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Crain's Detroit Business
The University of Michigan athletic department sits atop $240 million in debt at a time when several major college athletics programs are grappling with enormous and potentially crippling debt loads.
Fueling that peril are ESPN subscriber losses that sap revenue from a network whose gargantuan spending on college football TV broadcast rights is a vital revenue stream for major universities. Other worries are the ongoing struggle to monetize content - how do you make money on Snapchat? - to an audience consuming college sports in dizzying arrays of formats, and the trend of dwindling football crowds for some schools.
Unlike its some of its cash-strapped peers, Michigan has a packed Big House on fall Saturdays, deep-pocket donors, an elite credit rating, and it expects its share of TV money to keep increasing - a mix the university expects to give it the financial maneuverability to readily pay what it owes and to keep borrowing to build or refurbish its facilities.
But the potential threat on the horizon is real and increasingly less distant, something acknowledged by Michigan administrators.
"We watch very closely with what's happening to ESPN," said Kevin Hegarty, UM's executive vice president and chief financial officer.
A look at UM's financials shows that its athletics debt stems from spending on new venues and renovations such as expansion of Michigan Stadium and construction of the football team's Al Glick Field House. Millions more are owed for interest.
The $240 million in Maize-and-Blue borrowing accounts for one of the nation's largest college athletic department debt loads, but unlike some other struggling schools, UM's administration is confident that its reputation, budget controls and credit rating are enough to keep it out of trouble.
UM is keenly aware of a catastrophe taking place out West.
In the first week of the new year, Bloomberg Businessweek published an analysis of college athletics debt highlighted by the University of California at Berkeley, which may have to slash its number of intercollegiate teams because of a $22 million athletic department budget deficit last year on $445 million in debt. The rest of the story explains the origins of the college sports debt crisis - mainly the arms race for bigger and better facilities, especially for football - and how schools are coping.
The analysis showed Michigan, based on 2014 data, as being among the top 10 in athletic department debt nationwide.
But while there is worry in Berkeley, there's guarded optimism in Ann Arbor.
As CFO, Hegarty is UM's top financial mind and its budget steward. In a conversation with Crain's, he outlined why the debt load isn't worrisome. Namely, the reputation and credit rating allow the school to borrow money at favorable rates, administrators budget smartly, and deep-pocket donors writing big checks reduce the need to borrow, he said.
But first, a look at the numbers.
Michigan's fiscal 2016-17 athletic department budget of $161 million includes a $15 million debt payment for eight projects, including $9.2 million for the 2011 Michigan Stadium renovation, according to UM Athletic Director Warde Manuel's June 2016 operating budget report to the university's board of regents. The budget predicts an $800,000 surplus while factoring in a 4 percent annual increase in costs.
A more detailed breakdown of the athletic department's current debt shows $371 million in principal and interest payments for 10 projects through 2046, according to information supplied by the university under a Freedom of Information Act request by Crain's.
That breakdown shows the athletic department's annual debt payments will leap to more than $20 million beginning in 2019 before leveling off to about $15.7 million annually from 2022-36 - provided the department takes on no new debt, an unlikely scenario as the department seeks to upgrade older facilities and build new ones to remain competitive.
Hegarty said the athletic department can absorb the increased annual debt payments because revenue is expected to rise equally quickly.
UM could end up paying less than $371 million if it pays off principal sooner, which reduces or eliminates interest - the same as with a home mortgage or auto loan.
The interest part of the equation is purely theoretical. Hegarty's office is constantly seeking lower rates to drive down payments. The athletic department currently has $131 million in interest payments on the books through 2048, but Hegarty stresses that the amount will change as the university seeks to refinance debt, and it could pay down its borrowing early thanks to donations and other revenue sources.
It also will take on new debt, such as for the plan approved recently to spend $21 million to refurbish the Oosterbaan Field House for the football team.
"We are constantly in the market, looking for opportunity to take advantage of reduced interest rates," Hegarty said. "We'll manage that down as much as we can."
That said, UM certainly will pay a large chunk of that interest, just as homeowners who stay in their home pay far more than the list price over a 30-year mortgage. But unlike a homeowner, UM isn't going to sell the football stadium to move elsewhere.
Budget controls, options
The athletic department itself opted not to say much about its budget and debt, instead deferring to Hegarty and the board of regents.
A departmental spokesman did issue a short statement.
"Operating expenses go directly against revenues and Michigan has been able to balance its budget while operating independently as a self-sufficient entity. We accept no university or state monies. This long-term debt is less than 10 percent of our operating budget," Kurt Svoboda, UM's associate athletic director for external communications and public relations, said via email. The athletic department declined to make Manuel or any senior department business staff available to discuss finances and debt.
Internally, the athletic department plays it cautious with assumptions in its budgeting and debt estimates, Hegarty said. The principal and interest payments last year were a couple of million dollars less than budgeted, thanks to that conservative planning and efforts to refinance rates.
