MELNYK’S GAME PLAN
Eugene Melnyk tells JAMES BAGNALL why he believes he can build a contender without Alfie — and do it on a tight budget.
The Senators’ owner talks to James Bagnall about the team’s finances and why he thinks the Sens can compete — even on a tight budget.
At Manhattan’s $400-a-night Sofitel Hotel, just a few minutes’ stroll from Times Square, time was running out. NHL Commissioner Gary Bettman left an abbreviated negotiating session with the players’ union representatives in a determined, abrasive mood. It was Aug. 9, 2012. If there was no deal on a new contract by Sept. 15, Bettman said, the players would be locked out. There would be no season.
The owners — many of them self-made billionaires — wanted a bigger share of the league’s revenues. Indeed, they saw this round of bargaining as crucial for creating profitable team operations. But there were a few owners who also viewed the upcoming deadline with something approaching alarm. Eugene Melnyk for one.
The proprietor of the Ottawa Senators since 2003, Melnyk had seen his once-staggering wealth — more than $1.5 billion when he bought the team and arena — shrink significantly.
The pharmaceutical entrepreneur is still, by any ordinary standard, immensely wealthy. But his diminished fortune — estimated in the hundreds of millions of dollars — is tied up in a variety of assets and commitments unrelated to the hockey team. Melnyk has sufficient cash to cover his Senators’ cash losses — which have been averaging close to $10 million per year. But last August he faced the prospect of significant further bleeding. And it worried him.
Indeed, Melnyk was more exposed to the financial consequences of a lockout than outsiders realized. Prior to the expiry of the players’ collective agreement, he had been negotiating a new loan to cover the team’s $130-million debt — held by a syndicate of eight banks including Scotiabank and CIT Group of New York.
The loan had expired at year-end 2011 and had been operating under a series of extensions, with appropriate financial penalties applied. Melnyk was being forced to cover millions of dollars in extra debt interest payments until he could line up a new set of lenders.
Ordinarily, Melnyk might have been able to convince the original group of eight to agree to new terms on a fresh loan. But some members of the syndicate had decided to get out of the business of lending to sports teams and others were concerned by the extent of the Senators’ debt load, which is approaching 50 per cent of the estimated $300-million value of the team and the arena.
This is high, even by the standards of the NHL. The Senators consider it manageable.
The day Bettman emerged from the Sofitel Hotel, the Senators’ owner had been negotiating with a new group of banks, including HSBC Group. Melnyk had been confident that fresh financing was within his grasp.
But the arrangement was still tentative, and proved vulnerable to second-guessing by at least one of the banks in the group. When rumours of an NHL lockout surfaced, a member of the proposed new syndicate dropped out. When the lockout became fact, convincing another lender to fill the gap proved impossible — pushing Melnyk back into the arms of the original group of lenders, and their regime of extra fees.
The result was that last autumn the Senators faced a series of financial stresses, including ongoing losses on operations, higherthan-usual debt interest payments, and probably more than $10 million in additional costs related to the lockout and the resulting loss of ticket sales.
The financial squeeze affected every level of the Senators’ organization, from payroll to marketing. Loose talk, misplaced as it turned out, held there wouldn’t be enough cash on certain weeks to settle paycheques. “There is no truth to the rumour that we had a payroll issue at any time under Eugene’s leadership,” said Senators president Cyril Leeder during a recent interview.
It was only after the league returned to action, allowing the Senators to generate revenues from ticket sales, that Melnyk finally arranged $150 million in fresh financing — this, according to Davies, the law firm that helped to negotiate the deal. He signed a four-year deal in April 2013 with a pair of U.S. specialty funds. By this time, the mantra of conservative spending was even more firmly embedded in the Senators’ financial culture. This posture would be an important factor in the ill-fated contract negotiations involving the Senators’ long-serving captain, Daniel Alfredsson.
The issue was not so much whether Alfredsson would settle for $4.5 million or $7 million — the initial variation between the two sides. It was, rather, the context. Under NHL rules, the Senators can allocate up to $64 million U.S. for players’ salary next season. But the team was holding the line at $51 million U.S. or so. The lower figure was established by Senators’ general manager Bryan Murray, though he did so understanding full well the financial stresses endured by the team over the past year. For Alfie, the $13-million gap represented money not being spent on hiring free agents who might increase the Senators’ odds of progressing further in the playoffs.
When the Swedish star revealed July 5 that he had accepted a one-year contract worth $5.5 million U.S. to play for the Detroit Red Wings, disbelief among Senators fans gave way to anger, then resignation. More recently, there has been a cooler appraisal of what it takes to create a winning franchise in a small market such as Ottawa. While financial commitments to his outside business and personal interests have hurt Melnyk’s flexibility with respect to the Senators, he appears quite at peace with the
‘Could we spend more money on players? You could. But stats have proven over and over that there is a road of less return because you’re starting then to pay for more mediocre players, especially in the unrestricted free agent market where everybody is scrambling. It’s no different than the horses. You’ve got your superstars up here, then you’ve got the other 80 per cent.’
