Behind the Curtain: Zuffa's Finances Come Into Focus

By Adam Swift Oct 17, 2007
Randy Couture's (Pictures) resignation from the UFC and subsequent speculation about the company's pay scale have shoved Zuffa's finances back into the spotlight.

As a privately held company, Zuffa has no public reporting obligations. The information that is made public is carefully screened and released only when convenient to tout the growth and success of the UFC brand.

As a result the company's financial status and business model are largely left to speculation. But recent reports by Standard & Poor's, one of the leading financial services companies in the world, have provided new insight into the finances of the undisputed leader of the MMA world.

On Sept. 14, S&P cut Zuffa's credit rating outlook from stable to negative, but overall S&P reports revealed a business that is still growing. While profit margins are down substantially due to European expansion efforts, pay-per-view -- the company's key revenue source -- is up 35 percent through the first half of the year. Furthermore, despite more than doubling operating costs from a year ago, the company remains profitable.

According to S&P, roughly 75 percent of Zuffa's revenues are generated through the production of live events. Pay-per-view buys account for the lion's share of live-event revenue with gate receipts playing a much smaller role.

For example, although an average show might generate $2 million at the gate (ticket sales), it generates at minimum roughly $4.8 million in pay-per-view revenue (assuming 300,000 buys and a 60/40 split between Zuffa and the PPV distributor). The company's contract with Spike TV and assorted sponsorship revenues account for the remaining 25 percent of revenues.

Last year Zuffa experienced what can only be described as explosive growth. In 2006, S&P reported that the average buy rate per event nearly tripled compared with the previous year.

Accordingly the company's EBITDA margin (EBITDA represents earnings before interest, taxes, depreciation and amortization; an EBITDA margin is akin to a profit margin) more than doubled from the mid-teens in 2005 to more than 40 percent of gross revenues in 2006. Dave Meltzer of the Wrestling Observer Newsletter reported that Zuffa is believed to have grossed $190 million last year and posted a before-tax profit of $76 million.

Entering 2007 Zuffa was expected to post an EBITDA margin of more than 50 percent.

Pay-per-view buys for domestic events have increased 35 percent over the first half of last year and total revenue growth is up 30 percent, but the company's EBITDA margin has declined more than 50 percent due to dramatically increased operating costs.

Operating costs have more than doubled thanks to production expenses associated with two events held in the U.K. and an aggressive marketing campaign to establish the UFC brand in the U.K., the scale of which was criticized by the company's financial officers, according to the Wrestling Observer Newsletter. As a result the company's EBITDA as a percentage of gross revenues has fallen to roughly 20 percent for the year thus far.

S&P began covering Zuffa earlier this year in anticipation of the company securing a $350 million senior secured credit facility. That number represents a term loan for $325 million due in 2015 and a $25 million revolving credit facility (a so-called "revolver") due in 2012. With the arrangement, according to S&P, the company "will have few, if any, external funding requirements in the intermediate term once the new capital structure is implemented."

It is interesting to note that the term loan was originally proposed at $275 million, as of the May 22 S&P report, only to be increased to $325 million by the time of the Sept. 14 S&P report. This time frame coincides with the closing of Zuffa's purchase of Pride's assets, though the significance of the increase and its connection to the purchase of Pride is purely speculative.

Proceeds of the term loan were used to pay a one-time special dividend to Zuffa's owners, the Fertitta brothers (90 percent) and Dana White (10 percent), and to refinance the company's existing debt. The amount of debt Zuffa refinanced and the amount it paid out in dividends can only be speculated.

However, some comments in the S&P reports suggested that the dividend payments could be quite substantial. The company has full availability on its revolver, indicating that to this point Zuffa has funded operations out of its normal cash flow. Therefore the revolver currently represents little more than a rainy day fund. Meanwhile, as of June 30, 2007, Zuffa's total debt outstanding was $325 million.

The loans are secured by bank-issued securities as opposed to the company's assets. In fact, Zuffa has very little in the way of tangible assets. S&P expects meaningful recovery (50-70%) of the principal in the event of default, placing the estimated resale value of Zuffa's assets, namely its brands, contracts, and cash, assuming a forced liquidation, at roughly $150-240 million.

As a result of these numbers, free cash flow is paramount in the minds of the company's creditors. The company's credit rating outlook was cut because of weak free cash flow caused by decreased operating margins. Unless free cash flow improves, the owners will be forced to reduce dividend payments to avoid a cut in their rating.

S&P initially assigned Zuffa a credit rating of BB on May 21. A BB rating reflects a company that is less vulnerable in the near term than other lower-rated obligors. Yet the rating also indicates that Zuffa faces ongoing uncertainties and exposure to adverse business, financial, or economic conditions that could lead to its inadequate capacity to meet its financial commitments. Bonds rated BB and below are considered junk bonds due to the risk of failure associated with the companies that issue them.

At the time of the May 21 rating, S&P issued the following outlook:

"The stable outlook reflects our belief that Zuffa's ability to successfully market UFC events will continue to drive strong revenue and cash flow growth through the next few years. We also believe UFC has gained a solid niche following, which will add stability to the company's financial profile over the intermediate term.

"A shift in consumer interest away from MMA or a shift to a more aggressive financial policy could lead to downside rating pressure. Conversely, if the company continues to drive increased interest in the sport over the intermediate term while maintaining currently healthy EBITDA margins and free cash flow generation, the outlook could be revised to positive."

S&P also expected Zuffa "to reduce the scale of its international UFC bouts going forward, with the intent to limit potential losses generated by these events and return consolidated cash flow to a level more consistent with 2006 results."

It will be interesting to see if Zuffa can meet this expectation given Dana White's stated commitment to the European market place and aggressive expansion plans. Regardless, despite the anticipated cost reduction, S&P does not expect Zuffa to return to its previous EBITDA margin of 40 percent because of "increasing fighter costs and production expenses for domestic UFC content."

S&P's most recent report, on Sept. 14, concluded that Zuffa's credit outlook is negative:

"Failure to improve the company's currently depressed margins through more stringent cost controls and continued top line growth or a shift to a more aggressive financial policy over the intermediate term could lead to a downgrade. Conversely, if the company can restore its previously strong credit metrics through cash flow growth and debt repayment, the outlook could be revised to stable."

Still, credit outlook aside, the numbers behind the cut reflect a healthy, growing business.

Adam Swift is the author of Payout: The Business of MMA.
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