Diamond Sports Group’s Bankruptcy Could Rock the Baseball Revenue Boat by Ben Clemens January 30, 2023 Albert Cesare/The Enquirer / USA TODAY NETWORK At this point in the offseason, the micro-level events that will shape the 2023 baseball season have almost all been settled. Aside from the odd trade, teams have largely set their rosters. Injuries, unexpected performances, and trades will start to affect individual fortunes when games begin, but we’re at a local lull. But there’s big news afoot for the game in a macro sense. Diamond Sports Group, the company that owns Bally Sports Network and thus the rights to 14 teams’ local broadcasts (plus minority stakes in two team-owned broadcasts)*, is careening towards bankruptcy. Per Bloomberg, the actual bankruptcy declaration is merely a formality: the firm will reportedly skip an interest payment due in February, triggering a restructuring that will wipe out the firm’s existing equity and convert all but the most senior debt into equity stakes in the new company, leaving its current creditors in charge. That’s a shocking turn of events for a media group that sold for more than $10 billion in 2019. Heck, it’s a shocking turn of events for a company that made more than $2 billion in revenues in the first nine months of 2022, and more than $3 billion in 2021. It might also affect long-term cashflows for every team in the league; after all, local broadcast rights are a key piece of the revenue pie, and broadcast rights have exploded along with MLB revenues in the past decade. How could this have happened? Which teams will be impacted, and what will that impact be? How will the league adapt to the new media landscape brought on by this bankruptcy and any subsequent dominos that fall as a result? I don’t have the answer to all of those questions, but I’ll walk through each in turn before speculating about what might happen next. The easiest thing to figure out is how this happened. In early 2019, Sinclair Broadcast Group purchased the Fox Sports Networks brand and its associated networks from Disney as part of Disney’s acquisition of 21st Century Fox. They bought it via a subsidiary called Diamond Sports Group, which is an annoying bit of corporate legerdemain that allowed Sinclair to keep the business at arm’s length and decline to backstop it if things went wrong. That set this entire chain of events into motion. See, Sinclair didn’t buy this large collection of regional sports networks with cash. They used some financial sleight of hand known as a leveraged buyout. They paid $9.6 billion to Disney for the business (other investors put in $1 billion to make the aggregate purchase price $10.6 billion), but they didn’t do so by peeling an unending string of crisp new hundreds from their wallet. They only put up $1.4 billion of their own money, in fact. The remainder was covered by $1.8 billion in senior debt, $3.1 billion in secured debt, and $3.3 billion in a subordinated term loan facility (read: $8.2 billion in borrowed money). In some sense, this bankruptcy was preordained. When Sinclair opted for a debt-enabled purchase, they considered these risks extensively. In fact, there’s no doubt about the way they thought. Scour the prospectus for one of the notes they issued, and you’ll find 22 references to bankruptcy, as well as an interest rate that assumed some chance of default. That’s hardly unusual in debt financing, but the point remains: behind all the ponderous wording that pervades financial documents, these bonds were issued and purchased with the understanding that Diamond Sports Group might not be able to make all of its payments. One peek at their financial reports could tell you that. Leveraged buyouts have a reputation as bankruptcy-inducing, and it’s well-earned. Taking on large debt burdens to pay for a purchase gives the resulting company less wiggle room. Think of it this way: if you have a carwash business that makes $1,000 of profit each year and business declines by 50%, you’re still making $500. If you owe $530 dollars in interest payments every year thanks to some debt you took out on that business, though, you’re suddenly in the red. Why take that debt out in the first place? Let’s stick with the carwash example. Let’s say that your good friend John Disney has a carwash business that is clearing $1,000 a year in profit. He wants to sell it to you for $10,000. Bad news, though: you only have $2,000. He gives you two options: you can either buy 20% of the company, or take out a loan for $8,000 and buy the whole thing. Let’s further say that the loan pays 6.625% interest, the rate on one of Diamond’s bonds, to inject a bit of reality. Consider your two options. If you bought 20% of the company, you’d make $200 a year, 20% of its $1,000 profit. If you instead took out the debt and bought the whole company, you’d clear $470 a year – $1,000 in profit minus $530 in interest payments. In each case, the transaction costs you $2,000 out of pocket. As an added kicker, interest payments are tax deductible for arcane (read: rich-getting-richer) reasons, so it’s clear which transaction is more attractive. That’s not to say it’s without risk. In our example above, a 50% decline in profit would send you to bankruptcy if you had taken out debt. You’d owe $530 every year, and only have $500 in profit