Private equity firm CVC has been praised for the turbo-charged return on its investment in Formula One auto racing. However if the sale of F1 to Liberty Media Group gets the green light from regulators it could prove to be one of the worst exits in CVC’s history as it stands to get at most $354 million in cash for its controlling stake.
As F1 meets this weekend in Singapore for its Grand Prix insiders are still digesting the details of the Liberty deal. Last week it came to light that it plans to take over F1 though, as Forbes has revealed, it first has to clear a number of roadblocks. Perhaps the most serious is the conflict of interest at the heart of the sale as it requires clearance from auto racing’s regulator and if it goes ahead the same regulator will be paid $44 million from the proceeds.
CVC bought F1 in 2006 in a leveraged buyout financed with $1.1 billion of debt from the Royal Bank of Scotland (RBS) and a loan of around $965 million from its investment Fund IV. From that moment it was inevitable CVC would ultimately have to sell up. This is because, in essence, private equity funds use investors’ money to buy companies and later sell them at a profit for their backers.
It made the sale of F1 a hot topic in recent years with Mark Kleinman, the city editor of British broadcaster Sky News, alone linking no less than 15 companies with a takeover even though not one of them actually invested. Liberty’s interest in F1 was revealed in 2014 by New York Post media reporter Claire Atkinson so it shouldn’t have come as a surprise when it finally announced that it planned to to buy the series. But there was good reason why it did.
The deal puts an $8 billion enterprise value on F1’s parent company Delta Topco and much has been made of this in the media. However, when you lift the hood a little it gives a very different picture.
As this investing website explains, “enterprise value is calculated as follows: Market Capitalization + Total Debt – Cash.”
Liberty’s investor presentation shows that Delta Topco has $700 million of cash and debt of $4.1 billion. This gives net debt of $3.4 billion and it comes part and parcel with the company. It directly affects the price of a company’s shares as the greater the debt level, the less its shares are worth. The number of shares multiplied by their price is known as the market capitalization or equity value and this is the total amount that a buyer pays.
As Liberty’s presentation shows, the price it is prepared to pay for Delta Topco’s shares gives the company an equity value of $4.4 billion. Combined with the $3.4 billion of net debt and $200 million in deal-related adjustments, it gives Delta Topco an enterprise value of $8 billion.
So, Liberty is paying a total of $4.4 billion for Delta Topco but that is just the start of the story. The most remarkable aspect of the Liberty takeover is how little cash it is offering to fund the purchase.
The investor presentation reveals that there are three components to what Liberty is offering the current owners of Delta Topco. The first is a $351 million debt instrument which can be exchanged into shares in Liberty. Secondly, it is offering 138 million shares in Liberty which comes to a total of $2.9 billion based on their latest price of $21.26. Finally, Liberty is paying just $1.1 billion in cash which is the grand total of $135 million more than CVC paid for F1 from its own fund a decade ago. It doesn’t stop there.
The investor presentation reveals that when the deal was announced last week the first step involved Liberty buying an 18.7% stake in Delta Topco for $746 million in cash. It included a $75 million discount which will be paid to Delta Topco’s current owners in 2017 if the sale gets regulatory clearance. At that time Liberty would also pay the remaining $279 million to bring the total cash amount to $1.1 billion and give it 100% of Delta Topco.
So far so good. The twist comes in a report from Citi Research which reveals that the first “stage of the transaction did not directly involve F1’s controlling private equity shareholder CVC but rather certain minority holders.” In other words, when Liberty paid $746 million for its 18.7% last week it didn’t get any of the shares from CVC and therefore CVC didn’t get any of the money.
That leaves at most $354 million in cash for Liberty to pay CVC for its shares if the deal gets clearance and closes next year as planned. This assumes that none of the other current shareholders will get any of that cash which seems unlikely. It means that CVC will get at most $354 million in cash for its 38.1% stake in Delta Topco which, pro rata, is worth $1.7 billion based on the company’s $4.4 billion equity value. In reality its stake should be able to command a lot more than that as it comes with control of Delta Topco through CVC’s directors having the power to outvote all of the board members of the company.
