Excel Model: Uncertainty Surrounding Diamond Sports’ DTC Product Rights and ‘Commercial’ Partner Conversations Continue to Complicate Creditor Negotiations; New-Money Component to Company Proposals Could Address Potential 2023 Liquidity Shortfall but Risk Higher Debt Levels

Relevant Documents:
June 21 8-K - Initial Proposals
Oct. 7 8-K - Updated Proposals
Link to Excel Download on Data Page (Transaction/Projection Models)

Diamond Sports, or DSG, has pursued at least a dual approach of both managing the company’s debt load amid declining fundamentals and attempting to raise new capital for the company’s intended launch of a direct-to-consumer, or DTC, product. The company stated that its Oct. 7 transaction proposal cleanse was driven, in part, by ongoing discussions with certain parties related to its proposed DTC product launch. The company’s 8-K does not identify these parties. The disclosure says that the creditor negotiations “are dependent, in part, on the outcome of Sinclair and DSG’s ongoing discussions with certain interested parties, including commercial partners, on the evolution of DSG’s business and those parties’ support for and potential involvement with a proposed direct-to-consumer platform.”

Sinclair CEO Chris Ripley on the company’s Aug. 4 second-quarter earnings call, however, maintained that the DTC product launch remains “on schedule” to launch in the first half of 2022. However, Reorg highlights a number of issues that could affect creditor negotiations, including liquidity and negotiations with sports league and team partners.

According to a cash flow analysis by Reorg, Diamond Sports could run out of liquidity by early 2023 in a low-case scenario involving continued cost inflation and Dish not returning as a carriage partner. Diamond’s exchange proposals made to both secured creditors and unsecured noteholders included a new cash component to bolster liquidity.

Regarding certain commercial partners, Ripley said on the second-quarter call that DSG has “clearance” from its distributor partners for the DTC product, but he added that Diamond/Sinclair still needs to secure DTC rights from “several” Major League Baseball, or MLB, teams. He also highlighted on the second-quarter call that Diamond needs to complete renewals with several National Basketball Association, or NBA, and National Hockey League, or NHL, teams.

Below are Diamond’s sports rights contracts and their estimated expiration dates, which reflect the recently disclosed renewals with the Detroit Tigers and Detroit Red Wings:
 
On the second-quarter call, Ripley confirmed that streaming rights for the NBA and NHL must be renewed after the completed 2020 to 2021 season. He said that the company is “having productive conversations and negotiations” with the leagues and that the deadline will be helpful in “driving to the finish line.” Ripley claims that “as it relates to the digital rights, we are the only buyer for those,” adding that “there is no one else they can be sold to.”

Five days after Diamond cleansed the proposals to its creditors, MLB Commissioner Rob Manfred on Oct. 12 at the Creative Artists Agency World Congress of Sports indicated that Sinclair/Diamond has significant hurdles to launching its DTC product. According to the Sports Business Journal, Manfred said, “The accurate statement would be that Sinclair does not have enough digital rights from enough clubs in order to have a viable direct-to-consumer product.” He also asserted that MLB intends to own and control any DTC platform connected to its local rights. Manfred said, speaking on alleged economics of any DTC, “An ownership ‘stake’ probably understates it. We believe those digital rights are crucial, and we want to own and control the platform on which they're delivered, we may have partners in that process.”

Manfred also pushed back on the notion that Diamond has gambling rights along with its regional linear content rights, saying Sinclair/Diamond has “talked a lot about gambling rights, they don’t have those either.” He concluded, “We've been very clear with them from the beginning that we see both those sets of rights as extraordinarily valuable to baseball, and we're not just going to throw them in to help Sinclair out.”

NBA Commissioner Adam Silver took a more constructive tone on the NBA’s relationship with its RSNs at the CAA World Congress of Sports. He acknowledged that the cable bundle is “broken” and added, “I mean, we’re seeing now an issue that’s very topical at the moment, our regional sports networks, Sinclair in particular, and they’re, we’re trying with them to work through those issues.”

Against this backdrop of numerous unknowns relative to the execution of the DTC launch, in this report Reorg examines:
 

• Potential transaction timing considerations;
• DTC structure considerations;
• The relative benefits of the cleansed proposed transactions to Sinclair/Diamond;
• Changes to the recently cleansed proposals compared with their prior iterations; and
• Estimated pro forma capital structures based on the new proposals.

Diamond’s June 30 capital structure is shown below:
 
Below is Sinclair and Diamond’s summary organizational chart:
 
Transaction Timing Considerations

Six months passed between the cleansed secured proposals, and five months passed between the cleansed unsecured proposals. As examined further in this report, the framework for each proposal has remained largely intact, but the company has been unable to reach an agreement with either creditor group. Below we explore a handful of the timing considerations that are likely affecting creditor negotiations.

