Tuesday, July 13, 2010

More On That $33.5 Million Gift To Herb Simon's Pacers

It's always fun taking a closer look at anything that comes out of the CIB. You always learn things upon closer inspection that were conveniently overlooked during the press briefings. This process began with the Pacers demanding that the CIB pick up its maintenance and operating expenses for Conseco Fieldhouse or the team might move to another city that appreciates them more. Free use of a nearly $200 million basketball arena constructed specifically for their use and getting to keep all revenues generated from the facility just wasn't cutting it. At first we were told those expenses were $15 million. As we grew close to the June 30th deadline imposed by Herb Simon for negotiating a new deal, that number suddenly jumped to $18 million. In the end, Herb settled for $30 million payable over the next three years in $10 million installments, plus a minimum investment of $3.5 million in capital improvements to the facility, which could actually grow to more than $8 million under the deal.

[As an editorial note, I want to point out that Councilor Robert Lutz, whose committee the CIB's bailout legislation passed through last year, assured people in attendance at a public hearing on that bailout that it did not include any money to give to the Pacers as part of any lease renegotiations. I would like to hear his explanation now about how the CIB could immediately commit us to the first in a series of $10 million loans to the Pacers if neither that bailout ordinance or the CIB's 2010 budget included money for this taxpayer give-away.]

The first thing I noticed when I looked at the proposed amendment to the lease agreement was the parties to the agreement. They include Pacers Basketball, LLC, Herb Simon and the Herb Simon Revocable Trust. Just as I earlier reported, Herb Simon did indeed buy out the interest of his late brother, Mel, in the Pacers franchise. Why is this important? Pacers Sports & Entertainment's CEO, Jim Morris, insists the franchise has lost $200 million since the team moved into Conseco Fieldhouse, losing money in all but one year since 1999. Why did Herb want to own 100% of a business that was supposedly losing so much money? Why didn't Mel's children or wife get their father's interest in the business? Forbes has valued the franchise at $281 million. Herb and Mel Simon bought the Pacers franchise for a mere $11 million in 1983. I think the handwriting is on the wall. Herb is trying to position the franchise financially to sell to an outsider rather than keeping it in the family, notwithstanding Morrison's claim that Herb is in it for the long haul, particularly since he's not so young any more at 74. If the public is being asked to subsidize the franchise to the tune of tens of millions of dollars more, I think the public has a right to know the facts surrounding this change in ownership.

The next point I would make about the $10 million a year, $30 million, three-year deal is that it is not characterized as a subsidy to the franchise. Instead, the lease agreement calls this a loan to the franchise. The first $10 million installment is being paid upon the execution of the amendment. The Pacers are giving up their lease termination rights through June 30, 2013 in consideration of the $30 million loan and the capital improvements the CIB agrees to undertake. The Pacers are given the right to serve notice of a lease termination on July 1, 2012 to become effective at the end of the 2012-13 season. The loans over three years to the Pacers are interest-free of course. Approval of the second and third installments on the loans payable in January 2011 and January 2012, respectively, however, are subject to the City-County Council approval. This is where it gets interesting. If the council refuses to appropriate the money for the loans, the deal is off as is the restriction on the Pacers' early termination of the lease.  But there's this kicker. Because the CIB intends to give the proceeds of the first installment of $10 million immediately upon the effective day of the amendment, that first installment loan is forgiven in its entirety if the City-County Council fails to approve the second and third installments on the loans. If the council approves the second installment but not the third installment, then the second installment loan is forgiven and the first loan is subject to repayment on a sliding scale basis as discussed below.

Without specifying the reason, the amendment says the loans are immediately to be repaid if the operating agreement is terminated; however, if the team is sold or the ownership of the assets is sold that triggers the CIB's right of first refusal to purchase the franchise, then the loan proceeds are payable at the closing of the sale or the transfer of the assets. The amendment states that repayment of the loan proceeds does not alter the CIB's rights to collect the penalty for early termination of the lease that is determined on a sliding scale basis. Currently, that termination fee is more than $130 million as I read the lease agreement; however, the CIB and Pacers are oddly figuring the penalty to be only about $20 million according to comments that have been made to the press. Why? The Pacers termination rights are rescinded by the lease amendment should they renege on their obligation to repay the loans.

The proceeds of the loan are to be used exclusively for maintenance of the fieldhouse according to the amendment. There is absolutely nothing in the lease amendment, however, that gives the CIB the right to audit the Pacers books to make sure those loan proceeds are being used for maintenance expenses and not salaries or other expenditures. At the conclusion of the 2013-14 season, portions of the loans will be forgiven on a sliding scale basis, starting with $2 million the first year, increasing to $3 million the second year, to $6 million each of the next four years and $1 million by the end of the 2018-19 season. After that, the loan repayment is forgiven in its entirety.

