Insight: Sports and Entertainment Industry to Face Brisk Headwinds Due to COVID-19

05 May Insight: Sports and Entertainment Industry to Face Brisk Headwinds Due to COVID-19

Posted at 16:33h in News, Publications by Lorene Branch

While the effects of COVID-19 are being felt throughout the economy, few groups will encounter greater headwinds than those operating in the sports and entertainment world. Companies operating in this industry often feature a unique combination of high fixed costs, an inflexible workforce, and seasonal revenue. With the sudden elimination of revenue due to corona virus restrictions and little ability to solidify a cash position prior to this unexpected event, many companies will be left trying to determine how to meet their short-term obligations. Additionally, the uncertainty of returning demand after quarantine periods will provide further challenges in the management of operations.

Many of our professionals at Amherst Partners have considerable experience working with organizations in this industry. While this disruption is like nothing we’ve seen before, we can apply what we know from past experience to help draw a picture of what the future may hold for businesses in this space.

Major League Sports and Arena Entertainment Organizations

Professional sports organizations are an interesting case study. Major sources of income include television revenue, gate receipts, and advertising, but with most teams being owned by entertainment companies or holding companies with outright ownership or de facto control of arenas and other venues, ultimate owners’ bottom lines are also impacted by other events offered at the venue, along with parking and a portion of concession revenues. Owners rely upon the fixed revenue from TV rights and advertising, supplemented by the variable revenue driven by event volume to cover high fixed costs of operations. In normal times, players’ and coaches’ salaries, the largest portion of payroll, are fixed and combine with debt service, maintenance costs, and rent to make up the fixed costs to be covered. COVID-19 challenges this traditional paradigm and brings up some interesting questions.

One of the more interesting dynamics to watch will be how the cancellation of sporting events impacts previously fixed television revenues. While TV contracts may not have clear clauses accounting for such an occurrence, most likely include force majeure clauses that may become a point of contention if networks choose to dispute their liability for broadcast right payments. That may be moot if the networks are concerned with alienating powerful league partners, locking them out from future TV deals.

Another interesting factor is how player compensation will be affected by an elongated suspension of activities. Some leagues compensation structures feature a locked in split of revenues to players, such that if revenues cease coming in, players’ salaries drop in correlation with the revenue loss. Additionally, some leagues have force majeure clauses that would apply and allow them to cut payments to players. The question of alienating a key constituency arises here again, as cuts in player pay may lead to significant issues in the future for ownership and the leagues.

A situation where player salaries were still owed in full and TV rights were withheld would lead to dire consequences for many owners.

Should games be played and other events be held, significant issues will still be faced. Variable gate related revenues for sports and other arena/stadium events will see a meaningful drop off for months due to concerns over future virus transference and a reduction in disposable income, while administrative and event staff will have to be brought back online. Minor league sports are facing an even greater crisis than those struggling major league organizations, as they rely mostly, or solely, on gate related revenues to maintain operations. Teams previously challenged to cover their fixed costs with this volume will fall behind. Cash conservation, strategic cost cuts, and managing relationships with creditors and lenders during this period will become crucial.

Music and Theatre

Orchestras and theatre groups rely upon gate receipts, as well as donations, to cover their costs of operations. These groups will face the same gate challenges as sports leagues, though maintaining their level of donations will also be a concern on two fronts. First, short term economic challenges will likely reduce excess income from some who might have previously donated. Second, there may be some level of donor fatigue.

Over the last 10 years, the fiscal assistance required for metropolitan arts groups has been considerate. Coming out of the last recession, the music world saw the closure of the Albuquerque, Syracuse, and Honolulu orchestras, as well as the bankruptcies of the Philadelphia Orchestra and the New York City Opera. The 2010’s were rife with conflict with unions, and a constant battle has existed between maintaining the quality and number of the artists and keeping out of the red. All through this period, donors have been helping keep the boat afloat. The continued call for support, as well as the myriad other causes that will be requiring assistance coming out of COVID-19 economic distress, may exhaust donors’ ability to give.

At the same time, the largest expenses for an arts group – location costs and artistic personnel are highly inflexible. It costs just as much to play to a full or a sparse crowd, and the latter may be the norm for the foreseeable future.

Amusement Parks

Another sector of the entertainment world that will suffer from COVID-19 effects is amusement parts. Three major obstacles await them. First, should quarantines continue, parks could remain completely shutdown during the summer season, which is heavily relied upon to cover lower volumes during other parts of the year. Second, after opening, gate reductions due to concern over virus contraction in a densely crowded area and lower disposable income will factor in here as well. Third, several parks are destination locations, rather than local operations, and may be affected by customer concerns over air travel in a post-quarantine world.

Cinema

Cinemas will also face significant challenges from COVID-19. Small cinemas have begun filing for bankruptcy and some larger chains are scrambling to raise debt to cover losses. Cinemas run on very slim margins and a long-term quarantine would be catastrophic. When starting back up, they will see a reduction in ticket and concession revenues, as consumers will be wary to be in a tightly packed location for hours and government mandated capacity limits may be imposed. Premium Video on Demand offerings, where studios simultaneously release films in the theater and in-home, may also become more prevalent after studios assess results achieved from such actions during quarantine. Disposable income drops should not be as significant an issue here as in other entertainment options, as theatres have seen increased rates of attendance during six of the last eight depressions.

Most major releases planned in recent months have been moved back in the calendar year. Crowded release schedules will provide an incentive for theatergoers to return, but for those willing to attend, they are unlikely to see as many films over a short period compared to a wider release schedule.

Another factor to consider is the revenue sharing model of theaters. Theaters share a large portion of ticketing receipts with studios. Theaters’ retained share of ticket prices typically correlates to the length of time which the movie has been running. With a crowded release slate, films will be staying in theaters for a shorter period or more quickly facing competition from other new releases, reducing the amount of tickets with the greatest financial benefit to the theaters. Given the typical drop of attendance after the first few weeks of release, and the fact that ticket margin is dwarfed by that of concessions, the level of impact this have may not be highly significant, but this is another headwind all the same.

One of the most interesting interplays in the industry to watch over the coming year will be lease negotiations between theaters and lessors. Given the difficulty in repurposing or re-leasing a cinema space, as well as the glut of commercial real estate currently available and that expected to become available because of COVID-19, theaters may have some leverage in negotiating agreements that may help them to continue operations.

Conclusion

There will always be a market for entertainment. Customers will return to the arena, the concert hall, the roller-coaster rides, and the movies. The mission for entertainment providers in fighting through the short term is to make sure theirs’ is the company to meet that need at the end of the tunnel.

A prolonged quarantine period may be fatal to companies with a seasonal business model, high fixed costs, and a meaningful debt load. Sports organizations will face difficult contract discussions and will be more challenged then ever to get people in the stands. Metropolitan art groups will be forced to rely even more heavily upon donations for survival at a time when those donations will be hardest to solicit. Cinemas will face yet another industry hurdle.

Most of these operations can demonstrate healthy long-term viability, but the short-term will be trying. As they look to cover debt and other fixed and semi-fixed costs in an attendance-limiting environment, these businesses will need to work with creditors and lenders to navigate a path through to a mutually beneficial outcome, and to avoid destruction of value to all parties.