SPORTS INVESTMENT INSIGHTS
Investing in F1
As investment activity in F1 increases, the aim of this article is to act as an initial point of reference for organisations considering an investment in the sport. It sets out five “need-to-know” points which will be key to an investor when assessing the regulatory and commercial landscape of the sport. Each sport has its own unique characteristics and F1 is certainly no different in this regard. This article draws out the most important features to provide prospective investors (including those who may have invested in other areas of the sports industry) with a need-to-know guide on the specific areas which will be relevant to an investment in F1.
Background
Historically, potential investors in F1 may have exercised caution due to financial instability (with equity owners of teams having to fund losses in order to compete, resulting, in several cases, in financial distress) and the traditional focus of the sport under previous ownership on its core demographic of older and wealthier fans. However, there are now a number of structural and commercial factors which are making the sport an increasingly attractive investment proposition. These include:
- a modernisation of the commercial model of the sport under the ownership of Liberty Media including investment in social media output and the Drive to Survive Netflix series which, coupled with the expansion of races into new markets (most notably in the US), has attracted an increasingly global, younger and more diverse fanbase;
- the introduction of financial regulations which aim to enhance financial sustainability and competitive balance; and
- the scarcity value of a limited number of teams competing in a “closed system” without promotion/relegation with new entrants facing barriers to entry in order to join the championship (including the payment of a new entrant fee).
The sport is currently attracting a diverse group of capital partners. Examples include the investment by a consortium of investors (including Otro Capital and RedBird Capital Partners) into Alpine F1 (announced in June 2023) at a reported valuation of c.€900million and the recently announced minority investment by Arctos Partners into Aston Martin Aramco Cognizant F1 at a reported valuation of £1billion. These transactions indicate the start of a new wave of institutional investment into either one of the ten existing F1 constructors (also known as teams) or new teams looking to gain entry.
This article acts as a guide for investors considering these opportunities and highlights areas which warrant particular attention.
Key consideration #1 – The regulatory landscape
Any investor conducting a buy-side due diligence process on any sport asset should ensure familiarity with the overall regulatory framework of the relevant sport. From our experience of acting on a number of transactions across a range of different sports, this is an often-under-appreciated risk factor that can have significant reputational, sporting and financial consequences post-closing for both the asset and investor.
Key players and stakeholders
Before we delve into the F1 regulatory landscape, it is important to understand who the key players and stakeholders are within F1.
Governing body
Fédération Internationale de l’Automobile (FIA)
World governing body of motorsport. Owns and organises the sport of F1 (subject to the exclusive appointment of Formula One Group to promote and exploit the commercial rights of F1).
Regulates the sporting, technical and safety aspects of the F1 World Championship through the F1 Commission and World Motor Sport Council.
The Cost Cap Administration, part of the FIA, is responsible for administering, and monitoring compliance with, the Financial Regulations (see below).
Commercial rightsholder
Formula One Group (owned by Liberty Media Corporation since 2017)
Separate from the FIA.
Promotes and exploits the commercial rights of F1 under a grant of rights from the FIA (currently due to expire 2110).
Teams (also known in F1 as "constructors")
Currently ten teams: Red Bull Racing, Mercedes, Ferrari, McLaren, Aston Martin, Alpine, Williams, Alfa Romeo, Haas F1 Team, AlphaTauri
Employ and manage the drivers who participate in F1.
Design and manufacture the chassis (the car) and either (i) also design and manufacture the engine or (ii) act as a ‘customer’ of another team/constructor or engine manufacturer for its engines.
Regulatory landscape in F1
F1’s regulatory landscape is bespoke and will be novel to investors who have not previously been involved in the sport.
The starting point of F1’s regulatory framework is the International Sporting Code (ISC), which sets out the default regulatory position and applies to all motorsports. There are then three additional F1-specific regulatory regimes:
Sporting Regulations
On-track activities, for example, flags and marshalling.
Technical Regulations
For example, the limits on the design of the cars.
Financial Regulations
Which contain the cost control measures described in further detail in Key consideration #2.
Separately, dispute resolution and related procedures in F1 are governed by the Judicial and Disciplinary Rules and Practice Directions (covering, for example, disputes between teams regarding car specifications and modifications etc). In addition, the FIA’s own statutes set out the organisation’s powers and governance structure.
Finally, and perhaps most importantly when considering an investment in F1, there is a framework agreement between the key stakeholders in F1 (the FIA, Formula One Group (through a subsidiary company - Formula One World Championship Limited) and the F1 teams) known as the “Concorde Agreement”, named after the location of the FIA’s offices in Place de la Concorde in Paris. The Concorde Agreement is a private and confidential agreement but provides, among other things, for the participation of teams in the F1 World Championship, the setting of the championship calendar as well as the distribution of revenues to teams through a “Prize Fund” distribution mechanism (under which a share of the Prize Fund is paid to Ferrari in recognition of its heritage in the sport, with the remainder paid to teams based on their results as a team in prior F1 World Championships, particularly the prior year’s results).