to pay it with. If you’d opted for the 20% stake instead, your profit would be cut in half, but with no debt to service, you’d survive. That’s the tradeoff in leveraged buyouts: more steady-state profit, but a higher risk of ruin due to downside variance risk in operating profits. Diamond Sports Group hit that downside risk head-on. I’m sure that you could produce a discounted cashflow model that valued this bundle of regional sports networks at nearly $11 billion in 2019, particularly when taking into account some nebulous synergy that Sinclair could claim. Perhaps they could exert pricing power on cable companies, perhaps they could cross-sell; that’s beyond the scope of my analysis, and frankly I don’t care. The point is, they thought of these networks like our carwash. Thanks to their subsidiary model, Sinclair isn’t on the hook for those debt payments; Diamond Sports Group is. Diamond Sports Group’s profits have been less than expected, and now they don’t cover interest payments. Sinclair owns Diamond Sports Group, but for all intents and purposes, that’s no longer the case; if, as is widely expected, DSG fails to make an interest payment in February, the debt holders will be the new equity holders, and the DSG board is already acting independently of Sinclair. The reasons for this failure are myriad and interrelated. Did the structure of the purchase set DSG up to fail? Yes. Did the COVID-19 pandemic and the resulting shortening of several sports’ 2020 seasons lead to financial difficulties? Yes. Did continued cord-cutting erode the carriage fees that DSG was able to collect to offset its rights payments, as Travis Sawchik detailed last year? Yes. Did the Bally Sports rebranding work? It certainly doesn’t seem so. As Daniel Epstein noted at Baseball Prospectus, Sinclair went about their merry way with stock buybacks while DSG was burning, which is certainly a bad look. To be honest, though, I don’t think that was the culprit here, even though it indisputably weakened Sinclair’s financial position. Per DSG’s audited financials, they received $2.4 billion in “capital contributions from parent” in 2019. You can read that as pure cash put into the company, debt financing excluded. Conveniently, there’s another line in there, “distributions to parent,” that lets us know how much money actually flowed out of DSG. That amount comes to $920 million across the entirety of DSG’s existence, $500 million of which was in redemption of preferred shares. In other words, DSG’s parent companies put in roughly $2.5 billion and got back $1 billion. They took a $1.5 billion loss – ouch. To put it in words that Sinclair might appreciate, Diamond Sports Group stood athwart the tide of media history yelling “Stop!” – and the forces changing the media landscape merely laughed and cast DSG aside like a rag doll. Financial shenanigans notwithstanding, this investment worked out tremendously poorly. That doesn’t mean that the regional sports networks underpinning DSG are worthless. In fact, we’re likely to see how much they’re worth later this year. The bondholders who will own the company are high-yield/distressed debt experts, but they aren’t media companies. Prudential Financial (side note: “It was an insurance run, so I hit it to the Prudential Building” is one of my favorite baseball quotes of all time), Fidelity, and Mudrick Capital are among the chief bond holders. They’ll likely sell off the company after it emerges from bankruptcy and restructuring. The details of that restructuring are important, and have broad implications for the baseball teams whose rights DSG currently holds. Bankruptcy will give them the option to end or renegotiate rights contracts, which could result in major league teams not getting broadcast money this year. I find that to be unlikely, given that the creditors want to sell the network after it emerges from this restructuring. Who would buy a regional sports network with no sports to show? But there’s certainly an increased risk of missed payments or renegotiated contracts here. One thing that should give teams at least a small sliver of confidence: this bankruptcy has to do with debt service, not a catastrophic business failure. In 2021, DSG was profitable before interest payments, taxes, depreciation, and amortization – they recorded a positive EBITDA, as they say in finance. The same was true in 2020, and while we don’t yet have financial statements for full-year 2022, the group was profitable on an EBITDA basis for the first nine months of 2022. Sure, cord cutting and economic turbulence might have put a crimp in expected profits, but the books still balance – at least, if not for those pesky debt payments, which totaled $436 million in 2021 and $415 million in the first nine months of 2022. Of course, breaking even isn’t as good as making a profit from a financial perspective, so DSG’s new ownership is likely to look for ways to either cut costs or expand revenue. The group is currently experimenting with a streaming service to capture some of the audience they’ve lost due to cord cutting, though early results have been lackluster. MLB recently hired Billy Chambers, a former Fox Sports and Diamond Sports executive, as Executive Vice President for Local Media, which suggests that they’re at least open to working out some kind