By Ken MacFadyen
iddmagazine.com

Some of the most notable names in private equity, Steve Pagliuca and Tom Hicks, have made personal investments in sports franchises, but rarely have these deal makers pursued similar bets on behalf of the firms listed on their business cards. Indeed, the Chicago Cubs–currently up for sale–wouldn’t exactly typify a model PE deal and that may be why John Canning is rumored to be a potential bidder for the famed baseball franchise rather than his private equity firm, Madison Dearborn.

Institutional money, though, may be slowly creeping into ball parks, race tracks and even soccer fields.

“I get calls daily from both private equity firms and hedge funds looking to see what we’re working on,” says Steven Horowitz, a partner at sports-focused investment bank Inner Circle Sports LLC.

Horowitz notes, though, that investors managing third-party money aren’t necessarily planning to take on the role of a lead investor in a transaction involving a major league sports team. Instead, he believes that “you’ll see hedge funds looking to get into other areas of the capital structure, whether it’s in mezzanine or preferred stock.”

To wit, when the Glazer family acquired UK soccer giant Manchester United in 2005, hedge funds such as Perry Capital and Oz Management could be found in the regulatory filing listed among the investors in the company’s preferred securities.

While the Manchester United filing provides a glimpse into where institutional money gravitates, it also offers a hint as to why some fund managers eschew a prominent role: the sticky politics that crop for owners of sports franchises.

In the filing, which detailed the Glazers’ offer, the family had to paint a picture depicting itself as an ownership that puts fans and community ahead of profits. The Glazers, in their offer, cited their ownership of the NFL’s Tampa Bay Buccaneers franchise as evidence that the family reinvests profits back into players, stadium and the local community. And to fans currently hoping Man U won’t let soccer star Cristiano Ronaldo walk to Real Madrid, that track record is important.

It also speaks to why institutional money rarely fits in the sports marketplace. Take the NBA’s Boston Celtics franchise. Highland Capital Partners’ Wyc Grousbeck and Bain Capital’s Pagliuca, co-owners of the team, followed up a last place finish in 2007 by green-lighting trades that swapped young prospects and draft picks for high-priced talent, notably Kevin Garnett and Ray Allen. In private equity, that’s called throwing good money after bad. But, for Grousbeck and Pagliuca, however, it underscored a commitment to the team and paid dividends. The team has its 17th NBA title.

Contrast that sensibility with public pensions, meanwhile, which would probably be more pleased with with actual dividends they can bank.

There is one area in sports, however, that has a history of attracting institutional capital as is illustrated by Boston Ventures’ recent purchase of a control stake in Nascar racing team Petty Enterprises.

Andrew Davis, a managing director at the firm, describes that he’s looked at other sport franchises but found those assets were more akin to “trophy properties.” What distinguishes Nascar, he says, is that a racing team has characteristics akin to more traditional industries–sectors such as advertising that the firm has targeted in the past. Davis believes economies of scale exist that benefit racing programs carrying more than one team. It’s not unlike a rollup strategy in the auto-parts space that might yield synergies by sharing technologies or best practices. In fact, it was the consolidation among other rival teams that necessitated Petty’s search for outside capital in the first place.

Boston Ventures’ experience in areas such as entertainment and media helped the firm grasp the economics behind backing a race team. “It’s something we could understand and evaluate,” says Davis. “We’re looking at it, essentially, as a 200 mph billboard.”

Petty Enterprises also controls the Richard Petty Driving Experience, which allows fans to get behind the wheel of a race car. Davis equates that to “an experience very similar to a theme park,” which is another area in which Boston Ventures has previously invested.

Perhaps the most significant factor that makes Nascar a fit for private equity is that the interests are aligned. Team success yields greater proceeds from sponsorships, not to mention hectic merchandise sales. It’s no surprise that Hendrick Motorsports, Roush Fenway Racing and Joe Gibbs Racing are Nos. 1, 2 and 3 in terms of valuations, according to Forbes, as all three have drivers dominating the auto races every week. All three are also operationally profitable.

It’s this ability to stay out of the red that has made institutional investors feel safe backing racing teams. In addition to Boston Ventures, Chartwell Investors backed RCR Racing in 2003, a team that generated $19.1 million in profits last year, according to Forbes.

This profitability contrasts with other sports. Out of baseball’s top three teams, for instance, Forbes listed just one as being operationally profitable. Last year’s World Series champion, the Boston Red Sox, posted a reported loss of $19.1 million.

At the same time, though, Nascar teams do face headwinds in the form of a slowing economy. Dario Franchitti, a Scottish driver who moved to stock car racing from the IndyCar Series this year, lost his ride because Chip Ganassi Racing could not find a sponsor for his car.

Few anticipate the institutional interest in Nascar will flood over to rival sports, especially considering how high valuations can reach. For instance, Donald Watkins, a lawyer-turned-dealmaker, has made multiple attempts to buy a major league baseball team. He lodged back-to-back failed bids for the Minnesota Twins and Anaheim Angels in 2002 and 2003, respectively. Despite his interest, however, he warns that an investment in the wide world of sports is no sure thing. “You have to have the right team, in the right market, under the right terms and conditions. If you don’t have all three of those factors in perfect alignment at the same time, you will be upside down in the investment.”