There have been various iterations of the Concorde Agreement over the years, with the most recent being entered into in 2021. A detailed understanding of the terms of the Concorde Agreement will be a key area of diligence for any potential investor. See Key consideration #5 below for more insights on how the next round of negotiations of the Concorde Agreement should be factored into the investment decision-making process.
Investors may commonly be familiar with investing in teams participating in a league owned by the teams. The obvious example would be the English Premier League in which the clubs become shareholders automatically upon participation in the league. A contractual model of participation on a relatively short-term basis (roughly five-year cycles) clearly presents a different risk profile to the relative certainty of a shared ownership model, particularly with regards to: (i) security of participation; and (ii) continuation of the competition in its current guise. There are, however, upsides to this model and opportunities for teams. Particularly, improvements in commercial terms may be afforded in the repeat renegotiation processes provided by the contractual model. The relative appetite for risk and reward would need to be assessed.
Any investor conducting a buy-side due diligence process on any sport asset should ensure familiarity with the overall regulatory framework of the relevant sport. In addition, a combination of legal due diligence and contractual protection is recommended to limit the risk of the investor suffering the consequences of historic non-compliance by the relevant team with the sport-specific regulations. We commonly see breaches of sporting regulations (which, in certain cases, may have a significant impact on value through sporting sanctions (e.g. point deductions or fines)) as red flag items to work through as part of a transaction. From our experience of acting on a number of transactions across a range of different sports, this is an often-under-appreciated risk factor that can have significant reputational, sporting and financial consequences post-closing for both the asset and investor.
Key consideration #2 – The cost cap
The cost cap is still a nascent regulation in the sport and will likely continue to evolve over time. This follows the trend of financial regulations in other sports such as football where regulations are striving to adapt to the evolving complexity of the commercial and financial transactions within the sport. These regulations will continue to be an important part of any investment thesis and investors will need to be alive to any changes in the operation of the cost cap as well as the approach taken by the regulator in its enforcement.
F1’s Financial Regulations came into force on 1 January 2021 and form part of the terms and conditions for teams to compete in the competition. The regulations limit certain costs that may be incurred by an F1 team in a single calendar year, while leaving the team free to allocate resources within the cost cap.
Objectives
The objectives of the cost cap are:
- to promote competitive balance of the F1 World Championship;
- to promote the sporting fairness of the F1 World Championship; and
- to ensure the long-term financial stability and sustainability of the F1 teams,
while preserving the unique technology and engineering challenge of F1.
It is noted that maintaining competitive balance has been a historic issue for the sport where certain teams (e.g. Mercedes in the past decade) have dominated the sport for extended periods of time. The strengthening of competitive balance drives consumer and commercial interest (as illustrated by the 2021 title race between Hamilton and Verstappen). It is a commercial peculiarity of sports teams as investments that there is value in the (moderate) success of your competitors and the cost cap is one method for seeking to ensure a measure of competitive balance.
Overview of operation of cost cap
In 2023, the cost cap was fixed at c.$137.4million (prior to any adjustments (e.g. for inflation)). The “Relevant Costs” which are included in the cap start from the premise that all costs incurred by a team in connection with the activities undertaken by the team relating to the operation of the F1 team and its participation in the F1 World Championship are included and specific exclusions are then listed as sitting outside of the cap. Notable costs which fall outside of the cost cap include:
- driver costs (e.g. salary and image rights payments);
- costs of employment/service of the three highest earning individuals (excluding drivers);
- finance costs;
- engine/power unit supply costs (which are governed by a separate set of regulations); and
- sustainability initiative costs.
Therefore, these regulations have a material impact on the operating and financial model of the team and will need to be understood by an investor in respect of any ongoing investment strategy. There are no restrictions on equity contributions / shareholder loans from investors but the reality of the cost cap means that there are constraints as to how cash injected into a team can be spent.
Sanctions for non-compliance
The sporting and financial penalties for failing to comply with the cost cap are potentially severe. The regulations provide for a broad range of sanctions, including a public reprimand, a fine, limitations on the ability to conduct aerodynamic testing, points deductions and/or suspension/exclusion from the championship.
In respect of recent enforcement action, the FIA announced in October 2022 that Red Bull had entered into an ‘Accepted Breach Agreement’ (ABA) with the FIA Cost Cap Administration in relation to the 2021 season (the first season during which the cost cap was in operation). The team were ordered to pay $7million to the FIA within 30 days of the date of execution of the ABA and also received a 10% reduction in allocated wind tunnel and computational fluid dynamics testing time.
