Zuffa's Loans: Re: Payout: The Business of MMA: Second Opinion: Zuffa's Finances Come Into Focus

Payout: The Business of MMA: Second Opinion: Zuffa's Finances Come Into Focus

My Response

It's no secret, lawyers don't know shit about accounting. So, Zuffa, LLC (which owns the Mixed Martial Arts promotions UFC and WEC, and the former MMA organizations Pride and WFA) took out a loan. This is allegedly a big deal. Yeah, it is, but again, not necessarily how you think.

What we know

Zuffa has a $350 million financing package, this is composed of a term loan and a line of credit.

The line of credit is $25 million, and Zuffa, apparently, hasn't used any of it. This is basically like their Mastercard, they can borrow against it anytime they want, and interest will be charged only on the amount they borrow. However, there is the equivalent of an annual fee somewhere, because banks LOVE MONEY.

The term loan is $325 million and is what's called a Term B Loan. Term B Loans are a type of loan that comes due in one huge payment as of a specific date, they have additional qualifications and terms, but that's basically all you need to know.

So, why does Zuffa need a loan?

The same reasons any company needs a loan: they need cash to fund operations, to fund expansion, and to pay off existing liabilities (non-owner entities holding equity in Zuffa's assets).

Context

Zuffa, LLC was founded by Frank Fertitta III, Lorenzo Fertitta, and Dana White. Dana White is an outspoken, energetic entrepreneur with absolutely no self-censoring capabilities who had been operating a chain of boxing gyms. The Fertitta brothers are somewhat famous for their casino operations (the Station Casinos, they're relatively small operations, but it's a huge industry). The company existed for the sole purpose of purchasing and operating the Ultimate Fighting Championship from Semaphore Entertainment Group (which had purchased UFC from WOW Promotions after HBO and Showtime passed).

At that time, UFC was dying an ugly death. MMA was just beginning to gain legitimacy as a sport after years of persecution by politicians like John McCain. They had lost the ability to air most of their events on pay-per-view cable in most cities, and were reduced to running shows in tiny venues in out of the way places like Iowa and Alabama. It had been a long fall from their Denver origins. They were making major strides in terms of becoming a regulated sport though, and New Jersey had just recently passed laws permitting their boxing regulatory commission to regulate MMA. The modern "Unified Rules" had their origins in the regulations passed by other smaller states (like Iowa), but New Jersey was the first major player in combat sports to regulate MMA, which gave it legitimacy and protection from naysayers who claimed that it was an unregulated no-holds barred street fighting organization, in short, a blood-sport with no place in civilized society.

Zuffa purchased the UFC, and then, conveniently, Nevada passed laws regulating MMA (there is a conspiracy theory about this, that the Fertitta's were blocking the regulation until after they had purchased UFC to drive the price down). The so-called "black period" of the UFC wasn't over yet though. They had a substantial number of shows that were still blocked by major PPV outlets and never became available on home video. These events were expensive to run, and were not able to generate enough ticket sales and PPV buys to make a profit.

In the years after Zuffa bought LLC, the company lost millions of dollars.

Ultimately, the UFC turned things around. Currently, they have record PPV buys, ticket sales in the millions of dollars per show, and marquee fighters appearing in media and on television in the UFC's own reality show.

However, the loans that Zuffa had taken out during that period came due, and the company did not yet have enough cash to pay them off. Additionally, the company wanted to expand into Europe to increase their revenues, and were in the process of the rapid acquisition of three rival MMA promotions (WFA, WEC, and Pride). This stuff takes cash.

Accounting for it

Let's take a thumbnail look at the type of accounting transactions that occurred (all figures are estimates and not necessarily reflective of actual amounts):

The initial loan came due, to pay it off, the company needed cash, so they took out a new loan, and used the proceeds to pay the old one.

Cash                         125m
Debt (old loan)              200m   
       Debt (new loan)                325m

Interest Expense (old loan)   50m
       Cash                            50m

The only part of this transaction that will have an effect on the owner's equity of Zuffa is the interest payment, which will be closed into owner's equity at the end of the year. The increase in creditor equity is offset in large part by the receipt of cash and the payoff of the old loan.

The aquisition of a new loan does not in itself cause Zuffa to have a decrease in owner's equity. The interest expense does decrease owner's equity, like any other expense of the company would. That isn't to say that Zuffa actually had positive owner's equity to start with though. The accumulated losses from the early period of the company may well have reduced Zuffa's owner's equity to a number lower than zero, which would indicate that the creditors of the company had the right to more stuff than Zuffa actually posessed.

Creditors might still be interested in loaning money to a company with negative equity, as long as they were assured that the company was likely to have enough cash to pay off the loan in the future.

There are distinctions between cash flow and net income that I'm not going to go into at this time, but in a nutshell, when a company uses the "accrual basis" of accounting, certain revenues and expenses are not recorded in the year that they are received or paid, they are recorded in the year that they are earned or incurred instead. This means that the amount you pay out and receive in cash may not tie to the amount that you are reporting as expenses and revenues in any particular period.

Because of these differences, banks are typically more interested in the "cash flow" of a company than whether or not it is reporting a profit or whether it has positive owner's equity when they are considering whether or not to lend the company money.