Tuesday, October 22, 2013

Valuing Athlete Earning Potential? Tracking Arian Foster!

In a week during which both Google and Netflix hit all-time highs, you would think I would pick one of these high fliers for special valuation attention. While I still plan to look at these companies, I am going to spend this week on a quirky valuation challenge: valuing tracking stock on a star athlete’s future income. Last week, a company called Fantex filed an S-1 (prospectus for a forthcoming security issue) with the Securities Exchange Commission, making public its intention to issue tracking stock on Arian Foster, a star running back for the Houston Texans in the National Football League (NFL). In the filing, Fantex reported that it had paid $10 million in early October to Mr. Foster in return for 20% of all contract and endorsement income that he will earn after February 28, 2013. The S-1 also specifies that Fantex plans to raise approximately $10 million (thus covering its outlay) from the issuance of 1.055 million Arian Foster tracking shares to the public, and use its share of Mr. Foster’s income to pay dividends to these shareholders. The picture below captures the initial set up: 

Fantex intends to use its platform to attract more athletes and celebrities into the mix, thus creating a portfolio of tracking shares that can be traded by investors. 

Arian Foster: Background 
Arian Foster was born on August 24, 1986, and is a running back for the Houston Texans. He played college football at the University of Tennessee and was signed as an undrafted free agent by the Texans in 2009. In 2010, he had a monster year, leading the NFL in rushing, yards from scrimmage and touchdowns. He continued with impressive performances in 2011 and 2012, as can be seen in his career statistics page

Arian is also clearly a self-promoter (in the best sense of the word) and has aspirations beyond the gridiron. He has his own website, where he characterizes himself as an all-pro running back, entrepreneur, philosopher and father. 

On March 5, 2012, Arian signed a five-year contract with the Texans worth $43.5 million. The contract had a guaranteed payment of $20.75 million, including a signing bonus of $12.5 million, his first year salary (2013) and $3.25 million of his second year salary (2014).  He is also entitled to bonus payments, based on performance in games, of up to $5.25 million in 2013, $5.75 million in 2014, $6 million in 2015 and $6.5 million in 2016. He is a free agent in 2017. 

Claim and Contract details 
To value the claim on Arian Foster’s income, you need to break down the cash flow claims that you have on the income. Note that while Fantex has a contractual claim on 20% of Foster’s future income, investors in the tracking stock don’t have that direct claim. Instead, they are dependent on the dividends that Fantex chooses to pay out from that income. 

As noted in the figure, there are at least two expenses that Fantex will incur that will make the dividends paid less than the income that they get from Foster. The first is that a portion will be set aside to cover the expenses associated with managing and maintaining the Fantex platform. The second is that Fantex views its role as not just a contractual intermediary but also as a brand building organization. Effectively, that implies that Fantex can and will use some of the Foster income to market him better (and hopefully increase endorsement income). 

To value the Foster tracking stock, we will go through three steps. In the first, we will lay out broadly the risks faced by investors in the tracking stock. In the second, we will value the cash flow claim that Fantex has on Foster’s contract and endorsement income. In the third, we will evaluate the claim that investors in the Foster tracking stock have on the dividends they receive from Fantex.

The Risks 
The S-1 goes to great lengths to emphasize the point that this is a speculative investment, but since that should have been obvious to anyone thinking about the investment, it is important that we break down the risks at each stage of the process: 

Working the risks through the pipeline, here at the layers of risks that we see, starting with risks to the earning stream and then moving on to risks in the intermediary and ending with risks at the investment level.
Earnings Risks
1. Player Risks
The most immediate impact on player earnings comes from the athlete with two big risks to earnings: injuries that are career ending or a drop off in performance skills, either as a result of age or earlier injuries.
1.1. Player Skills/Longevity
A. Player Injuries: If you are laying claim on a professional athlete’s future earnings, you are exposed to any injury/event risk that impedes his or her capacity to perform on the field. Part of this risk can be mitigated at the contract level, if you have guaranteed income (that will be paid even if the athlete is injured) but it will still affect the athlete's earnings power in terms of getting contract renewals & bonus income.
Arian Foster shares: Foster's guaranteed income on his contract has dwindled down to $3.25 million and almost all of his remaining income will be at risk if he is injured. While Foster has been durable through his early years, there are two reasons to worry. The first is that he just hurt his hamstring this season, an injury that may keep him out for a portion of the season and may be a harbinger of things to come. The second is that injuries tend to climb as athletes age, and especially so for running backs whose bodies take significant punishment on the field. 

