The Puck Stops Here

The National Hockey League can be saved. Here’s how.

When private equity firm Bain Capital Co. and Game Plan International offered $3.5 billion last week to buy the entire National Hockey League, fans, commentators, and team owners were puzzled.

Pro hockey would seem to be a particularly unattractive investment. After all, it ranks a distant fourth in the hearts, minds, and pocketbooks of American consumers and advertisers. TV ratings are rotten. Labor relations are so poisonous that the current season has been canceled.

But in fact the bid was inspired, because the NHL is a classic candidate for a leveraged  buyout, the tactic pioneered by Kohlberg Kravis Roberts & Co. and now practiced by Bain and dozens of firms around the world. LBO artists—and the LBO is an art as much as a business—understand that seemingly broken-down industrial companies can become undervalued in the market when management screws things up over a long period of time. By changing leadership and capital structure and renegotiating labor deals, LBO wizards have extracted value from even the most mortally wounded corporate dinosaurs. The debt that fuels LBO deals imposes a discipline on managers that the public markets and other ownership structures don’t.

Which brings us to the NHL. Like the first LBO targets in the ‘70s and ‘80s, the NHL is a classic old-economy industry. It’s losing market share. The areas in which loyalty to the product is strongest—Buffalo, Pittsburgh, etc.—are shrinking. Demographic trends are pounding the NHL. U.S. population and economic growth are happening west and south and among non-whites. And like many LBO targets, the NHL got into trouble by expanding too rapidly into unproven markets, like Florida, Atlanta, and North Carolina, thus diluting its ability to produce a quality product. It’s no wonder the market is starting to treat hockey as a distressed asset.

LBO candidates are also characterized by entrenched managers who lack the discipline to save themselves by cutting costs and taking other painful measures. That describes the NHL exactly. The NHL commissioned former Securities and Exchange Commission Chairman Arthur Levitt Jr. to conduct a study of the league’s finances. Over the past nine years, he found, the NHL has collectively lost $1.5 billion. In the 2002-2003 season, NHL notched an operating loss of $273 million on about $2 billion in revenues.

When it comes to controlling costs, NHL owners are pathetic. Over the nine-year period, revenues rose 173 percent, but labor costs rose 261 percent. Sure, the NHL doesn’t have a salary cap. But neither does Goldman Sachs or the Gap, and they still manage to make money while competing for talent. As this Forbes article points out, NHL player salaries rose because general managers and owners made economically stupid hiring decisions.

Any class of MBA students could figure out what to do with the NHL post-LBO. First, the new owner—a single, investor-controlled entity rather than 30 bickering tycoons—would likely close 10 teams immediately. According to the Levitt report, six teams lost more than $20 million a year, and 12 lost more than $10 million per year. Shutting some of them down would stop a lot of the bleeding instantly.

Next, install new managers at the teams and make their compensation contingent on turning profits. The problem with the NHL—and with many sports franchises—is that the teams aren’t run to make money. Owners of many sports teams generally don’t expect, or need, a dividend check from their team each year. Instead, they’re happy to take their returns in capital gains, by selling the team to a bigger ego with a bigger checkbook. Buy for $40 million in 1990, and sell for $140 million in 2000. So long as teams can rise in value even as they lose money each year, that’s a rational choice. But the NHL may have reached the limit. The guys who overpaid for teams recently—like Ted Leonsis, who dropped $80 million on the Washington Capitals in 1999—may never get their windfalls.

As for the players, the new owner could get tough without being obnoxious or abusive. Salary cap or not, the new management would make it clear that the salary pool for players is limited. Teams would have strict budgets. With a single owner the suicidal salary escalation that has crippled the league would end. And nothing would rein in the players’ union more than losing one-third of its positions when the league shucks 10 teams. With fewer teams operating, market forces would drive the price of talent down. Even at reduced salaries, the NHL would still get the world’s best hockey talent.

There are sure to be objections from fans. Diehards in Buffalo and North Carolina—are there any in North Carolina?—would rage about losing their teams. An NHL owned and operated by a single entity would have a tendency toward greater parity. And single-entity league ownerships don’t have a great record in the United States. Isiah Thomas’ purchase of the Continental Basketball Association ended poorly. In Major League Soccer, the league owns all player contracts and enforces a strict salary cap on its teams. Sure, it has a difficult time hanging on to talent—because so many leagues in Europe pay better. But at least MLS is having a season this year.

After a few more months off the ice, NHL players will be glad to skate for a bunch of hard-hearted, hockey-hating, profit-hungry investment bankers. Better that than playing in Slovakia.