Fantex Holdings shook the sports business community earlier in the year when it announced plans to release an investable security linked to the performance of athlete-entertainer brands.
A little background
Arian Foster was planned to be the first IPO. The Houston Texans halfback was slated to receive a $10 million windfall. Fantex, in exchange, was to receive a 20% stake in future contracts, endorsements, broadcast deals, and any brand-related business income. As a result of Foster's injury and season-ending surgery, Fantex and the NFL running back agreed to postpone the IPO.
I caught up with Fantex cofounder and CEO, Buck French, for an update on the company's activity post-Foster. Despite polarizing debate between economists and sports enthusiasts on the investable athlete brand concept, Fantex remained persistent with its approach. In January, it added golf legend Jack Nicklaus to its advisory board, stating in a release "Nicklaus brings to Fantex more than five decades of experience as a professional athlete, brand builder, investor, and entrepreneur."
The current Fantex IPO is with with San Francisco 49er Vernon Davis. The all pro tight end receives a $4 million lump sum payment. Fantex receives a 10% stake in future Davis brand-related income, with stipulations of course. Fantex has effectively valued the discounted future cash flows associated with the Davis brand to be $40 million; but of course only own 10% of this, offered to the public in the form of the investable security.
In an effort to clarify this process, Fantex scheduled a cross-crountry road show (fittingly, in a John Madden-used bus) to help educate potential investors. Fantex is now armed with a young and promising athlete brand, showpiece advisor additions, and perhaps most valuable the awareness-boosting marketing efforts.
French admits the largest obstacle thus far has been educating the investor. Many are uncomfortable investing into the concept given the unfortunate Foster events. "Approximately 10 shares of Fantex Vernon Davis cost the same as a jersey" French explains "but there is a mental barrier. It is crucial to build up the level of trust and awareness, and that's what we are building right now."
How it works
"The business model is designed to increase the branding associated with athlete entertainers. Ultimately everyone's interests are aligned," says French. "If we can generate awareness and interest with the brand then the brand can activate on that awareness. This turns into income, which then flows into Fantex. This is all positive for everyone."
At the core, Fantex is using the IPO to raise capital. Davis received one lump sum payment of $4 million. Fantex values this as 10% of his discounted future earnings. The offering includes 421,100 tracking shares at $10 each. This means that if the expected sales are reached, Fantex will raise $4.21 million. Fantex retains the balance.
To be clear, the shares only simulate an ownership portion of the athlete-entertainer brand. In fact, Fantex reserves the right to convert the tracking shares into company stock. Yes, the Fantex exchange earns a 1% transactional commission. Also, dividends are expected to be paid but are not guaranteed. This should remind investors that the security is not only tied to speculation with Vernon Davis, but also to the continued operation of the company itself.
Fantex remains a risky start-up anticipated to incur significant costs associated with efforts to achieve or maintain profitability. According to the prospectus, "We will need to obtain additional funding to acquire additional brands and we may also need additional funding to continue operations. If we fail to obtain the necessary financing, or fail to become profitable or are unable to sustain profitability on a continuing basis, then we may be unable to continue our operations at planned levels and we may be forced to significantly delay, scale back, or discontinue our operations."
Who makes money?
Injury, arrest, a public relations debacle, other brand events, or simply the athlete entertainer falling out of favor are all taken into account by the discount rate applied to the cash flow stream. As anyone who has sat through an introductory finance course will tell you, that's the best way you adjust for risk. Let's look at the Vernon Davis IPO with this in mind.
Like any investment, you are looking for a positive return. With the Davis example, the investor wants the NFL star's compounded future income to reach over the projected $40 million. Stockholders will benefit from the return on investment. But unique to this security as described above, you also have to worry about Fantex operations and whether your shares will be converted into common company stock.
Fantex takes on a significant portion of the athlete-entertainer career and contract risk. When you are talking NFL, with concussions, high-impact collisions, and an average league tenure of only three years, the upfront payment is a favorable compromise for many players.
But in the case of a marquee athlete brand, like Vernon Davis, there is a higher expectation of future earnings. Assuming expectations are met or exceeded, Davis would have made a sound financial decision with Fantex – even after surrendering 10%. Hypotheticals are elaborated on in this case study.
A quick anecdote on Davis: Earlier this month, I was sitting just a few seats over from Vernon Davis during a Roger Goodell Super Bowl press conference. Davis was covering the event for Monday Morning Quarterback, a popular Sports Illustrated blog. After the commissioner spoke, Davis asked about post-career health, especially related to brain injury. The exchange can be seen here. I bring this up for two reasons: 1) to reiterate the high risk of injury in the NFL and therefore athlete stocks, and; 2) to demonstrate that Davis is articulate and interesting, which are as French says "key big bucket items" for investable athlete brands.
Fantex estimated gross projected cash flows of about $61 million for the Vernon Davis brand. On a present value discounted basis, the cash flows were purchased at $40 million. Remember the $4 million lump sum Vernon Davis received? That was 10% of his discounted cash flow projections. Fantex expects to sell 421,100 shares at $10, for a capital injection of $4.21 million.
These figures do not take into account the marketing and brand building that Fantex claims to deliver to the athlete entertainers. Fantex views the balance as compensation for the risk Davis doesn't realize the cash flow stream. But of course they want Vernon Davis to play for as long as possible, or at least for his brand to grow for as long and big as possible in order to profit from continued multidimensional income. Fantex also earns a commission of trades executed on their exchange.
The Fantex concept, like any asset valuation, is based on present value of future cash flows, but that of course assumes the market is efficient. The crucial variable is the certainty of the income stream. Yes, when Davis signs an endorsement deal or a brand-related activity occurs, his stock will rise as news moves markets. But not all of Davis' future income is tied to the stock as Fantex reserves restrictions delineated in its prospectus. This combined with Fantex's admitted reliance on additional funding and future brands joining its platform leaves me a little dubious.
That being said, Fantex is best suited for the casual investor, fans, and weekend warriors with disposable income. Sports fans will attach credibility to John Elway, who is on the board, advisor Jack Nicklaus, and high-profile athletes like Davis and Foster. This audience does not care that Fantex is not a porfolio diversification tool.
The price point allows for play money to easily be thrown into the Fantex system to supplement fanhood on Sundays. You need to look no further than fantasy sports for proof of concept. The fan attachment phenomenon is evident by fantasy games and social media. The social dynamic marries well with Fantex and as French says, helps build brands into the post-career as the platform gives the athlete a voice. As we continue to see the fragmentation of media, there will continue to be pools of hyper-localized audiences. This is the space for the athlete-entertainer security Fantex is pushing.