EUGENE MELNYK, owner of the Ottawa Senators
idea that you don’t have to spend big money to create a winner in the NHL.
“Could we spend more money on players? You could,” Melnyk said during a lengthy interview with the Citizen. “But stats have proven over and over that there is a road of less return because you’re starting then to pay for more mediocre players, especially in the unrestricted free agent market where everybody is scrambling.
“It’s no different than the horses,” he added. “You’ve got your superstars up here, then you’ve got the other 80 per cent.”
The difference in talent between the top and the bottom outside the pool of superstars is “marginal” Melnyk noted, and not worth the extra spending — especially when other factors such as coaching, linemates and the free agent’s work ethic can be great equalizers when it comes to talent.
Certainly this is the lesson Melnyk drew from the experience of the 2010-11 season, when, according to Capgeek.com, he spent nearly the maximum allowed on salaries and his team still failed to make the playoffs.
Melnyk, for the most part, lets Murray get on with the job of putting the team together. The owner sees his role in more basic terms: He’s determined to resolve the team’s underlying weakness, which is a long-running inability to generate profits. In fact, this is the deep flaw embedded in the operations of all but the big city NHL teams such as the Toronto Maple Leafs and the New York Rangers, which can charge substantially more for tickets to home games. For mid-market teams, the economics amount to covering annual losses in the hope that the value of the franchise will rise even faster. It’s a formula that demands the owners have sufficient wealth to cover immediate cash needs, which is why so many NHL teams are controlled by billionaires.
Practically from the moment Ottawa regained its NHL franchise in 1990, the Senators have struggled financially.
Bruce Firestone, the real estate developer who launched the improbable campaign to secure the franchise, is a successful businessman but hardly a tycoon. Rod Bryden, the former bureaucrat and high-tech entrepreneur who owned the club for most of the 1990s, is a promotional genius. But he lacked the wealth that might have seen him through the economic downturn of 2001 and 2002. Instead, Bryden was forced to seek bankruptcy protection for the team in 2003, following the earlier insolvency of Ogden, the entertainment conglomerate that held the mortgage on the arena.
Things were supposed to be different with Melnyk, who rescued the Senators from bankruptcy on Aug. 26, 2003. Melnyk at the time was CEO and largest shareholder of Biovail — the Toronto-based drug maker he founded in 1989. The value of his shares in the firm was $1.5 billion. In addition, he had exercised share options in 2000 and 2002 for gross proceeds of nearly $68 million U.S.
Yet Melnyk chose to finance nearly half his $127-million purchase of the Senators and the arena with debt.
“We were in a blackout period” Melnyk explained, referring to the period during which key executives of publicly traded firms such as Biovail are prohibited from trading shares. Normally, a restriction such as this would merely entail a delay in Melnyk’s ability to buy or sell shares. But this would prove a most unusual financial quarter for Biovail — on Oct. 3, the company reported that its revenues for the three months ended Sept. 30 would be at least $45 million U.S. below what investors had been expecting.
It was the first time Biovail had fallen short of financial expectations — and company officials blamed the shortfall on a truck accident involving the spillage of a significant amount of Biovail pharmaceuticals.
That explanation would later be challenged by investigators from the U.S. Securities and Exchange Commission but the short-term impact was a steep fall in Biovail’s share price that pushed the value of Melnyk’s shares from $1.5 billion to little more than $600 million in just two months. When the blackout period ended, Melnyk had no desire to sell what he regarded as undervalued shares for cash. “We thought the shares would recover,” Melnyk said.
But they never did, not on Melnyk’s watch. He quit as CEO in 2004 and resigned as chairman in 2007. After he lost a fight to regain control of Biovail from a competing faction of directors, Melnyk sold his entire stake in the firm (now called Valeant Pharmaceuticals), generating several hundred million dollars in proceeds. Along the way, he reinvested the proceeds in a dozen businesses, including two early-stage pharmaceutical startups, Trimel and PurGenesis.
Melnyk’s decision to divest his Biovail shares — a great chunk at less than $20 per share — cost him dearly, at least in the short-term, because Valeant’s managers have proved sharper than he expected. Had he held on to his stock, Melnyk would have realized more than $1.5 billion in capital gains. (Valeant shares closed Thursday at $106.12 per share.)
However, this sort of inactivity is not the way of entrepreneurs.
“I wouldn’t have bought other things that are going to make me a lot more money,” he replied when asked whether he has regrets about selling his Biovail stake. “PurGenesis is a little company but it’s got the potential to become a billion-dollar company,” he added, referring to the Quebec-based startup that is trying to build a business on the basis of the antiinflammatory properties of certain plants. Earlier this month, PurGenesis revealed its lead drug candidate, aimed at reducing inflammation in bowels, had done well in a proof of concept clinical trial. However, it may be years before the drug passes all regulatory hurdles, assuming it is successful.