Dish negotiations: Sinclair's transmission agreement with Dish expired on Aug. 15. John Ourand of Sports Business Journal via The Streamable reported, though not confirmed by Sinclair, that Sinclair and Dish reached a temporary extension for the carriage of Sinclair’s local stations and Tennis Channel that would have run through “mid-October.” Sinclair has pointed to this milestone in the context of its interest in packaging its RSN carriage and retrans contracts with Dish, which discontinued carrying Diamond’s sports-related content in July 2019. Previous Sinclair disclosures imply that Diamond predecessor’s Dish agreement, which included over-the-top service, Sling TV, was valued at approximately $416 million annually. Dish reported 8.55 million Dish TV and 2.44 million Sling TV subscribers as of June 30. Diamond’s creditors could prefer to see resolution of this negotiation before agreeing to provide new money or taking a sizable haircut to their principal in an exchange transaction.

Expected 2022 Charter distribution expiration: Diamond’s RSN distribution agreement with Charter Communications expires in March 2022, according to The Streamable. CFO Lucy Rutishauser on the second-quarter call said that Diamond has a “major distributor that comes up at the beginning of 2022”; this was likely a reference to Charter.

In July 2019, prior to the closing of the RSN acquisition, Sinclair disclosed that it had reached a “multi-year agreement” with Charter that provided “for a term extension” for the carriage of the RSNs effective upon closing.

Charter reported approximately 16 million video customers as of June 30. Sinclair disclosed that Charter represented more than 10% of 2021 consolidated revenue, but it has not disclosed the distribution revenue that it provides to Diamond. For context, Sinclair reported approximately 52 million RSN subscribers as of Dec. 31, 2020, and $2.472 billion of Diamond 2020 distribution revenue.

Similar to the Dish negotiations above, Diamond creditors would prefer to see clarity on this renewal prior to a transaction.

Planned first-half 2022 DTC launch: As mentioned above, CEO Chris Ripley maintained that the Diamond DTC product remains “on schedule” to launch in the first half of 2022. Diamond would likely use new-money proceeds from a transaction to, in part, fund the launch and acquire subscribers. Ripley described subscriber acquisition costs as the “second” major expense to operating a DTC platform, behind content costs. To the extent that Diamond plans to fund a first-half 2022 DTC launch, the company would likely prefer to access new money prior to its launch for marketing and other purposes.

Early 2023 cash crunch under status quo: Reorg estimates that without additional capital, Diamond’s legacy RSN business (non-DTC) could run out of liquidity in the first quarter of 2023 absent the return of Dish or other potential distributors.

As previously highlighted, Diamond’s rebate-adjusted sports rights costs have increased annually between 5.8% and 18.6% in recent periods. The company has guided to a 2% to 3% increase in sports rights payments in 2022. However, this guidance is inconsistent with recent trends and was provided prior to the resolution of the Detroit Tigers and Red Wings renewals in addition to the unclear status of its Cleveland Cavaliers and Minnesota Timberwolves contracts. Further complicating cash flow projections, any relief in sports rights inflation might reflect concessions provided by sports teams as a result of Diamond providing these teams with equity stakes in the RSNs. This type of EBITDA benefit would likely be offset to a certain degree by higher cash distributions to the minority owner sports teams. Diamond increased its low-end 2021 adjusted EBITDA guidance, which excludes a return of Dish, in its second-quarter earnings release, but the higher EBITDA was partially offset by higher guided payments to noncontrolling interests. Scant disclosures on Diamond’s individual RSN ownership and the company’s commercial agreements limit estimates of this impact.

To the extent that Diamond plans to internally fund a first half DTC product launch, its liquidity position might necessitate that it execute a new-money creditor transaction prior to ramping spend to acquire customers for the product.

Below is Reorg’s liquidity forecast for Diamond assuming no return of Dish, 7% sports rights cost inflation, $173 million of guided first half 2022 distributor refunds occurring in the first quarter and other assumptions consistent with the company’s prior guidance. An Excel model of quarterly projections, with multiple scenario toggles, is available on Reorg’s analysis page
 
DTC Structure Considerations

On the second-quarter call, in response to a question regarding DTC launch costs and whether the DTC product will sit in the Diamond debt silo, Ripley declined to provide a direct answer “due to confidentiality agreements” and said that the final structure and funding are still “in flux.”

Ripley emphasized that any intercompany agreements will be completed “on an arm’s-length, fair basis” and that the final DTC structure will provide “fair compensation paid for all parties involved.” Reorg previously highlighted certain streaming technology intellectual property at the Sinclair debt silo.

Reorg Covenants interprets Diamond’s debt documents to provide the capacity to:
 

• Transfer $1.4 billion of assets to unrestricted subsidiaries; and
• Issue $500 million of structurally senior debt.

Either of these mechanisms might be employed to position a DTC product outside of the current Diamond debt silo.

Further, it is unclear whether Diamond intends to sell a potential interest in the DTC platform to a third party, such as a strategic investor like Major League Baseball. As noted above, MLB Commissioner Rob Manfred said that the league intends to own and control its DTC platform, but it is unknown how MLB plans to execute such a plan. On Oct. 17 the New York Post reported that MLB intends to launch its own DTC product “as early as the 2023 season.”

