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The Formula For Boosting F1’s Profits By $450 Million

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Since Liberty Media got the keys to Formula One two years ago it has burned up combined operating losses of $105 million driven by accelerating costs and largely flat revenue. One insider has come up with a solution to turn that around.

It didn’t take long for Liberty to make its mark on F1. After paying $4.6 billion for the auto racing series Liberty listed it on the Nasdaq with the ticker FWONK and ejected its boss Bernie Ecclestone after nearly 40 years in the driving seat. He was replaced with 21st Century Fox vice chairman Chase Carey who embarked on an aggressive development plan which saw F1 double its headcount, move into a plush new office in London, launch a series of street demonstrations and start an Esports series.

Carey even spent money on cosmetic changes as F1 was re-branded and Hollywood composer Brian Tyler was commissioned to write a theme tune for the series. It all added up and over the first two years F1’s costs surged by 35.3% to $514 million. Revenue didn’t follow suit and neither did F1’s stock price which has never even been within $5 of the $47 target set by Morgan Stanley back in January 2018.

Over the first two years of Liberty’s ownership F1’s revenue nudged up by just 1.7% to $1.8 billion due to limited growth across its four key revenue streams. The day after Liberty’s acquisition got the green light, Carey was asked by CNBC which one had the greatest growth potential.

In response, he forecast that “the one that grows the fastest is probably sponsorships. Realistically today, we have a one-man sponsorship operation. There are many categories we’re not even selling into. Putting an organization in place that enables us to execute on that probably is the most immediate impact.” Carey did just that but it hasn’t paid off.

In an interview with the Financial Times in November he admitted that “the perception was just there are sponsors waiting...They were lined up out there and as soon as we had somebody to go call on them, they were just going to sign up. The world’s not that simple.”

More recently Carey added that “the challenge in the sponsorship world is probably tougher than it was a few years ago. For anybody who is not Google or Facebook, the broader advertising world is more challenging...I think it is fair to say that the sponsorship world has probably been more challenging than we would have expected it to be a couple of years ago.”

It began to look up last year when F1 signed a partnership with Amazon Web Services (AWS), a division of internet giant Amazon. However, Carey subsequently admitted that this isn’t purely a sponsorship deal as “there are two components to it. There’s a sponsorship component, recognized like sponsorship, and we are getting tech services from them.”

F1 seemed to step up a gear after that as it signed a betting agreement with sponsorship and event marketing agency Interregional Sports Group (ISG). However, this too isn’t a typical sponsorship deal as ISG sub-licenses partnership rights to operators rather than being the betting partner itself.

Nevertheless, it is still a partnership and can be added to F1’s tally which also includes beer brand Heineken, tire maker Pirelli, luxury watch brand Rolex, logistics firm DHL and the Emirates airline. They are F1’s ‘global partners’ and then come the ‘official sponsors’ which include auto maker AMG, whiskey brand Johnnie Walker, tech titan Tata and Amazon Web Services. Oil giant Petronas is a regional F1 sponsor in China, Italy and Mexico whilst suppliers include Securitas, Carbon, CYBER1 and automotive component manufacturer Marelli.

It gives F1 15 partners but around two thirds of them began under Ecclestone’s watch. Likewise, the biggest uplift in F1’s broadcasting revenue is believed to be coming this year thanks to a deal Ecclestone signed in Britain with Pay television broadcaster Sky Sports. F1 is broadcast in around 200 territories worldwide and is already shown on Pay TV in most major markets leaving limited potential for growth.

So far no new races have joined the calendar under Liberty so the growth in its hosting fee revenue has been restricted to escalators in the contracts which drive up the price by a few percent annually. In turn, the lack of new races has limited the growth potential of corporate hospitality ticket sales which represent one of the biggest sources of F1’s remaining revenue stream.

Carey attempted to create a fifth revenue stream by giving the green light to an online streaming service called F1 TV. As we revealed, in advance of the launch in 2018 investment bank Morgan Stanley forecast that it would only attract 104,000 subscribers worldwide in its first year. That was before it was beset with so many glitches that F1 had to repeatedly issue refunds.

Criticism was still regularly flooding in on social media as recently as three months ago though F1 has been tight lipped as to how much revenue the streaming service has generated. A report released on Monday by Bank of America Merrill Lynch gives some insight into this as it forecasts that new media will make no revenue this year, next year or the year after. Clearly Merrill Lynch doesn’t recognize the revenue from it as being material but there is no doubt that the expenses associated with it are and according to the report, F1’s running costs will increase by 3.1% to $530 million this year.