Other teams, however, argued that these sanctions were too lenient and therefore future breaches (with the system being more embedded) could result in more serious consequences (including sporting sanctions) for non-compliant teams. The FIA announced recently that all teams received certificates of compliance from the FIA Cost Cap Administration for the 2022 season.
Consequences and future developments
The most immediate consequence of the cost cap has been the knock-on impact on the profitability of individual teams. In 2018, the series’ ten teams combined to lose nearly $200million in operating income compared to the Forbes estimates for this year that the teams combined will achieve nearly $600million in EBITDA.
The cost cap is still a nascent regulation in the sport and will likely continue to evolve over time. This follows the trend of financial regulations in other sports such as football where regulations are striving to adapt to the evolving complexity of the commercial and financial transactions within the sport. These regulations will continue to be an important part of any investment thesis and investors will need to be alive to any changes in the operation of the cost cap as well as the approach taken by the regulator in its enforcement.
Key consideration #3 – Sponsorship
The growth of F1 is likely to lead to innovation in the sponsorship landscape and an understanding of a team’s existing contractual arrangements is the starting point to understand the flexibility to drive revenues which, given the cost cap, is likely to positively impact a team’s bottom line.
Sponsorship is a critical source of central revenue for the commercial rightsholder (Formula One Group) as well as at an individual team level. According to data gathered by Forbes, 35% - 40% of F1 team revenues are derived from sponsorship income.
The recent growth of the sport, increased audience size and expansion into new markets is translating to increasing interest from sponsors with reportedly 70 new brands entering F1 during the course of 2023. This is decreasing the supply of inventory available in the sport and helping to drive value (even against the background of a more depressed general economic picture).
From an investor perspective, a key consideration in the diligence phase should focus on security of sponsorship revenues (e.g. termination and reduction rights in favour of the sponsor) and ability to exit any undervalued deals in categories where there may be an increased value opportunity given the recent growth of the sport. This is in addition to normal areas of contractual focus such as the scope of any category exclusivity provided to a sponsor and the financial security of counterparties in higher risk categories (such as cryptocurrency).
We are continuing to see teams harnessing technology to create novel ways of diversifying their sponsorship categories and income streams. Take McLaren, for example: in a first for F1, the team created a rotating digital sponsorship on its car in order to maximise sponsorship rights income whilst trying to add as little weight to the car as possible in order to adhere to weight restrictions under the Technical Regulations.
The growth of the sport is likely to lead to innovation in the sponsorship landscape and an understanding of a team’s existing contractual arrangements is the starting point to understand the flexibility to drive revenues which, given the cost cap, is likely to positively impact a team’s bottom line.
Key consideration #4 – Drivers and key personnel
A key consideration for investors will be assessing the contractual status of drivers and other key personnel within teams, in particular in relation to image rights.
In part due to the success of Netflix’s Drive to Survive, all F1 drivers (regardless of team affiliation) are now valuable commercial assets in and of themselves. This presents a number of potential flashpoints for their relationship with their team, but in particular the risk of disputes related to use of a driver’s image rights and individual brand endorsement deals / partnerships.
Clearly drafted and commercially sensible image rights agreements are now more important than ever to avoid commercial fallouts that could quickly sour the sporting relationship between driver and team. Indeed, it was reported that one of the reasons F1 driver Lewis Hamilton left McLaren for Mercedes at the end of the 2012 season was the increasing media and sponsor duties imposed on him by McLaren, leaving him little room to pursue his own partnerships. Precedent image rights structures have developed organically across the sports industry – these offer a useful starting framework for F1 teams, provided they have the relevant legal and tax know-how at hand to navigate what can be a complex issue.
In addition to the drivers, an emerging theme in F1 is the enhanced profile and importance of other key individuals within teams. These include Team Principals (a title generally given to the leader of each team), Chief Engineers (who have overall responsibility for designing the cars) and, to a lesser extent, Race Engineers (a driver’s main point of contact during a race). In addition to the increasing commercial interest and opportunity for some of these individuals (such as Haas Team Principal, Guenther Steiner, who released a best-selling book, Surviving to Drive, earlier this year), a key consideration for investors will be assessing the contractual status of these key individuals. What is the term left on their contract? Do they have an image rights deal? What restrictive covenants are in place and for how long? Whilst ‘key man’ risk is an issue in many other sports and organisations, the risks can be particularly acute in F1, with a limited talent pool, and the outsized ability of that talent to impact on a team’s sporting performance.
Key consideration #5 – Anticipating upcoming developments
Investors should be aware of a number of anticipated developments that will have long-standing consequences for F1 teams, including Concorde negotiations, new entrants, self-promotion of races and ESG regulatory reform.
