The IPL money tree

The recent fiasco with the IPL’s plan to introduce two new franchises sparked a discussion with a good friend, Vivek Shenoy, on Twitter [this is him; this is me].

The upshot [tangentially, Twitter is proving a great place to learn stuff, and to source content] is this guest post Vivek did for me, on the IPL’s bidding process and the various pros and cons:

Step 1 – To bid or not to bid

Prospective bidders need to pay Rs 5 lakh to obtain a tender document — in other words, Rs 5 lakh is what it costs him to know whether he is eligible to bid or not. And that makes this a nice way to mop up some pocket change.

It is also not clear whether the said document provides the prospective bidder with a sense of what share of central revenue he can expect if and when his bid is successful.

The IPL has said new franchises will be given access to the financials of existing franchises — which I’ve just got to see; I can so well picture a Mukesh Ambani or a Vijay Mallya sharing their account books over a cup of tea or a pint of Kingfisher’s best, as applicable. Add to that the BCCI’s — and IPL’s — track record for transparency, and it’s a safe bet that the prospective bidder is basically taking a flier with one arm tied behind his back, and a blindfold to make things more interesting.

The basic takeaway at this stage is that the IPL is planned as a rich boys’ club. Prior to last weekend’s fiasco, the basic requirement for prospective bidders was that they should have a net worth of $1 billion or over. According to Forbes, there are 52 billionaires in India, so on the surface there is a large pool to chose from. The question though is how many from that pool would, for reasons of business or vanity or both, be willing to go through this process and acquire a franchise? The answer is moot; anecdotal evidence can be accrued if you look through that list and see how many have actually bid for a franchise.

Put that thought in your mental parking lot; moving on…

Step 2 – I’m a wannabe rich boy, so let me bid:

This is when I find [having paid Rs 5 lakh for that information] that the eligibility criteria = $ 1 billion net worth, and  100 million guarantee (some say it is an advance deposit – that will make it even more worse – let us treat it as a guarantee )

That is to say, we need to get a $100 million bid bond in favour of the BCCI. A bid bond, in this context provides a guarantee to the BCCI that the bidder will pay the franchise fee (and float a franchise) if selected. The following factors come into play in this regard:

  • Bid bonds (guarantees) are generally priced anywhere from 0.75% to 1.5% annum depending on the creditworthiness (read quantum of credit risk arising to the bank from its relationship with you), the strength of the relationship, past history etc. The pricing will be higher in foreign banks and lower in public sector banks
  • Banks generally will ask for a margin (fixed deposit to be placed with them lien marked against the guarantee) of 15-20%
  • We will be submitting the bond for a non-core business activity which will therefore be regarded by the bank as a higher risk.
  • Also the question whether we are obtaining the bond as a corporate or as the promoter (most likely as a promoter)

Considering the above, let us assume that we will be able to obtain a bid bond for Rs 450 crores ($100 million X Rs 45) at 1.25% per annum with a margin of 25% (ie RS 135 crore). The tenure of the bond / margin deposit will be 1 week to mirror the bidding process (if the infamous BCCI efficiency were to be at work, one can imagine spending another week or two to get a release letter for our guarantee – but, let us give them the benefit of doubt). In passing, note that if we were bidding in 2008, we’d have had to put up a bid bond of only Rs 20 crores — so basically, the new franchises are being penalized for not taking advantage of an opportunity that did not exist then.

But never mind that. What the numbers mean is that compared to 2008, we will have to pay an additional guarantee commission of Rs 10.4 lakh. On the assumption that the Rs 135 crore we put up as margin money would have fetched an additional 3% return in the business as opposed to my margin deposit, I lose a further  Rs 7.4 lakhs. Another alternative approach is to assume that the working capital I diverted to put up the margin money now needs to be refinanced at 11%; the margin deposit yields 8% which means the spread is 3%.

It is normal for a tendering company to ask for 10% of your bid amount to prevent frivolous bids. The BCCI in its overzealousness to protect itself (refer LKM’s quote) has in the instant case asked a bid bond of 45% of the base price of a franchise. My bottom line has suffered by Rs 22.8 lakhs (10.4+7.4+5) just by deciding to bid. “

Step 3: Oops, I won!

So we manage to jump through the various hoops, circumvent the designs of sundry politicians and others playing back stage roles in the process, and finally managed to secure a franchise by bidding $275 million. Thank you for your condolences — this is when we really need them.

As opposed to a 10% of bid amount guarantee in 2008, now we need to furnish a 10 year performance guarantee for the bid amount of Rs 1,238 crores. Incidentally, no bank issues 10-year guarantees – so let us assume that it is a guarantee that will be renewed every year.

From a bank’s perspective, a performance guarantee is riskier than a bid bond, and that perception results in a higher margin. Also, the amount involved is substantial and well may surpass what our company had approached the bank for in the past. We convince our bankers somehow and obtain the guarantee @ 1.25% with a margin of 40%.  The additional amount we pay as guarantee commission is only Rs 13.92 crores, and the opportunity loss for the margin money @ 3% is another Rs 13.37 crores – ie a total of Rs 27.29 crores (what fun it is doing all this math on a theoretical basis, knowing as we do it that it would cost a pang if we were throwing away such sums even in Monopoly money].

In essence, by bidding and succeeding, we have spent an additional Rs 27.52 crores (27.29 + 0.228) due to LKM’s love for super-rich boys.  And please note that we are yet to appoint our staff, determine our team (remember the cricket?), our marketing strategy, spend on operational costs  and step out on to the cricket field.

Most of the existing franchises made thumping losses in year 1 (year 2 figures will be out only after March 2010) as seen below:

Franchise Revenues Expenditure Net profit
Royal Challengers Bangalore 4,730 8,100 (3,370)
Mumbai Indians 6,580 7,800 (1,220)
Deccan Chargers Hyderabad 4,880 8,000 (3,120)
Chennai Super Kings 6,880 7,200 (920)
Delhi Daredevils 6,650 6,800 (150)
Kolkata Knight Riders 6,880 6,800 80
Kings XI Punjab 5,980 6,640 (660)
Rajasthan Royals 5,830 5,100 730

Source: GroupM ESP

Add the above Rs 27 crores handicap to the IPL operating finances, and see where you stand. If one were to consider that the guarantee will be in force for each year of the franchise on a reducing balance (10% reduction as the franchise fee is paid out), then the second year’s guarantee commission + opportunity loss would be Rs 24 crores; in the third year would be Rs 22 crores and so on. At the end of this gestation period, long even by LKM’s own admission, what you get is a still born.

Interestingly — in a classic example of making up laws as you go along — there is a clause that says the BCCI can reduce the guarantee amount to be put up at its discretion. In the past, this clause has been used to favor certain parties [this is just one story that seeks to unravel the labyrinth that is the IPL franchise structure; here's one that details the family tree that is the IPL -- and the key takeaway is the number of different ways power players in the BCCI have insinuated themselves into the system, and are using the game they supposedly serve as guardians to, to make a nice nest egg for themselves]; today, it is the equivalent of saying, ‘Dude, drop your pants because I say so, and I will then decide whether to f*** you over or not’.

So that is the story thus far; one that hopefully sheds light on the underwhelming response to the IPL franchise auction last weekend. And now for the future — which is another story, for another day. Back with you soon.