"We plan conservatively," said Hegarty, who noted that Michigan has $2.1 billion in total debt for the entire university.
Additionally, the athletic department has been modest in its pricing for tickets and premium seating, Hegarty said. If trouble emerged, there's room to charge more.
"Michigan had followed a real, real affordability path," he said. "They do have headroom to price up if they need to."
The athletic department also could lease its facilities for more events, something it traditionally has not done, Hegarty said. It brought in money from leasing the Big House for elite-level exhibition soccer matches in recent years.
If financial problems ever emerged, Michigan can always turn to its alumni for help, too.
"We as a campus have enjoyed very strong donor sponsorships in terms of gifts," Hegarty said.
Most notably, the athletic department - it has about 900 student-athletes and 350 coaches and staff for 31 teams - is using a $100 million donations from alumnus Stephen Ross to pay for its new south athletic campus.
Hegarty said he instituted monthly financial review meetings as part of his overall plan to more closely track how self-funding parts of the university handle their finances.
"It's a good time to bond with Warde's team, to work on problems together. It's been a huge positive," he said.
The ground rule for the athletic department taking on debt is simple: "When the time comes, they're going to have to have the money. The institution isn't going to provide that money," Hegarty said.
In other words, the university as a whole ultimately backs the bonds, but the athletic department has to convince the administration that it can pay off the spending without trouble. And that's been working.
"The regents are very comfortable where we are debt-wise and operationally," Hegarty said.
Mark Bernstein, chairman of UM's board of regents, said he's keenly aware of the athletic department's debt and is OK with it because of the university's fiscal position.
"I am mindful of the issues related to our debt obligations, and feel comfortable given our debt capacity related to the university as a whole and athletics in particular," he said.
The athletic department debt is backed by the university as whole, which has a AAA bond rating from Moody's Investors Service. That allows Michigan to borrow money at advantageous rates for lower-cost long-term investments, said Bernstein, who was elected regent in 2012 and is president of Farmington-based The Sam Bernstein Law Firm PLLC.
The debt level and questions about future revenue streams are on the regent's radar, he added.
"No doubt it is something that needs to be constantly evaluated. Athletics, both college and professional, are in a fragile place," Bernstein said.
If a financial crisis did erupt and debt default loomed, the athletic department would have to repay any bailout by the university as a whole.
"If things did go bad for athletics - I'd give that a low probability - the University of Michigan at large would be obligated to backstop that obligation," Hegarty said. Instead, the university could write the athletic department an internal loan from cash on the overall balance sheet, and the department would pay it back with interest, he said.
He noted that UM's preference is to use its savings and donations instead of debt financing.
"We have a lot of cash on the balance sheet, and we use it to finance a lot of capital projects," he said. "Very few projects are 100 percent leveraged with debt."
When the university does issue debt, the markets consider UM bonds a safe investment, and when the football team is successful, investor confidence can grow, Hegarty said.
"People like University of Michigan bonds," he said. "People want to invest in winners. It can drive revenue."
The great uncertainty
At first, it seems silly that major schools would worry about broadcast rights money. After all, the Big Ten recently signed six-year deals with ESPN and Fox Sports worth a combined $2.64 billion. Those deals begin in the fall, and UM is expected to nearly double its share of broadcast revenue to about $40 million.
But there are cracks in the paint.
In 2013, ESPN had 99 million subscribers. It now has 90 million, its lowest subscriber base since 2005. Daniel Salmon, analyst at BMO Capital Markets, recently estimated that ESPN could lose about 4 percent of subscribers in fiscal 2017. Other insiders say the losses could be even worse. And those ex-subscribers take with them cash ESPN uses to fuel its billions of dollars in professional and college sports broadcast rights deals.
On the other hand, a PricewaterhouseCoopers sports industry report from October predicts that media rights spending will increase, from $18.2 billion this year to $21.2 billion by 2020. That's nearly double the total broadcast rights spending in 2011, which was $10.8 billion.
The uncertainty breeds varying levels of concern. Specifically, the proliferation of platforms and ways in which college sports are delivered to consumers raises financial questions, according to Karen Weaver, a sports-management professor at Drexel University and specialist in college media rights.
There are no simple TV deals any more. Fans increasingly consume games on their mobile devices, and some indulge only in stats, highlights and specialized content that isn't pure game action. So, advertisers are not going to pay the networks a premium for content split among channels, the theory goes.
"That makes it difficult to monetize as efficiently and effectively," Weaver said. "It's enormously frustrating to a media industry that detests uncertainty and change."
UM's administration is confident that fans will continue to consume Michigan sports on whatever platform they prefer, and advertising and subscriptions will follow.
"I do believe this is sustainable in the long term, therefore the demand for our content will continue," Bernstein, the top regent, said. "There always will be a passionate following, and that's what puts us in the driver's seat with regard to the revenue model."
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