F1 is in a dynamic phase of development as a sport with a larger and more engaged fanbase and a repositioned financial model. Investors should be aware that this increased value opportunity may also act as a backdrop to future stakeholder negotiations regarding the governance of the sport.
Concorde negotiations
The Concorde Agreement – the contract which governs the relationship between the FIA, Formula One Group (via its subsidiary, Formula One World Championship Limited) and the F1 Teams – is due to expire at the end of 2025. The lead-up to previous Concorde Agreement renewal discussions have historically been drawn-out, fraught and (sometimes) accompanied by the threat of breakaway competitions from participants.
The 2021 Concorde Agreement managed to resolve, if only for five years, certain of the key sticking points that had been debated within the sport for decades, namely: (i) the introduction of cost capping regulations; and (ii) a more equitable distribution of prize money amongst teams. However, given the commercial development of the sport since 2021, the financial consequences of any changes to these relationships have increased and it will be critical for an investor to understand the dynamic of any renewal discussions.
New entrants
In October 2023, the FIA announced that, after a lengthy review process, it was putting forward a proposed new 11th F1 team, Andretti Formula Racing (a US-based team). If approved by Formula One Group (as the commercial rightsholder in F1), Andretti will join no earlier than the 2025 season. A number of other potential teams also submitted applications to join F1, which were sent to the FIA in February 2023, but only Andretti was selected for further consideration. It has been reported that, under the current Concorde Agreement, up to 12 teams may participate in F1 (there are currently 10 teams) with a new entrant required to pay an “anti-dilution” fee (reported to be $200million).
The resolution of the Andretti entry will be very significant for the stakeholders in the sport over the coming months. The reported principal concern of the commercial rights holder, Formula One Group, and the existing teams, is not to dilute their share of media rights revenue and prize money by adding a new team. Therefore, it is understood that any additional team will need to demonstrate that they can contribute to increasing the overall revenues of the sport. This is also likely to set a precedent for any new entrants in the future and any investors considering backing a bid for a new team to enter F1 will want to follow the Andretti case particularly closely.
Self-promotion of races
Liberty Media, the owner of Formula One Group, has been exploring the possibility of promoting and organising races itself, breaking from the traditional model of using local third-party race promoters. This was the approach taken at the inaugural Las Vegas Grand Prix (with support from city authorities and the main casino organisations). According to the financial chief of Liberty Media speaking ahead of the race, “Vegas is projected to be in the top five of all races in year one in terms of total profit to the company.” If the trend towards self-promotion of races in F1 continues, we suggest that this will be an area for investors to consider as part of their assessment given the indirect impact of the commercial success of Formula One Group on teams through the prize money distribution model.
Moving away from the logistical know-how of experienced third-party race promoters carries certain risks, demonstrated (whether fairly or unfairly) by the well-reported issues with track quality at the 2023 Las Vegas Grand Prix. The economic success of this strategy will only become clear in the weeks / months following the event, but the start-up costs of the approach are substantial. It is rumoured, for example, that F1 has spent over $240million on land in Las Vegas. The profits generated will ultimately decide whether or not the strategy is rolled out across other races, although it is noted that it may be more difficult for F1 to walk away (both in practical and publicity terms) from an event (such as Las Vegas) in which it has invested so much capital.
Other contractual implications of this change in approach will vary dependant on location, given that the terms of hosting agreements are bespoke to each host city. The commercial effects are, however, likely to be most relevant to areas such as on-track perimeter advertising, race-day activations and off-season events, where it is possible that teams will have more scope to pursue their own sponsorship and endorsement deals. Teams should ensure that they are well placed to draw on advanced commercial and contractual know-how to (i) identify and (ii) take advantage of any opportunities for commercialisation as and when they arise due to the trend towards self-promotion.
ESG regulatory reform
F1 has faced public pressure in recent years on a number of environmental, social and governance (ESG) matters, most notably in relation to environmental sustainability. This pressure has already materialised into regulatory reform via the upcoming 2026 engine regulations and has also prompted a commitment from F1 to achieve carbon neutrality by 2030.
This focus on environmental sustainability is attracting new participants into the sport – Audi, for example, cited the 2030 carbon-neutrality goal as a key motivation behind its entrance into the sport as a power unit supplier (rather than as a team itself), stating that F1 now represents “both a global stage for [Audi’s] brand and a highly challenging development laboratory”. This area is likely to continue to be a key focus in the coming years and mirrors the focus on ESG by institutional investors more generally.
Concluding thoughts
The combination of the modernisation of F1’s commercial model, the introduction of cost controls and the scarcity of opportunities creates an increasingly interesting proposition for institutional investors. This builds on the wider interest by sophisticated capital across the sports industry ecosystem.
To find out more about how Northridge can help on investments in F1, get in touch with Northridge corporate partners Ian Lynam, Jon Walters or Mike Herbert.