Neither the secured proposal or unsecured proposal addresses these matters. The updated Sept. 28 proposal to the unsecured noteholders adds a section titled “DTC Matters” but is filled with “TBD.” The Sept. 27 proposal to the secured creditors does not specifically mention the DTC platform.

Relative Benefits of Proposed Transactions to Sinclair/Diamond

To compare the relative merits of the cleansed transactions for Diamond/Sinclair, we compare them on the basis of the criteria below.

New-Money Amount and Use of Proceeds

The proposals to both the secured creditors and unsecured noteholders contemplate $600 million of new money. The use of proceeds provisions under the unsecured proposal, however, appear to provide Diamond with more flexibility. After the “Commercial Launch” of the DTC product, which is defined as “the date that content is broadcast through the application and any revenue from the application is received,” the unsecured proposal does not specify any limitations on the usage of the new-money proceeds. Comparatively, the proposal to the secureds specifies that the $600 million of new money must be “used for general corporate purposes including the operating needs of DSG and other capital expenditures.”

Diamond’s March 22 proposal to the secured creditors provided that, of $600 million of new money, up to $250 million could be “used for restricted debt payments.” The company would likely prefer to maintain the flexibility to use proceeds to address its capital structure.

Flexibility for Follow-On Transactions

The Sept. 28 Diamond proposal to the unsecured noteholders provides for the new-money proceeds to be placed into escrow until the “Commercial Launch” of a DTC product. Additionally, the proposal contemplates undescribed “[d]ocument tightening” for the tranche 1 notes. Otherwise, the proposal to the unsecured noteholders does not provide additional restrictive covenants.

On the other hand, the Sept. 27 proposal to the secured creditors provides for:
 

• New-money proceeds to be used for general corporate purposes;
   
• A security package of “all pledgeable assets that are already pledged and with additional perfection steps as may be agreed taking into account legal, contractual and practical considerations”;
   
• “More restrictive release of lien and guarantee provisions”;
   
• The “unrestricted concept” to be “limited to specific business needs of company to be specifically agreed (and with sacred right voting protections against amending); investment in non-guarantor subs to be restricted (and debt incurrences by such subs to be further restricted); Subject to carveouts to operate business, etc”;
   
• “Inclusion of Chewy protection in form and substance acceptable to Ad Hoc Group”; and
   
• “Inclusion of lien and payment subordination protection as a sacred right, only able to be amended by affected lender vote.”

While the unsecured proposal provides for less than $700 million of tranche 1 notes to receive “document tightening,” the provisions in the secured proposal appear to provide more limitations for follow-on transactions.

Comparative Barriers to Execution

The Sept. 28 Diamond proposal to the unsecured noteholders does not specify a minimum participation level. However, the Sept. 27 proposal to the secured creditors requires “minimum participation of >50 % of 1L Loans and >67% of 1L Notes,” indicating that this proposal has the higher barrier to execution.

Key Changes to Prior Proposals

A side-by-side comparison of significant changes in the Sept. 27 proposal to the secured creditors compared with the March 22 proposal is provided below:
 
On the basis of the cleansing materials, it is not clear how large of a rollup discount the proposal contemplates for first lien new-money participants. Similarly, any matters related to the DTC platform remain unaddressed in the materials.

A side-by-side comparison of significant changes in the Sept. 28 proposal to the unsecured noteholders compared with the April 29 proposal is provided below:
 
Similar to the proposal to the secured creditors, the cleansed unsecured proposal does not address matters related to the DTC platform.

Post-Transaction Pro Forma Capital Structures

While certain features of Diamond’s September proposals remain unknown, Reorg modeled each of the proposed transactions under a set of certain assumptions. An Excel model illustrating each of the proposals is available on Reorg’s analysis page.

PF Capital Structure Reflecting Sept. 27 Proposal to Secureds

For purposes of illustrating Diamond’s proposal to the secured creditors, Reorg assumes:
 

• 50% term loan participation;
• 67% 5.375% senior secured notes due 2026 participation;
• 67% 12.75% senior secured notes due 2026 participation;
• No rollup discount for participating secured creditors; and
• $600 million of new money from secured creditors.

On the basis of these assumptions and the terms provided in the cleansed Sept. 27 proposal to the secured creditors, total debt would increase by approximately $600 million, and annual cash interest would increase by approximately $41 million.

Reorg estimates the following pro forma Diamond Sports capital structure:
 
PF Capital Structure Reflecting Sept. 28 Proposal to Unsecureds

For purposes of illustrating Diamond’s proposal to the secured creditors, Reorg assumes:
 

• 33% of 6.625% Senior Notes due 2027 provide new money; and
• 50% of 6.625% Senior Notes due 2027 participate in the rollup-only exchange.

On the basis of these assumptions and the terms provided in the cleansed Sept. 28 proposal to the unsecured noteholders, total debt would increase by approximately $281 million, and annual cash interest would increase by approximately $38 million.

Reorg estimates the following pro forma Diamond Sports capital structure:
 
-- Adam Rhodes