Liberty’s outlook for F1 races is rosier than its digital performance. In 2020 its first new events will join the calendar when F1 heads to Vietnam and back to Holland for the first time since 1985. Estimates suggest that the fee to F1 for the former comes to $35 million whilst the latter is paying $22.4 million. It is a healthy boost but that is just the start of the story.

There are currently 21 races on the calendar and the teams are reluctant to attend more due to the increased travel costs and time away from their families. It is expected that this tally will rise to 22 races next year as the German Grand Prix will get the red light. It pays an estimated $20 million annually but its contract expires at the end of this year along with the agreements for the races in Britain, Italy, Mexico and Spain. They have all either been renewed, or are about to be renewed, and it has come at a cost.

As we recently revealed, the fee for the British Grand Prix alone has been reduced by an estimated $107.2 million over the next five years as the race was in financial difficulty. The same goes for its counterparts in Italy and Spain. The only exception is Mexico as it came to light yesterday that private investors have stepped in to secure the future of its Grand Prix. According to a very well-placed source, the new fee for it “is closer to $30 million” which is down from an estimated $34 million this year.

Our estimates show that four renewals, the two new races and the loss of the German Grand Prix will boost F1’s fee revenue by just $18.4 million next year. However the precise fees aren’t disclosed in F1’s filings and its spokesperson has stressed that they “don’t make any comment on these topics.” It doesn’t end there though.

F1 will also lose an estimated $3 million from the German Grand Prix title sponsor Mercedes as well as the revenue from corporate hospitality tickets at the race. Sponsorship and hospitality at the two new races should more than make up for that but the costs will be more than duplicated as Vietnam is in a far flung location. Accordingly it seems unlikely that F1’s bottom line will get a big boost in 2020 but an insider has come up with a solution which would rev it up.

F1 is on track for major change after next year when its contracts with the teams expire. Liberty is taking advantage of it by introducing a cap which would limit team budgets to $175 million annually in a bid to stop them spending beyond their means. The difference usually comes from debt or the team owners themselves so it favors ones with deep pockets. In turn, they tend to be the most successful teams as the likelihood of victory in F1 is proportionate to the level of spending.

The lack of a cost cap has propelled the average budget to $265 million with the top teams spending north of $500 million. Smaller outfits struggle to keep up and over the past five years three of them have crashed into administration, the British equivalent of Chapter 11 bankruptcy. Liberty wants to prevent that from happening again and its plan doesn’t stop with a budget cap.

Around 48% of F1’s prize money currently goes to the top three teams – Mercedes, Ferrari and Red Bull Racing. However, Liberty wants to redistribute it to ensure that the minnows have enough to keep their wheels turning. There is more than enough to go around as F1’s prize money came to a staggering $913 million last year. In general, the teams spend every Cent of it in a bid to win on track which seems incredibly wasteful. This is actually the heart of the problem and capping their spending will not change that.

The teams’ prize money could be cut in half and it would still give them $450 million which is an astronomical amount. However, even though the prize fund is F1’s biggest cost, Liberty has not given any suggestion that it will cut it at all. One well-placed source says it should do just that as the saving would fall straight to the bottom line.

“It’s very easy, if I was Chase I would have made a nice contract and I would say to the teams ‘these are the regulations for the championship, this is the deadline and this is what we will pay you. You have got ten days to sign it’ I would put on there that this will not be extended under any circumstances and I would put it out to the press that the teams have got to sign it. I would get them all signed within ten days giving them half what they get now and regulations that I think would be best.

“The teams haven’t got any choice. What are they going to do? Close the factories and lay off 800 or 900 people? They have got a lot of commitments already to drivers and sponsors beyond 2020. I’d like to be in Chase’s shoes because he could do this and comfortably forecast what the increase in profit will be over the next five years. He would walk off with a nice bonus.”

Indeed, the upside would be so significant that F1’s high-margin Pay TV deals could even be scrapped and its profits would still increase even if its revenues reversed. The global exposure on free-to-air TV would give the series a firm foundation for global domination so it would be in the interests of fans as well as stockholders.

The losers would be many of the staff at the teams who would have to be laid off in order to compensate for the lower prize money payments. However, given that even the minnows employ around 600 staff they should be well aware that they are in a bubble which cannot continue.

As we revealed, over the past decade staff numbers at the seven F1 teams based in Britain have accelerated by 28.5% and it can easily be argued that the current levels are excessive, especially given that all they are doing is getting two cars around 21 tracks each year.

Few individuals would spend all of their income in a bid for victory and this profligacy has been fuelled by turbocharged prize money payments. F1 may need to put the brakes on them not just to boost its profits but to drive the entire business into the future.

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