1.2. Player performance
While a player’s current contract may be unaffected by declining performance, there are two reasons why it will feed through into the earnings claims. First, if there are bonus payments, as is the case with Arian Foster, they will clearly be put at risk, if performance deteriorates. Second, to the extent that you are counting on a continuation of earnings from a contract renewal (from the current team or another team), future earnings will be lower, if the player’s performance deteriorates. 
Arian Foster shares: Age has to be factored into the equation since he is 27 in a sport where running backs seem to age faster than everyone else in the field. One assessment of running back output based on age yielded the following graph on production for running backs (and quarterbacks): 

Note that output for running backs peaks early (24-25), levels off until about 27 and starts deteriorating after that age. Foster may very well be the exception to this rule, but it is dangerous to bet against history. 

2. Macro Factors
There are two macro level risk factors that can affect a player’s earnings. 
2.1. Collective Bargaining Constraints
In most sports, there is a players’ union that negotiates with team owners on both contract rules and constraints. While individual players may negotiate on their own behalf with teams, the constraints imposed by collective bargaining agreements may affect earnings potential for individual players. For instance, the hard caps on team payrolls imposed in the NBA and NHL and even the soft caps in the MLB (soft, because they can go over the cap as long as they pay the penalty tax) have affected player negotiations and contracts. 
Arian Foster Tracking stock: The NFL’s current salary cap is $123 million per team and each team is required to spent more than 95% of that cap. Both teams and players, though, have become adept at evading the cap constraints by loading more of the payment into future years. With Arian Foster, I am going to assume that this will be a minor factor. 

2.2. Economic factors
The magnitude of a player’s earnings may be affected by the overall economy, especially if a large proportion comes from endorsement income and that income is expected to grow over time. The growth in the aggregate economy can also affect revenues to a sport in the aggregate and thus indirectly affect how much can be paid out in contracts to players. 
Arian Foster Tracking stock: Since only a small portion of Foster’s current earnings (less than one million) came from endorsements in 2013, the impact of the overall economy on his earnings is likely to be small. 

3. Player Default 
Even if the athlete in question generates high earnings, the earnings stream to investors is dependent upon that athlete carrying through his side of the contractual agreement and delivering the promised portion of earnings to investors. If the athlete defaults on that obligation, your earnings down stream are at risk. You could, of course, seek legal recourse but given that an athlete who defaults is also likely to have other financial problems, it is unlikely that you will get much of your promised payback. 
Arian Foster shares: We have little evidence on Arian Foster’s default history. The strongest case that can be made for him is that he is ambitious and hopes to parlay his pro career into entrepreneurial ventures. Presumably, that will mean that he will not be cavalier in defaulting on contract obligations. That does not mean that there is no default risk but we will assume low default risk. 

4. Intermediation Risks
Investors don’t have a direct claim on Arian Foster’s earnings, since those earnings will be first collected by Fantex, which will then decide how to much of these earnings will be returned to investors as dividends. Consequently, there are three additional risks to factor into the assessment: 

4.1. Poor brand building investments
Fantex views itself as a brand builder for the athletes who decide to use it. That would imply that some of the earnings collected from the athlete will be spent in trying to increase earnings in the future, primarily from endorsements. There are no guarantees, though, that this trade off will be a positive one. Thus, it is possible that Fantex will expend 20%, 30% or even 50% of Foster’s earnings, trying to increase his marketability, with no discernible effect on endorsement earnings. 

4.2. Spillover risks
 One of the stranger features of the Arian Foster stock is that investors in the stock may be called upon to bear losses incurred by Fantex on other athletes that it may have in its portfolio. Thus, if Fantex makes a big up front investment in a potential superstar (Andrew Luck) and that star suffers a career ending injury, investors in the Foster stock may take a hit. 