There is an interesting provision of the lease amendment that provides that the loan proceeds, although they may be forgiven in their entirety, cannot be considered "net cash flow" as that term is defined in the lease agreement. In other words, if the Pacers claim they are still losing money during the next three years, the $30 million loan proceeds will be excluded in determining the franchise losses. I'm not sure the IRS will view these so-called "loan proceeds" as non-taxable income, which they obviously will become at some point if they're not repaid, but we'll leave that to tax auditors to figure out.

The lease agreement contains another give-away to the Pacers. Under the original lease agreement, the Pacers were required to pay a lease fee for the use of the Virginia Street garage; however, the CIB says the Pacers have never paid a dime to the CIB in eleven years because of unspecified contractual offsets. The lease amendment makes the Pacers' use of this parking garage, as well as unspecified temporary parking spaces, free of use. What is the value of this give-away. Why aren't there more specifics about why the Pacers have been given free use of this parking garage taxpayers paid to build for eleven years?

The obligation to pay $3.5 million in capital improvements is a little more complicated to understand. At first blush, it limits that obligation to $3.5 million, but on closer examination you realize its $3.5 million, plus the additional amount of money the CIB receives from the state for the expanded professional sports district downtown established in 2009 that captures state income and sales tax revenues that are received as of the effective date of the agreement, including for taxable period prior to the effective date of the lease agreement. It's not readily apparent how much this amount is, but I understand it could provide for up to $8.2 million in capital improvements to the fieldhouse. I should also point out that the CIB has assumed several million dollars in capital improvement-related work on the fieldhouse that it was not legally obligated to pay under the current lease agreement.

The amendment takes disputes arising out of the amendment that would call for specific enforcement not to be subject to the arbitration clause provided under the lease agreement, which means the CIB can go to court to enforce the terms of this deal.

This analysis does not discuss how the CIB plans to pay for the $33.5 million plus it gives to Herb Simon under this so-called bridge agreement. I've studied the CIB's financials and come to the conclusion that (a) the CIB will have to borrow the full $27 million from the state authorized by last year's bailout legislation for the CIB to pay for this deal; and (b) the CIB will have to raise taxes to pay back the loan from the state, in addition to more than $20 million in deferred loan obligations, unless the state forgives that loan. The CIB still has a window over the next two years to enact a tax increase on admissions to events at the CIB's facilities and car rentals. You can also bet that this bridge agreement will lead to more demands from the Pacers for further financial assistance through the balance of its original lease agreement, which doesn't end until 2019. Again, where will the money be found to pay post-bridge agreement? The CIB has learned nothing from its past expenses. Borrow and spend today, worry tomorrow.


Downtown Indy said...

I think you are on track about selling the team, given Herb's age. I have never heard much about any Simon children being involved in the franchise that suggested they were being prepped, ala Jimmy Irsay, to take over. I think one daughter has some involvement but it's been ages since I heard any mention of her.

Also, they opted for a Revocable Trust vs Irrevocable so apparently transferring the assets to children isn't the main objective, rather hiding the details from public scrutiny and also letting the terms change so it could be sold outside the family.

But I'm not a lawyer, so maybe I'm all wet on this?

Gary R. Welsh said...

Your right about the revocable v. irrevocable estate. Its revocability makes it part of Herb's estate at death. While the inheritance tax was set to expire under the Bush tax cuts, it springs back into its full fury if Obama gets his way and allows the the abolishment of the tax to sunset.

Downtown Indy said...

There are just SO many reason to 'love' Obama.

We so need to get rid of inheritance taxes.

People complain about 'regressive' income taxation, but jeeze, taxing the already-taxed estate of a dead person is just the lowest. And Obama revives it. What a pal.

Unigov said...

The CIB does not have the authority to loan money to the Pacers.

Indiana State Constitution:

Article 10, Section 6
Article 11, Section 12

So, what is going on ?

Gary R. Welsh said...

That's how it should be interpreted, Unigov; however, I believe the state of Indiana once loaned money to Chrysler at one point didn't it? I still remember Councilor Bob Lutz insisting there was no money in last year's CIB bailout ordinance for the Pacers during the public hearing on it. Do you think he will be upset the CIB made a liar out of him?

Blog Admin said...

I don't know what Lutz does or doesn't know, Gary. But I can say this. In the half a dozen or so times I've been in the room with that man at a committee or council meeting, I never felt that he was paying attention to anyone, especially normal citizens. If he gets an opponent, primary or general, I might actually donate money to that candidate. And that says a lot, coming from the cash strapped 20 something crowd.

dcrutch said...

Indy Student: Thanks for being out there. I wish we had 20 more your age.

Citizen Kane said...

"Herb is trying to position the franchise financially to sell to an outsider rather than keeping it in the family, notwithstanding Morrison's claim that Herb is in it for the long haul, particularly since he's not so young any more at 74."

I wouldn't doubt that everything they are doing is to try to make the Pacers more attractive for a sale, particularly if a prospective new owner wants to move the team somewhere. I wouldn't be surprised if negotiations with a new owner were occurring simultaneously with these "tough negotiations."

Russ said...

Bob Lutz lives down the street from me. The man is, plain and simple, a douchebag. I live on the west side along the county line, and I would jump and click my heels if he decided to move across the street.