presents several problems. Once a team announces it will move, the fans in the city where it will play the next four seasons before AEG’s Farmer’s Field is finished are unlikely to support the team. Besides, an existing owner will have the benefit of having his team play in a state of the art stadium filled will profitable luxury suites without having to risk any of his own capital building the facility. AEG knows from owning both the Kings and Staples Center that it is more tax efficient to own both the stadium and its tenant. This is because profits made at the stadium can be sheltered from taxation by the huge amount of depreciation that is generated from the initial capital expenditure.

Therefore, AEG likely badly wants its own team, either through expansion or from the purchase of an existing franchise. Either of these options is going to require the permission of the NFL, and it is hard to believe that AEG will be the only suitor for a team to play in the nation’s second largest television market, their ownership of the stadium notwithstanding. AEG has proven its success in real estate development, but their history as owners of a professional Hockey team has, to put it charitably, been mixed. Some others would use harsher terms. Hence, it is essential for the company’s wider business interests to prove to the NFL that they can operate a successful team in a major sport. Here we find the real reason why Dean Lombardi has been given carte blanche to spend what it takes to ice a winner. AEG badly wants to win now for business reasons, and the fans are the beneficiaries. The flip side of this is that the pressure from ownership on Lombardi and Coach Terry Murray to win and go deep into the playoffs this season is enormous. Anything less and we could see some significant management changes made as AEG pursues its quest to enter the NFL.