4.3. Corporate governance risk
The nature of tracking stock is that holders of the stock are onlookers when it comes to corporate governance, since they have no power to change or even influence managers. This is going to be a factor on two levels. The first is that Fantex will take a portion of the collective revenues it gets from player earnings to cover management expenses & fees; if it keeps “too large a portion” of the earnings for these expenses, there is little recourse for you as an investor. The second is that Fantex is not required to pay the residual earnings (after brand building expenses, management expenses and other portfolio charges) to investors) as dividends. While this is always a problem with publicly traded company stock, investors in conventional shares get a claim on the cash balance which may compensate (at least partially) for the unpaid dividends. There is no such compensating claim with tracking stock. 

5. Investment Risk
If you are an investor who decides to buy Arian Foster tracking stock, there is one final risk that has to come into the picture. Since there is no ready market (yet) for these shares, it may be difficult and expensive to liquidate these investments. In valuation, that is generally a reason for either charging a “illiquidity premium” in your discount rate (increasing the discount rate) or attaching an “illiquidity discount” to the value. The extent of the effect will depend upon how much you value liquidity as an investor and how easy/difficult it is to trade these shares. 
Arian Foster tracking stock: Since this is the first set of tracking stock, I will assume that there is substantial illiquidity risk. That risk may decline over time as more athletes get listed and the Fantex trading market becomes more liquid, but neither is a reality yet. 

Valuing the Fantex Claim 
To value the claim on Arian Foster's earnings, I began by forecasting aggregate earnings to Arian Foster. In making these forecasts, I assumed that:
  1. Expected playing time: I will assume that Foster will play for nine more years, until the age of 36, at which point both his contract income and his endorsement income will end.
  2. Current contract: The current contract would deliver on the remaining $23.5 million due between 2013 and 2016. On average, that works out to $5.875 million a year. During the current contract period, I will also assume that he will earn approximately $2 million in bonuses each year, approximately a third of his overall potential bonus payments.
  3. Contract renewal: At the end of the current contract period, I am assuming that Arian Foster will get resigned to a new contract for the rest of his, worth $4 million a year, assuming that his age (31) and the production decline that comes with age with affect his earning power. I will also assume a step down in bonus income to $1 million a year for the rest of his career.
  4. Player fines/penalties: Given Foster's clean history and the position he plays, I will assume no dollar penalties will be imposed on his during his lifetime.
  5. Endorsement Income: Arian Foster's endorsement income in 2013 was $687,750 (though some of it is contingent on performance). I will assume that there is substantial growth potential (10% annual growth rate) in this income.
To value the cash flows, I have to make assumptions about player and default risk. For player risk, I will assume that there is a 5% probability of a career ending injury each year, resulting in cumulative probabilities that will increase over time (to 37% by the last year). For default risk, I will assume that Arian Foster's history & desire for commercial success will keep default risk low (a default spread of 1.50% and a discount rate of 4.1%). will be added to the risk free rate. For endorsement earnings, I will assume that there is low exposure to macroeconomic risk, resulting in an equity risk premium of 3% (and a discount rate of 5.60%). The table below captures the cash flows, discounted value and the value today (with the link to the spreadsheet).

The value of the claim on Foster's earnings to Fantex, based on these assumptions, is $10.06 million (before accounting for expenses and injury probabilities).  Fantex paid $10 million to get these claims, this looks like a break even deal for both sides of the transaction, with Arian Foster having the slight edge.

Valuing the Tracking Stock
To value the tracking stock, I have to factor in the drains on the cash flows from management expenses and branding investment, as well as the additional risks from not getting a direct claim on the earnings. For the first, I will assume that management expenses will consume 5% of the flow through earnings (as specified in the S-1) and branding investments will account for 15%, leaving 80% of the earnings as residual earnings. While I will assume that all of the residual earnings will be paid out as dividends, Fantex has no history (good or bad) in this respect and I will add an extra 3% to my discount rates to capture my absence of any corporate governance power (over either expenses or dividends). Finally, I will incorporate an additional premium of 3% in my discount rate for illiquidity, since it is unclear to me how I would exit this investment, without bearing significant costs. The value of my claim is illustrated below (with the link to the spreadsheet):

Specifically, I will be willing to pay $6.11/share for the Adrian Foster tracking shares, with my assumptions. There is a conversion feature on these shares, but it can be exercised only by the company to convert these tracking shares into Fantex platform shares; that option will make my claim less valuable, not more so. Consequently, I would not be a buyer at the $10 share price that Fantex has tentatively tagged the shares as worth in the S-1 filing.

