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When Fantasy Sports Get Real

EJ and Eric Manuel in 2013
EJ Manuel of the NFL (left, pictured with his father in 2013) is among the athletes who have signed up with Fantex. Photo by Rod Pearcy

The banter on Sunday morning football shows is often peppered with discussions of whether a player’s “stock” is rising or falling. A new company is banking its future on whether investors are willing to put up cash to make those discussions much more literal.

Fantex promises sports fans a chance to invest in their favorite professional athletes or rather, as the company puts it, the income of a pro athlete brand. For now, the only athletes participating are football players, but the company plans to add athletes in other sports in the future.

Fantasy sports are almost as popular as their real-world counterparts. The Fantasy Sports Trade Association reports that over 41 million people participate in fantasy sports in the United States and Canada alone. That figure has exploded in the past decade, largely due to the rise of widely available Internet access. A special exception for fantasy sports baked into the main law governing online gambling has undoubtedly boosted the pastime’s popularity as well. Since fantasy sports are legally considered games of skill rather than luck, sites such as FanDuel and DraftDay can legally pay cash prizes for fantasy play.

Fantex has attempted to differentiate itself from fantasy sports by treating fans’ predictions of player performance as a matter of investment, not gaming. Yet while Fantex uses the language of investing to characterize their offerings, calling new player offerings IPOs and referring to players as “brands” in which participants invest, buying Fantex shares is really more like gambling than it is like investing. While you may imagine yourself buying the next Jerry Rice, Peyton Manning or Tom Brady, odds are just as good you could end up with the next Ryan Leaf, Brian Bosworth or JaMarcus Russell.

Many investors decry the fact that investor scrutiny in the public stock market causes company management to focus on hitting quarterly earnings targets to the detriment of the company’s long-term health. Falling short of investors’ expectations can cause a company’s stock to plummet. The weekly evaluations a professional football player undergoes is like quarterly earnings reports on steroids. And in a business that embodies the attitude of “what have you done for me lately,” a player’s value is subject to wild swings.

Consider EJ Manuel, a first-round draft pick in 2013. Despite a subpar first season, Buffalo Bills coach Doug Marrone initially said Manuel would be the starting quarterback for 2014, signaling confidence in Manuel’s prospects. However, at the end of September, the Bills benched Manuel in favor of Kyle Orton. Before the announcement, Manuel’s Fantex stock was trading at $9.60 per share - close to its IPO price of $10 - only to fall to $5 per share after the announcement. It has trended lower ever since.

While Fantex does not represent an investment per se, evaluating a player does share some characteristics with evaluating a company before buying shares. A potential buyer has to think about a player or company’s future earnings potential based on their performance so far and their prospects based on demonstrated products or abilities. The buyer also needs to consider business risks. For instance, GT Advanced Technologies recently went bankrupt after Apple unveiled the iPhone 6 with no mention of the sapphire screen that GT was poised to manufacture. The announcement shocked investors, and while GT blamed Apple’s “oppressive and burdensome” supplier agreement, it faces a class-action lawsuit from shareholders who claim it misrepresented its financial position. A player’s career, likewise, can be profoundly influenced by the makeup of the team he plays on, often in ways beyond his control.

Players, like companies, also face reputational risk. Think of Ray Rice or Adrian Peterson, who serve as two recent examples of how off-field conduct can profoundly influence a player’s career, and thus his potential earnings. Similarly, McDonald’s “pink slime” controversy, the major Tylenol scandal of the 1980s and the General Motors ignition switch recall earlier this year all had the potential to deeply impact those companies’ profits in the long term. Some such scandals blow over with time and smart management; some do not. Few if any of them could have been anticipated.

Perhaps most concerning for those considering Fantex, investors need to consider the liquidity risk associated with holding a player’s stock. It doesn’t matter whether you think your stock is worth millions of dollars in theory if there is not a robust market to trade your shares. Either you will likely take a significant price reduction in order to unload your shares or your shares will languish in the market. Imagine trying to sell snow blowers in South Florida: Snow blowers are inarguably a useful invention, but since no one is going to want one in that market, the blower is effectively worthless. You cannot buy or sell Fantex’s tracking stocks anywhere except on Fantex’s website. Unless Fantex can attract enough buyers and sellers to its marketplace, you will probably find selling shares difficult. So far, Fantex’s platform has seen less than an average of 50 shares of player stock exchange hands daily, if they traded at all.

It is easy to see why a player would want to sign up with Fantex. For players whose earnings potential is relatively high but who face the prospect of an extremely short career - the average is about three and a half seasons - Fantex takes some of the risk off the table. Athletes get an initial payout against earnings they may or may not be in line to collect one day.

But for the fans, this “investment” gets worse the more carefully you pay attention to the details. Looking at the prospectuses for the tracking stocks shows that buyers are not only betting on the player, but committing to an investment whose performance is heavily tied to the success of Fantex as a company and its ability to collect on the player’s contracts and to generate interest in its platform.

Fantex has no right to require the athletes who enter a contract with it to take any certain actions to attract, maintain or otherwise generate brand income. The athlete’s career is what it is, and Fantex could not take any responsibility for it, even if the company wished to try. In addition, Fantex’s business model relies on athletes to file a mandated quarterly financial report detailing their income. Professional athletes, even successful ones, are not always known for their business savvy. The brand contracts also have several exclusions related to what income counts as brand income; in most cases, the earnings must be sports related. For example, EJ Manuel could become a billionaire real estate investor, but those earnings would not necessarily be considered brand income payable to Fantex and the holders of his tracking stock.

Worse, Fantex can refuse to make payments under brand contracts. The tracking stocks are a series of Fantex’s common company stock, which means that they are exposed to the additional risks associated with the company as a whole. Fantex could be required to use assets attributed to one tracking stock to pay a different tracking stock’s liabilities. In addition, the board of directors of Fantex can elect to convert the player tracking stocks into Fantex common shares after a set period of time, generally two years.

Investors should also note that, while they are essentially buying a concentrated position in Fantex itself, the company’s directors are under no obligation to pass on any earnings as dividends either. While Fantex has paid some dividends so far, those could evaporate at any time, even if the company prospers.

While the Internet creates all sorts of opportunities for sports fans and investors alike, not all of those opportunities are good ones. Fantex’s offerings appear to be a bad bet for everyone, except perhaps the athletes who can secure big upfront paydays by becoming tracked brands. Many fantasy owners may see Fantex as their opportunity to test their skills in the real world, but they would be much better off deploying their cash elsewhere and letting the Jerry Joneses of the world gamble on players. Those guys have a lot more chips to play with.

Senior Client Service Manager ReKeithen Miller, who is based in our Atlanta office, is the co-author of Chapter 14, “State Income Taxes” in our firm’s recently updated book, Looking Ahead: Life, Family, Wealth and Business After 55. He also contributed to the firm’s book The High Achiever’s Guide To Wealth.

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