Clearly, the majority of CVC’s payment from Liberty is due to come in the form of shares in Liberty with cash representing at most only $354 million of the $1.7 billion value of its stake. CVC’s co-founder Donald Mackenzie and partner Nick Clarry are apparently smart guys and have spent the best part of the past five years assessing offers for F1 so it seems stunning that they have settled on a deal which offers so little cash.
The first point that needs to be made here is that, as Forbes has revealed, CVC has already made an estimated $4.4 billion from Delta Topco through dividends and share sales. So it wasn’t relying on cash from the sale and it certainly won’t make a loss. Quite the opposite as even if the Liberty deal doesn’t get the green light from regulators and CVC is forced back to the drawing board it will still have made a 351.8% return on its investment in F1. So the investors who put money into the CVC fund which bought F1 have no reason to be worried.
Nevertheless, cash is king and the Liberty deal doesn’t offer much of that. Instead, the owners of Delta Topco are getting a lot of shares in Liberty which owns assets like the Atlanta Braves baseball team, a 1% stake in media company Time Warner and 34% of event promoter Live Nation. Make no mistake, they are blue chip brands but anyone who has kept their money in a private equity-owned business for a decade might not expect their reward to be shares in a completely different company when it is finally sold.
Investors generally don’t put their money in private equity funds, or the businesses they invest in, to get long-term growth but rather medium term capital. Accordingly, it seems surprising that after 10 years the investors in F1 still haven’t all got cash for their equity stakes in the business.
There is no evidence that any of the investors has demanded this but the fact that they aren’t in a position to get it from this much-vaunted deal seems strange to say the least. Given that CVC spent so long trying to sell F1, and it is widely seen as one of the most glitzy assets out there, one would have thought that it would have been sold to a buyer offering more cash than shares not the other way round. Accepting a deal with such a small percentage of cash seems to be one of the biggest missed opportunities in business and makes the F1 sale look like one of the worst exits in CVC’s history. So why would it do a deal like this?
The investor presentation reveals that Liberty had just $104 million of cash in the bank as of 30 June this year so anyone hoping that F1’s new owner has got billions to pour into the sport may be sorely mistaken. However, Liberty could presumably have raised more cash through loans to give to Delta Topco’s shareholders so why wasn’t this a condition of doing the deal?
A clue could come from an interview that Mackenzie did with Reuters in 2015 when he said “we like owning it (Formula One), we don't want to sell it. There are always some people who’d like to buy it, it’s a very good business.”
Given that the majority of CVC’s payment comes in the form of Liberty shares it’s little surprise that it will remain the second-biggest shareholder in F1. Liberty itself will be renamed the Formula One Group and CVC is due to have a 24.7% stake in it with Liberty’s parent company and executives owning 35.3%. So if CVC sees financial growth still to come from F1 then it will get nearly a quarter of the proceeds through its shareholding. It makes sense but is still perhaps not the whole story.
The way that CVC is structured sees it managing a series of funds and in turn the funds invest in companies. The fund that acquired F1 closed many years ago meaning that it is not believed to be making new investments. The deal on the table involves a significant amount of shares, rather than a significant amount of cash, in Liberty which is not a company that CVC has already invested in. Accordingly, the shares in it can be held by one of CVC’s newer funds giving an opportunity to profit from F1 for a second time.
F1 hasn’t just delivered financial returns for CVC but also networking and hospitality benefits. Mackenzie is known to be a fan of F1 and both he and Clarry have attended races. They have made the most of the opportunity with Mackenzie seen in the paddock at this year’s Monaco Grand Prix introducing his young guests to pop star Justin Bieber. As Britain’s Daily Telegraph revealed in 2014, CVC’s funds also get a free table and meals for 10 people in F1’s corporate hospitality outfit The Paddock Club at 18 races with tickets usually costing up to $6300 each.
It isn’t clear whether CVC will continue to get these benefits if the sale goes ahead but it will share in the financial rewards and this could be why it put Liberty in the driving seat.
Time will tell whether it will pay off as much over the next decade as it has in the past ten years. If F1 goes downhill then CVC’s fund investors and the other shareholders in Delta Topco may end up regretting the decision to do a deal comprising so little cash. It is far from the Grand Prize that has been reported.