Melnyk claims most of his businesses are profitable. Exceptions are his two pharmaceutical startups — which require minimal funding at this stage — and, of course, the Senators. Because the team has consistently been a moneyloser, he has quietly been selling holdings here and there to generate cash. “I sold a little bit of Trimel stock,” he said, and recently sold his Junior A hockey team, the St. Michael’s Majors, along with a significant portion of his herd of race horses.
How much are the Senators costing him? It’s impossible to be definitive because, despite its high public profile, the team is a private company.
Not only that, the NHL regularly warns the 30 franchise owners not to divulge details about their operations. Nevertheless, Melnyk and two of his long serving senior executives — Leeder and chief financial officer Erin Crowe — offered some insight into the team’s finances.
On Melnyk’s decade-long watch, they say, the team has generated a grand total of just $6 million on operations — that is, total revenues minus the costs associated with paying and moving the players, advertising and managing the arena. After subtracting items unrelated to operations — such as interest on the team’s debt and capital expenditures to keep the arena upto-date — Melnyk has had to absorb cumulative cash losses of $94 million. In short, he is losing an average of $9 million to $10 million a year. And this excludes the additional interest and fees related to the debt extensions.
Again, without seeing the books, it’s difficult to know if these numbers exaggerate the team’s financial condition or not. But they do seem to line up with Melnyk’s behaviour during the past couple of years: his drive to secure a casino in Ottawa; his determination to keep the Senators’ salary capped at $51 million annually; and the new, more lucrative naming deal for the Senators’ arena, called Canadian Tire Centre as of last month.
Although the executives declined to say what the new naming arrangement means in dollar terms, it’s no secret that Canadian Tire is paying more than Scotiabank did, perhaps $1 million to $2 million more a year. To be fair, the Canadian Tire arrangement is more ambitious in scope, involving significantly more marketing and potential revenue streams for both the retailer and the Senators.
Will it be enough to close the gap and turn the Senators into a break even operation? Probably not. Still, there seems little doubt of Melnyk’s commitment to continue covering the losses for now, even if it means selling more of his non-hockey assets.
He is also fortunate in other ways. The team debt would have been much higher had Melnyk not acquired it for a deep discount out of bankruptcy court. And the arena itself, despite 17 years of operation, remains surprisingly modern. Credit for that goes to Bruce Firestone who hired the same architect, Rossetti Associates, that designed the Palace — the home base for the Detroit Pistons basketball franchise. When the Palace opened in 1988, it provided the template for a new generation of sports arenas — equipped with multiple tiers of corporate suites for which the arena owner could charge a small fortune.
The Palace’s owners (currently billionaire Tom Gores claims title to the team and stadium) have invested a further $100 million U.S. in their facility, suggesting it may be time for some heavy duty upgrades at the Canadian Tire Centre. A closer look, though, shows Melnyk to be on track in terms of capital investment. For one thing, about 30 per cent of the Pistons’ stadium upgrades were related to the addition of a Pavilion in 2006.
The Senators’ arena was one-third larger than the Palace from the beginning. In addition, Senators’ owners have spent roughly $60 million in upgrades over the years, to cover items such as a high-definition scoreboard, restaurant renovations and a covered walkway from the arena to the parking lot. About $40 million was contributed by Melnyk, as you might expect, given the facility’s more advanced age compared to Rod Bryden’s watch.
Melnyk talks wistfully about the government assistance provided to other arena owners throughout the league, particularly in the U.S., where cities and states frequently pony up funds to keep teams where they are. The Senators’ owner also chats frequently with Daryl Katz, the reclusive owner of the Edmonton Oilers, which recently received city approval for building a $480 million arena. Related infrastructure will cost another $125 million.
The complex arrangement, years in the making, will see a majority of the costs picked up by the city and the province.
By the time the Oilers play their first game in the new facility in 2016, the Senators’ arena will be 20 years old — in a business that sets the average lifespan of these stadiums at roughly 30 years.
At some point, hopefully not soon, the City of Ottawa will have to begin a serious debate about the value of a new arena and whether it should contribute to the costs of building it.
In the meantime, Melnyk has hit upon an inexpensive formula for trying to solve the irksome issue of the Senators’ bottom line.
It’s something he outlined to former Citizen columnist Jim Kyte a couple of months before his purchase of the team. “I don’t imagine we are going to go out and sign any big name free agents,” Melnyk said. “I get satisfaction out of developing talent. Using the thoroughbred horse analogy, I had an opportunity to purchase the winner of last year’s (2002) Kentucky Derby but decided against it because I get more satisfaction out of starting with a yearling, develop it and see it prosper.”
That’s certainly the less expensive way to go, as Alfie appreciates very well. He was the role model for this approach — he was drafted 133rd in 1994 and became steadily more valuable and expensive. There are many more uncertainties and risks associated with developing a team of young guns — a notion Melnyk appears to have little trouble embracing. Whether Senators fans will like the results will depend entirely on how the risks pan out.