Update: In both the Fantex and tracking stock claim valuations above, I did not incorporate the injury probabilities. Since I have an estimated probability that Foster will be playing in future years, I decided to incorporate that probability into the value and not surprisingly, it brings both numbers down:
Note that there is only a 63% chance that Foster will be playing in year 9 and the value of the Fantex claim drops to $8.2 million, giving Foster the clear edge on the deal, and the value per claim drops to $5.07. 


Anonymous said...

Great post

Anonymous said...

So you think Foster is going to be an NFL RB until he's 36?


John Keys said...
This comment has been removed by the author.
John Keys said...

Great post. I don't think he plays that long or gets paid that well I bet he is done by 30, and cut in the next 2 years.

There is positional risk, the team brings in a younger player or drafts someone who bumps him from his role.

I guess this is more of a bet then an investment.

Sell all day at $6.11

Aswath Damodaran said...

Making a judgment call on a NFL player is more dangerous & opens up more discussion than making one on Tesla. That is why I put the spreadsheet to change my inputs. If you think Foster is going to be done at the end of this contract, put that in as his expected pro life. I assumed he would hang around and become a second string running back for some team (and I am perhaps over paying him for that privilege). My point is that even with my optimistic assumptions, I cannot get close to the $10/share that Fantex is asking for.

Gil Meriken said...

I suppose the next step in the evolution of this asset is going to be the tracking shares on a group of athletes to reduce risk. Maybe the "All-Pro RB" index, or perhaps some will suggest you diversify, and have athletes from different sports in your basket of players.

After these become popular, micro-cap bloggers will turn their attention to the less followed table tennis and field hockey shares in search of and edge on valuation.

Anonymous said...

One additional point- This security is absolutely ripe for insider trading, right? We're not just talking about an insider who knows that a company just inked a deal that will increase revenues by 5%. We're talking about insiders (friends of Arian) who will know injury statuses before they're announced, contract negotiations before they're announced, and retirement plans before they're announced, which hugely impact this stock.

For those of you willing to make this bet, more power to you, but the NFL is insanely fickle. Take Josh Freeman as an example. Literally in a matter of weeks, he went from a franchise quarterback to unemployed and then back to being a starting quarterback. Millions to nothing and then back to millions. Don't know if it gets any more fickle than that.

Sarath said...

Brilliant stuff!

Patrick Garcia said...

Is there a chance that ad revenues will be considered in that deal? If so, couldn't they bring the revenues and therefore the share prices up?

Eli Fabens said...

Thanks for doing this, I read through the filing and the whole time was hoping you would release an annotated version, so thanks!

Aswath Damodaran said...

Ad revenues are counted in the deal, and on the question of insider trading, don't even get me started. There are all kinds of incentive problems to worry about. In this case, since the 20% comes out of pre-tax income, Arian Foster will effectively be handing over 60%+ of his income to others (since I am sure that his tax rate at the margin is 40%+, even if he lives in Texas). Will he try as hard to earn that extra dollar?

Would I invest in this security? It is not for me. I am not great at fantasy football, would make absurdly bad picks in my portfolio and would lose money. My point is that there may be some who feel informed enough about the NFL to make these investments and I wanted to create a template for doing so.

Rusty Mitchener said...

I run a sort of "career fantasy sports" game similar to this. We offer customers the chance to buy "player assets" and trade them on our exchange. The assets are backed by annual dividends proportional to the players salary that year.

Long story short, it's a similar idea to what Fantex does (there are some LARGE differences of course).

Foster is currently selling at our site for $3.35, which equates to a $33.5 million valuation of his career earnings potential. We don't include endorsements, however we do give out bonuses for winning various league awards so they should basically cancel each other out.

This is a very well done post, however I do believe $10 is far too high. Thanks for putting some real thought into this idea!

Rusty Mitchener said...

Forgot to mention, our site is:


I'd be happy to address any questions about our version of this game.

Barklie Estes said...

