In recent years, there has been an increase of private equity firms as well as nation states, mainly from the Middle East, looking to invest in professional sports teams. As we wrote several weeks ago, Saudi Arabia has made big moves by acquiring English Premier League football club Newcastle United F. C. as well as signing famous players like Cristiano Ronaldo to the Saudi Pro League. All of this begs the question: can professional sports actually be a good investment? A straightforward answer is difficult, but if we look at the differences between sports competitions, some are clearly more investable than others. Most importantly, despite the romantic views of sports fans, a bigger budget is actually a good predictor of success in the long term.

Generally, success in professional sports depends on teams getting into a virtuous cycle: better athletes lead to more victories (which leads to better sponsorships, increased ticket sales and better media contracts) that, in turn, lead to a higher free cash flow for the team. More cash creates an opportunity to sign better athletes – and the cycle continues. We have visualized the cycle below:

Our cycle suggests that a higher budget in professional sports will lead to a higher ranking for the team. Indeed, there is solid scientific evidence to support this view (see the graph below). It debunks the popular myth that money does not buy success in sports. Think of the famous quote by the legendary Dutch football player Johan Cruijff: “I have never seen a bag of money score a goal”. Whenever a small football club beats a bigger, wealthier club, Dutch fans often refer to Cruijff’s quote. However, despite the romantic views of sports fans, money actually does buy success in the long term:

Our cycle also shows that for investors professional sports is a unique market. After all, in most markets, the businesses that spend the most money do not necessarily have the most success.

So, should we simply invest in the sports teams with the biggest budgets? Well, no. The  next step is to look more closely at the differences between sports competitions. This is where it gets more interesting for investors. There are  two important differences between professional sports competitions: the main  goals of the owners, and the rules set by the organizing body. Together, they  determine the attractiveness of investing by either harming or protecting the  profitability of the competition as a whole.

First, some competitions have teams with owners that do not aim to balance their budget and this harms the profitability of the competition as a whole. Take Manchester City. Its Emirati owners purchased the English football club in  order to boost the prestige of the United Arab Emirates, Abu Dhabi and its ruling elite. As a result, Manchester City’s ownership is prepared to sacrifice finances for the higher goal of prestige. It is important to see that whenever a competition has teams like Manchester City, the profitability of the competition as a whole is put under pressure. After all, teams that still aim to balance their budget are no longer able to compete financially to sign the best athletes, which prevents them from creating the virtuous cycle that is required for long term success.

Second, some competitions have budget caps set by the organizing body of the competition and this protects the profitability of the competition as a whole. Indeed, the potential emergence of an organization like Manchester City is exactly the reason why American sports competitions for basketball (the NBA) and American football (the NFL) set budget caps a long time ago. These caps make the entire competition more future-proof by protecting the  profitability of the competition as a whole (and of team owners in particular). The Formula 1 introduced budget caps in 2021 for the exact same reason.

In the following table, we show an overview of the different types of sports competitions:

All of this points to a key insight for investors. Contrary to Cruijff’s principle, professional sports actually follows the logic of money to a relatively high degree. In most competitions, it pays off to be the team with the biggest budget. If the organizer of the competition decides to introduce budget caps to stop this from happening, the dynamics shift, and the profitability of the competition as a whole becomes more resilient, which makes the competition more attractive for investors.