of rights-sharing deal with the reconstituted networks. Sources reported to Bloomberg that DSG is also open to “bringing in teams and leagues as equity partners,” so maybe there’s some kind of deal to be worked out here that ends up netting teams an even bigger piece of the pie in exchange for payment leniency in the short run. Quite frankly, there’s a lot we don’t yet know about how rights deals will be renegotiated. While there’s definitely potential for short-term losses, and it’s always possible that sports broadcast rights are a long-term bubble, there’s not much indication of that being the case right now. The league added $115 million annually to their bottom line in deals with NBC and Apple in exchange for the exclusive rights to 100 games just last year. There’s clearly still an appetite for sports rights, and with Google recently scooping up NFL Sunday Ticket, another streaming goliath is now angling for games. I’d be most worried about the future of local broadcast rights for teams that recently signed new deals with DSG. The Brewers signed a new deal in 2021, though the exact terms haven’t been reported. The Marlins signed a new one worth between $40 million and $50 million per year at the same time. The Royals signed a deal worth roughly $50 million per year in 2020. The Tigers signed a new deal after the 2021 season worth more than $50 million per year, though the terms aren’t public there either. Quite frankly, none of those deals look like an egregious overpay to me, and I doubt that the Detroit and Milwaukee pacts were huge outliers. They’re in line with deals signed in similar markets a half-decade ago, and while cord cutting continues apace, rights deals in other sports (signed by non-Diamond Sports Group networks) don’t give much indication of a bubble popping. Whichever media company ends up with what’s left of Bally Sports, or even whichever media companies if the rights get divided up in a sale, they’ll still have to deal with the market forces that have made sports such an attractive tentpole in a fragmented TV landscape. I don’t mean to say that the sports media rights bubble will never burst. That question seems unanswerable to me today; it’s certainly a possibility, but that was going to be the case whether or not the Diamond Sports Group transaction fell apart. That doesn’t make what happened any less objectionable, or the use of leveraged buyouts to arbitrarily add default risk to any random business less annoying. Fox Sports Network was a completely fine business before Disney was forced to sell it for regulatory reasons; the big problem here was the debt. I think it’s likely that broadcasting sports on regional networks is less lucrative now than it was in 2019, but well, duh. That doesn’t mean it’s suddenly unprofitable; it just means that the particular structure that Sinclair used to spend $10 billion when they only had $2 billion on hand didn’t work out. Teams will likely use the potential of missed rights payments to talk down spending, but it’s not clear whether any payments will actually be missed. It’s certainly possible, but given the amount of cash DSG already has on hand and the expected carriage fees they’ll collect, they could almost certainly meet all of their rights obligations this year. They took in $2.145 billion in gross revenue in the first nine months of last year, and they have another $600 million or so in cash on hand. They reportedly pay roughly $2 billion per year in rights fees; you can do the math as well as I can there. Producing the games isn’t free, but it’s much cheaper than buying the rights to them. If they make as much money this year as they did last year, the math adds up, particularly now that bankruptcy is likely to modify some debt payments. From a league perspective, all this turmoil brings both risk and opportunity. The risk is clear: there’s a chance teams won’t receive rights payments this year. That’d be bad, and likely lead to interminable legal wrangling to boot. The opportunity is nebulous, but it’s there: the league might have an unprecedented chance to partner with its distribution channels, something that Rob Manfred and his lieutenants are surely strategizing about already. In a year or two, Bally Sports will likely show up in your living room under a different name. It might show up under a different guise entirely; maybe it will function primarily as a streaming service, or be owned by a large media network or a completely independent company. Maybe it’ll be an MLB/NHL/big tech partnership. I have no idea what the future holds there. What I do know is that it won’t be Sinclair running it, and that their financial tomfoolery cost them a billion dollars while also giving the business heads of 14 teams heart palpitations. Not the best day at the office. *DSG holds local broadcast rights for 14 teams: the Arizona Diamondbacks, Atlanta Braves (note: an earlier version of this article omitted the Braves), Cincinnati Reds, Cleveland Guardians, Detroit Tigers, Kansas City Royals, Los Angeles Angels, Miami Marlins, Milwaukee Brewers, Minnesota Twins, St. Louis Cardinals, San Diego Padres, Tampa Bay Rays, and Texas Rangers. They also own minority stakes in the Marquee network, which broadcasts Chicago Cubs games, and YES Network, which broadcasts New York Yankees games.