"The second is that Fantex is not required to pay the residual earnings (after brand building expenses, management expenses and other portfolio charges) to investors) as dividends. While this is always a problem with publicly traded company stock, investors in conventional shares get a claim on the cash balance which may compensate (at least partially) for the unpaid dividends. There is no such compensating claim with tracking stock. "

Is this referring to plowing money back into the company? I had no luck researching what you were referring to here.

Anonymous said...

That's cool!

Some thoughts -

1) Why endorsement income should not have a default risk - either from Arian or from Fantex?

2) Why cost of failure rates on other brands are not factored in cash flows?

3) Also why probability of injury leading to end of contract is not factored in cash flows?


Investing in the stock market said...

Post is very informative,It helped me with great information so I really believe you will do much better in the future.

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Anonymous said...

Great article! It would be interesting to compare how an athlete in another sport would compare. The first one that popped into my head was Mike Trout. I would think that the length of baseball careers and his earnings potential would require a large initial investment.

Barry said...

Is it possible to short the stock? If yes, it may lead to some really problematic ethical issues...
I can already see someone with a nice short position injuring him on purpose.

Aswath Damodaran said...

Very good points.
1. I brought in an equity risk component into the endorsement income. I end up using a higher discount rate already.
2. Since there are no other brands out there yet, I was not sure how to do it. You are right, though! This is a big problem with the structure of this contract.
3. It is easy to incorporate it. I was not sure how the existing contract is structured in terms of injuries. (When does the team stop paying him?)

Aswath Damodaran said...

Thank you for your comments. I just added a feature to the spreadsheet that allows you to incorporate injury risk into the value (if you so choose). That, in effect, also reduces the expected playing career for Foster and the value of the claim to about $5.

Anonymous said...

What about taxes? Fosters income isn't tax free and I think you are too interested in after tax return.

Anonymous said...

Thank you for your responses on those 3 questions Prof.

Aswath Damodaran said...

I was curious about taxes as well . Looking at how the S-1 defines foster's income, the 20% I looks like it is on pre-tax income.

PD said...

Great post - looking forward to seeing if Fantex platform can continue growing with a major NFL star in the fold

shyam maddali said...

Great post explaining the intricacies of valuing an asset like NFL player.
I know it is pretty low but did you incorporate the risk of NFL and its popularity going down ?

shyam maddali said...

Also, there is a risk of lockout due to player disputes or something else. Given 9 years is long enough duration, there is a non-trivial probability of lockout and reduced earnings.

Rob V said...

Hi Professor,

When I heard about this arrangement, I was hoping you would value it. :)

The post says you assumed $1 million bonus per year after contract renewal, but the table shows $750,000. How much difference does this make in the total valuation?


Loganthan said...

Thanks for a thoroughly enjoyable post. I have a query and would appreciate your thoughts. The discount rates for Fantex and for the investors in Fantex intuitively appears to be low. When discount rates for large US corporates are between 8 and 10% the discount rate for Fantex of 4.1 and 5.6% and the discount rates for investors in Fantex of 10.1 and 11.6% appears to be low. I understand how you got these rates but it's just it seems that these are riskier cash flows and should have a higher discount rate - similar to higher rates for privately held companies.

Danny said...

Prof - do you think the Fantex model is susceptible to some form of insider trading?

For example, given that AF could possibly control his earning power (i.e acceptance of new contracts, endorsement, confidential trade talks, etc), he or a connected person could easily trade the tracking shares to their benefit?

Assuming that a tracking share like will move heavily on trade talks, new contract, endorsement announcement.

john said...

This is an awesome article. As a finance undergrad I'd kill to be able to study things like this instead of bond valuations lol.

Keep up the interesting posts!

Warner Carter said...

The Tracking Key runs on two AAA batteries, lasts for up to 60 hours of continuous driving time, and stores up to 140 hours of data; it also has a sleep mode that it uses when the vehicle isn't in motion. GPS vehicle tracking system

Moneycontrol said...

Mars Mission on track; orbit to be raised tomorrow...since the launch, the control of the mission has been taken over by scientists at ISRO Telemetry, Tracking and Command Network (ISTRAC) at Bangalore.

Anonymous said...

A great article on the bubble

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equity trading advisor said...

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Prashant Kothari said...

Is it possible that $10 price assumes more contracts in future, some of them could be in favor of Fantex? I know its being speculative, but just wanted to see if stretching the valuation argument for that makes any sense?