Coronavirus, the NBA, and the Houston Rockets: Assessing the Financial Impact (Part 2)

More than a month has passed since I initially wrote about the coronavirus pandemic and its impact on the NBA and the Houston Rockets. That month has felt like five years, as the world has dramatically been impacted by COVID-19. Countries, states and cities have imposed lock-downs as citizens have been forced to self-quarantine while businesses around the world have closed their doors.

Just as Americans became focused on flattening the curve as it relates to COVID-19, they need to think about doing the same for the U.S. economy.

In my first article, I argued the economic impact would have a far greater and lasting impact than the virus itself. While social distancing measures have been successful in slowing the spread of coronavirus – the number of potential deaths in the United States has been downwardly revised from a staggering 2.2 million to 200,000 to 60,000 – it has come at a steep economic cost not seen since the Great Depression. The U.S. GDP is expected to contract, on an annualized basis, an unfathomable 30% in the second quarter. The U.S.’ annual GDP is approximately $21 trillion, so this would result in a loss of $7 trillion, or $1.75 trillion per quarter. The $2 trillion stimulus package passed by Congress certainly helps in offsetting this loss, but there may be another round necessary, as it could take companies years to regain pre-COVID 19 performance and employment levels. More devastating is the 22 million Americans that have filed for unemployment in less than a month, putting the United States’ unemployment rate at 17.5%, nearly double of the 2008 Great Recession’s unemployment peak of 10%. Most major retailers that have been forced to close have furloughed as much as 90% of their staff, and the great fear is that the longer coronavirus-imposed shutdowns occurs, the more these furloughed employees could eventually be permanently laid off. There have been studies that have found unemployment has an adverse impact on one’s mental health, an intangible repercussion that simply can’t be quantified neatly in a chart. Just as Americans became focused on flattening the curve as it relates to COVID-19, they need to think about doing the same for the U.S. economy.

Thankfully, the conversation has begun to shift in this direction, as the US government released its “Opening Up America Again” plan. The plan calls for a phased approach to re-opening the U.S. economy and puts the burden on state and local officials. This makes sense, as each state in the United States has been impacted differently by COVID-19. In Texas, Governor Greg Abbott is looking to start allowing non-essential businesses to perform curbside sales, similar to what restaurants have already been doing, on Friday, April 24.

Source: Axios Sports, Two Circles.

So where does the NBA and Houston Rockets stand in their opportunity to return to business? Unfortunately, it is simply too early to predict whether the NBA will be able to finish the season. COVID-19 is set to halve the 2020 sports calendar, and, unfortunately, spectator sports will likely take longer than other parts of the economy to regain their footing, as getting people comfortable to once again share space with thousands of like-minded fans is going to take some time. Adam Silver has come out and said the NBA is still not in a position to make a decision on when to start games again. But if the NBA did restart, what would it look like and how could it be successfully implemented?

Much like the the U.S. government’s plan to re-open the economy, a successful NBA re-start would be predicated on rapid-response testing. Players will need to be rigorously tested in order to avoid a COVID-19 spread like the one that happened in March within the league. In addition, it appears almost certain that games will have to be played without fans, but there are ways to monetize this avenue as well as make it at least somewhat visually acceptable for broadcast. In Taiwan, baseball has resumed with mannequins and cardboard cutouts in place of real-life stadium goers, with fans even being able purchase a cutout in their likeness. If players are to play without fans in attendance, they may all need to be centrally housed under one location, as air travel currently may not be a risk the NBA would be willing to take. There have been talks of housing NBA players in Las Vegas or Disneyworld, both of which could use the revenue and have the facilities, housing and scale to support team rosters and supporting staff. Format will ultimately need to be agreed upon, but even if the NBA were to jump immediately into the playoffs, it may turn into a potentially lucrative opportunity. Americans have been deprived of live sports for over a month now and at least for the foreseeable future, so if the NBA can get a potential re-emergence right, they will have an audience that is more captive than ever. Further, with NBA salaries being withheld and many players living paycheck-to-paycheck, I would suspect NBA players will be ready to play even if the logistics are less than normal.

What about the Houston Rockets and its owner, Tilman Fertitta? As mentioned in my prior piece, Mr. Fertitta is arguably the most exposed professional sports owner to the economic crisis brought on by COVID-19. His wealth is single-handedly tied to businesses that will most likely take the longest to come back once the economy has re-opened. Restaurants, live sporting events and casinos are all discretionary in nature, so if consumers are less willing to take the risk to visit these places, and the unemployment rate stays relatively high, Mr. Fertitta’s businesses will unfortunately suffer a sluggish return. It is why Mr. Fertitta tapped Jefferies, his preferred bank, to raise $250 million in debt, with a 15% annual interest rate and October 2023 maturity, to give Landry’s some additional liquidity. This is on top of Fertitta drawing down $300 million of existing credit lines and investing $50 million of his own cash. The 15% interest rate on the loan is certainly eye-popping, and it illustrates the unfortunate type of financing available to Fertitta in these times – Landry’s debt, which was trading at a premium prior to COVID-19, is now hovering around $0.40 to $0.50 on the dollar. With everything at stake, it is no surprise that Mr. Fertitta is one of the 39 business leaders on Governor Abbott’s business advisory council to re-open the Texas economy.

Mr. Fertitta is not the only restaurateur that has sought creative forms of financing to keep his business afloat. Publicly-traded restaurants have lost half of their value over the past month, forcing them to either fully draw down on existing lines of credit or consider rescue capital, much like Landry’s. Cheesecake Factory yesterday announced a $200 million convertible preferred equity investment from private equity firm Roark Capital. While preferred equity is not as senior as the debt Fertitta is offering, it is senior to Cheesecake Factory’s equity holders, and the 9.5% preferred return the company will be required to pay Roark will significantly diminish overall earnings. Further, Roark has the option to convert the preferred investment into common shares on or after the 90-month anniversary of the deal’s effective date, which will dilute existing shareholders’ ownership. Nonetheless, the investment was sorely needed, as Cheesecake Factory furloughed 41,000 employees and told every landlord it was unable to make rent payments in April. Cheesecake Factory is not alone, as most restaurateurs and retailers that have been forced to close are asking landlords for some form of rent relief, which in turn puts strain on the landlords’ ability to service property-level debt.

Thankfully, it appears as though there may be light at the end of the tunnel. The US has reached its peak on the curve, and four states could open as early as May 4. Texas is on track to phase its re-opening, with the state expecting to transition from mitigation of the virus to a containment strategy by June 1. All this is to say that it is possible the NBA could return by this summer, in some form or fashion.