Financial Returns and Credit Markets

As Long Island digs out from the worst blizzard of the year, let's discuss some hard financial figures.

Financing

I'm amazed by the lengths Lighthouse opponents will go to throw up smoke-screens related to the project. Their newest broken-record track (taking off of Eden Laikin's recent article on the topic in Newsday) is that the Lighthouse will never happen because, given the condition in the credit markets, it will be impossible to get financing. Let me say this as clearly as possible: most of us believe ground-breaking will occur next year, after hockey season. It's incredibly naive to assume that the credit markets will still be frozen 15 months from now. The principals in the Lighthouse Project are well-to-do individuals who have equity in the site and should be able to secure the necessary financing with little difficulty.

Blogger's Note: I'm adding tigmet's excellent comment to this piece to give it greater visibility. Take it away, tigmet:

The other aspect, Nick, is that it is not the town's job to deny a zoning variance because they don't think the applicant can get the financing. What do they know about financing? Nothing, and that's not a criticism. They're supposed to be about land planning. If they grant the variance and Wang & Co. can't get the financing, well, so be it. But that's not the same thing as the town saying "We don't think you can get the financing, so variance denied." Not that I think the town would do that, and my guess is it would open itself up to a serious lawsuit if that happened. But that's what some of the opponents want to happen. They should let the bankers do their job, rather than asking the TOH to do their job for them.

The Arena "Question," in Numbers

Some Lighthouse opponents are clingling like grim death to the long debated issue about why the Coliseum as a stand-alone project doesn't work. As my previous post detailed, the Coliseum is meant to be used as a loss leader that will be financed by the surrounding development.

Some people have twisted my words here and now believe that I said the New York Islanders as a franchise can never be profitable, but I did not say any such thing. Remember, the arena renovation is estimated to cost $400 million. There is a profound difference between making money and making enough money to justify a $400 million investment.

I can best illustrate this using the financial concept of Net Present Value. To make a long story short, Net Present Value analyzes cash flow out and expected cash flow in to tell you whether or not a project is expected to be profitable within a stated time frame. Remember, money does not have an intrinsic and unchanging value; if I offered you $10 today or $10 5 years from today, you would and should take the $10 now. I decided to crunch the numbers using Investopedia's Net Present Value Calculator, and I invite you to utilize this tool to see for yourself.

First, let me explain my methodology in choosing numbers:

For income, I looked at several different figures. According to Forbes Business of Hockey 2008, the average profitability for an NHL team in 2007-2008 was $4.7 million. According to the team page, the Vancouver Canucks had an operating income of $12.8 million in 2006-2007 playing in a privately-financed arena. I decided to use this number, guessing that a new arena and a less onerous lease would open up new revenue streams for the Islanders and make them one of the more profitable teams in the NHL.

4% is the average rate of inflation, so I decided to use that as the discount rate.

Finally, according to this piece from Newsday, arena renovations are estimated to cost $400 million.

With that little background, here we go:

Discount Rate: 4%
Life of Project: 30 years
Initial Investment: -$400 (in millions, of course)
Income, Years 1-10: $12.80 (using the Vancouver figure)

When you calculate, the Net Present Value comes out to -$296.18. This means that a new arena alone would result in a loss of roughly $300 million between the initial investment and the expected cash flows.

What happens, now, if you change the numbers? If you remember, economist Andrew Zimbalist showed in a New York Times op-ed that local governments, on average, pay 75% of a new arena's costs. If you use the same numbers and change the initial investment to -$100, the Net Present value becomes positive. This is why stand-alone arenas can be built - taxpayers are left covering the costs.

Bottom Line

The Forbes piece shows clearly that some NHL franchises are very financially healthy. However, these teams have inherent advantages, such as owning their own arena and having the rights to adjacent development, that the Islanders do not (and in some cases will never have). Given these circumstances, the only suitable method for financial survival is to use the Coliseum renovation as a loss leader for future development. I am very happy that, instead of asking for a public handout or trying to foist the project on taxpayers without any due dilligence, the Lighthouse group has proposed a visionary concept and taken great pains to follow standard protocol and engage the community. This is the best deal the community could expect, and it may be the best deal a community has ever received from a sports team. We should not look a gift horse in the mouth.

I welcome your thoughts on project finances in the comments section. As always, don't forget to sign the petition and pass it on. I welcome your feedback at lettherebelighthouse@gmail.com.