Assessing the financial impact from the China fallout on the Houston Rockets

By now, everyone is aware of geopolitical firestorm created by Daryl Morey’s tweet supporting the Hong Kong protests. I won’t rehash the events, as they have already been covered extensively by every media publication around the world. I completely support Daryl on the basis of his right to express freedom of speech, and certainly abhor the strong-arm tactics China employed in trying to have Morey fired. Still, the financial impact on the Houston Rockets and NBA from the “tweet read around the world” is not insignificant.

It is no secret that the Rockets have been China’s most popular team since they selected Yao Ming as the #1 draft pick in 2002. Up until this 2019-2020 season, the Rockets donned alternate jerseys that paid respect to the Chinese market rather than their hometown. The team has also played in China three times and hosts the Shanghai Sharks annually at Toyota Center during the preseason. Further, the team has had longstanding sponsorships with several Chinese brands, including sports apparel company Li-Ning, bitcoin mining company Antpool, Shanghai Pudong Development Bank, and, most importantly, media conglomerate Tencent, for which the NBA just enacted a $1.5 billion five-year partnership to stream games in China. So when these Chinese businesses suspended ties with the Rockets, one begins to understand what is at financial stake for the team.

Jonathan Feigen and Paul Takahashi of the Houston Chronicle quantified the annual revenue loss from the incident’s fallout at $10-25mm. At first glance, this seems like a miniscule amount, contributing approximately 3-8% of the team’s total annual revenue ($326mm). However, when looking at the valuation impact on the team, it is more substantial.

Many people could scoff at the Houston Chronicle’s estimate, with the general line of thinking being if Mr. Fertitta can afford to pay $2.2bn for the team, what’s $10-25 million? But this would be an inappropriate way at looking at the impact, as one has to consider the drop in valuation and financial leverage Mr. Fertitta utilized to purchase the team. Assuming this revenue stream is lost forever, I arrived at a valuation impact of approximately $237mm. This has the potential to decrease Mr. Fertitta’s Adjusted Equity by 41% (from 2017 levels), while increasing the Adjusted Loan to Value to 90% from 85%.

The above illustrates why Mr. Fertitta tried to personally manage the fallout from Morey’s tweet that fateful Friday night. And yet, despite all of this, the Landry’s bonds continue to trade well above par at $103.60, indicating the debt marketplace is quite confident that Mr. Fertitta, as a testament to his proven success as an operator, will be able to pay off the $1.415bn in notes he used to finance the equity required to purchase the team.

Feigen and Takahashi’s figure doesn’t appear to account for the intangible impact the fallout will have on the team’s brand. That is a less quantifiable number, but, in a country where 490 million of 1.4 billion people are NBA fans, the impact to the Houston Rockets brand in China will be dramatic and may take years to recuperate. In fact, Forbes has postulated 12% of the team’s $2.3bn valuation is related to its brand.

If you are a Rockets fan and want to see the team finally hoist up its first championship trophy in 25 years, the lost revenue could make it more difficult for the team to cover player salaries and luxury taxes. In addition, the team could be further financially squeezed if the lost revenue to the NBA league from the incident drops the salary cap threshold 10-15%, though so would the rest of the league.

I am optimistic that a resolution will ultimately be reached between the NBA and China. The two parties, much like the ongoing trade war between the current U.S. and Chinese administrations, have too much at stake. Basketball is the most popular sport in China, so Adam Silver was right to call the Chinese Basketball Association’s bluff and (eventually) stand behind America’s founding ideals. The NBA, having laid inroads in the Chinese market since the 1990s, have too much history to simply spurn this highly valued business relationship, despite current tensions.

This preseason, the league held two games between the Sacramento Kings and Indiana Pacers in Mumbai, India. This was the first time a North American sports team played in the country. India, much like China was in the 1990s, is a nascent basketball market but, with a population of 1.34 billion, represents a massive opportunity for the NBA to grow its brand (and revenues). It also helps that India and the United States are both democratic governments founded on similar ideals. By growing its brand into the second most populated country in the world, the NBA continues to find ways to diversify and expand its market. This will only strengthen the league in managing situations that impact its revenues, like the one that just unfolded.

About the author: Justin Levine is a commercial real estate investor and developer for Levcor, Inc., based in Houston, TX. Justin’s business career includes experiences in Wall Street, private equity, media and tech. He has a B.S. from Northwestern University and an M.B.A. from The Wharton School. A lifelong Rockets fan since the team won it all, he regrets being too young to party on Richmond Avenue during that fateful eve in ’94. Twitter: @JustinLev

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