Maximizing Earnings: Dividend Policies and Acquisitions in Sports Business

1. chapter15 Spending Earnings Lonni Steven Wilson, Medaille College

2. Key Chapter Objectives • Describe different types of dividend policies and how they are used. • Describe how a business utilizes retained earnings. • Understand how mergers and acquisitions are a way for a sport business to expand. • Describe the legal concerns associated with mergers and acquisitions.

3. Key Terms dividend payments—Payments made out of earnings, in the form of either cash or stock, to a business’ owners or shareholders (Brigham & Ehrhardt, 2005). distributions—Similar to a dividend but paid out of sources other than current or accumulated retained earnings. retained earnings—Company keeps earnings for capital investment and forgoes paying shareholders.

4. Decisions About Using Earnings • The right decision about using earnings selects the option that will produce the greatest value to the • Ownership or to the • Shareholders (in the case of a publicly owned company)

5. Methods of Using Earnings In general, sport businesses have three choices for using earnings: • Pay dividends to shareholders, if it is a for-profit business • Retain earnings for reinvestment in the business. • Reinvest in other firms by purchasing a percentage or acquiring other firms outright.

6. Views on Making Dividend Payments • The first method of dealing with earnings is to pay dividends. Three views exist on how to pay dividends: • Pay the highest possible dividend. • Make a middle-ground dividend payment, somewhere between high and low, that will satisfy most shareholders. • Pay the lowest possible dividend. (Brealey, Myers, & Marcus, 2004)

7. Buying Back Stock Companies may opt to buy back stock as a means of repaying investors (i.e., instead of continuing to pay dividends). Results • The number of shares outstanding decreases • The book value per share increases Reasons a company may buy back stock • Distribution of earnings (instead of issuing a dividend) • Change capital structure

8. Paying Stock Dividends Companies may “pay” stock dividends in lieu of cash. • Potential negative results—A dividend paid in stock can have a dilutive effect on share price. • Potential positive results—Stockholders may save money on taxes. (continued)

9. Paying Stock Dividends (continued) Capital gains versus income tax: how shareholders may save • Cash dividend payments are taxed as income for shareholders. • Money earned from the sale of stock is taxed as capital gains. • If stockholders sell the new stock within one year of owning it, they are taxed 28% (as of January 2006) on their gains. • However, if stockholders sell the new stock after more than a year of ownership, they are taxed only 15% on their gains. • On the basis of taxation policy, many stockholders would prefer the repurchase of stock over dividend payments (Brealey, Myers, & Marcus, 2004).

10. Retaining Earnings The second method of dealing with earnings is to retain earnings. Dividend payments cannot exceed retained earnings on a business’ balance sheet (impairment of capital rule). Considerations in the amount of retained earnings • A business’ capital structure, capital budgeting decisions, and dividend policy • A business’ size • Target capital structure (proportion of debt to equity) • Managerial control

11. Reinvesting in Other Firms The third method of dealing with earnings is to reinvest in other businesses, which takes one of two forms: • Mergers • A merger is the combining of two or more businesses into one. • One business blends its business with the acquired business. • Acquisitions • In an acquisition, the acquiring company maintains control over the acquired company and serves in a dominant position over it. • The two businesses remain their own distinct companies.

12. Types of Mergers • Horizontal: Two companies in the same line of business are joined. • Vertical: A buyer expands operations forward toward the final customer or backward toward the source of raw materials. • Upstream markets (closer to raw materials) • Downstream markets (further down in the production process; closer to customer) • Conglomerate: Companies in unrelated lines of business come together.

13. An Example of a Sport Company Acquisition An excellent example of a company’s acquiring another business in an attempt to increase its own value is News Corporation, owned by Rupert Murdoch. • News Corporation operates television networks such as the Fox Network, Fox Sports, and BSkyB. • As part of an overall business strategy, News Corporation acquired the Los Angeles Dodgers for $311 million in 1998 (Chass, 1998). • One reason for the purchase was to provide broadcast content for the company’s television networks. (continued)

14. An Example of a Sport Company Acquisition (continued) • Therefore, although the Dodgers may not have been a company that provided large profits, Murdoch’s goal was to use them to help his other business ventures such as television and radio broadcasting. • Interestingly, Murdoch’s goal of using the Los Angeles Dodgers to generate profits for his other holdings in broadcasting failed to materialize. • In 2004, Murdoch sold the Dodgers to real estate mogul Frank McCourt for $430 million. (Frew, 2004)

15. Questions for In-Class Discussion • Is consolidation in the sport industry good? • Do you think it would be worthwhile to create another football league similar to the United States Football League or the XFL? Would another baseball, hockey, or basketball league be a better investment? • If you could make 10% from a government bond or 10% from investing in a professional sports team, which one would you invest in and why? • If you had this responsibility within a corporation, under what circumstances would you make a decision to reinvest versus issuing a dividend?