JUNE 13, 2008

What makes sense and what does not make sense

There have been a series of denials regarding rumours that there have been talks between CVC Capital Partners and News Corp about the possible sale of the Formula One group of companies. This is not really a surprise, although the existence of the rumours suggest that there is still a great deal going on in the background in F1 politics at the moment. This particular rumour is confusing in that they came to us from parties that might be seen as allies of the Formula One group in the ongoing disagreements with FIA President Max Mosley. If the stories had been leaked from the FIA there would have been a sound reason to disbelieve them, but the sourcing makes them interesting.

A sale of the F1 commercial rights to a media company makes a great deal of sense, indeed we have already seen that happen on one occasion, back in 2000 when Germany's EM.TV acquired a 50% shareholding in the Formula One group. This was passed on to the Kirch Group in 2001 when EM.TV ran into financial trouble, but then Kirch too hit financial difficulties and the F1 rights ended up in the hands of bankers until CVC came along and bought control of the business early in 2006. This was followed by a restructuring of the business, bringing Allsport Management and its subsidiaries in-hoose and in January 2007 CVC negotiated loans of $2.9bn from the Royal Bank of Scotland and Lehman Brothers to allow the investors to take money out of the business, securing the loans with the future revenues of the sport.

CVC thus has nothing to lose if it sells the business and has little to gain in the short term as it will be some years before the F1 loans are paid and the sport becomes a cash-cow again. The commercial rights holder can, in theory, then either take the profits each year or borrow against the future earnings once again and take another lump sum. The only pressure will be from the teams which will, inevitably, demand more of the income whenever it comes to negotiate the terms of their deals. On paper the Formula One group has an agreement with the FIA to exploit the commercial rights of the sport until the 2110, although part of the agreement is a clause which gives the FIA veto rights on the sale of the business. Formula 1 has many areas in which it could be improved and can become more productive, notably in terms of improving its merchandising, but the biggest profits are probably to be made from cutting out the middle men in the televising of the sport.

At the moment the Formula One group provides coverage for around 90 different broadcasters. Each pays an annual fee for the rights and offset their investment by selling advertising to go with their F1 programming. In recent years Formula One Management has taken over the TV production at most races, although Monaco, Brazil and Japan still act as host broadcasters. This means that the quality of the programming is much more consistent than used to be the case. The fear in the modern age is that the Internet will undermine TV revenues and change the model on which F1 is built. The best way to avoid this is to sell the business to a global media company that can provide TV coverage in all the different countries and generate its own advertising revenues.

News Corp is the major player in this respect. It has cable and satellite networks and produces and licenses programming across the world. It owns the 20th Century Fox movie studio, the publishing house HarperCollins, plus an impressive number of newspapers and magazines. In recent years it has also been building up the Fox Interactive Media operation, which oversees the company's Internet activities. The sites it owns include MySpace.com. These are designed to drive traffic to the TV operations to generate advertising revenues and to build pay-TV revenues.

Sport is a key driver in these markets.

In current F1 terms News Corp's Fox Sports already has a special deal which includes providing F1 coverage to many of the Spanish-speaking countries in South America, while also using its Star Sports offshoot in Asia to provide coverage to Hong Kong, India, Taiwan and Thailand. There are also Fox deals in Italy, New Zealand, Serbia and Canada. Buying the commercial rights to F1 would enable News Corp to reduce its overheads and thus increase its earnings.

CVC buys companies, restructures them and then sells them on at a profit. It has enjoyed enormous success but generally does not keep businesses for any longer than is necessary. Of the 49 companies that it currently owns 31 of them have been acquired in the last four years and the earliest purchase in the portfolio dates back only to 1997. There are only seven current CVC companies which were acquired in the 1990s.

It is still a little early for CVC to be thinking of selling the Formula One group, although it has been a very high profile problem child, even if it has already delivered huge profits to the business.

The rumours may not be true, but there is sufficient logic is such a deal to make them plausible if not tomorrow, certainly in a few years from now.