In a League of His Own w/ Arctos' Ian Charles

We've covered the growth of the secondary market extensively on dry powder, but one guest stands out as a singular innovator. Ian Charles, the managing partner of Arctose Partners, took us inside his strategy to buy minority stakes in professional sports leagues. I've often said that this is a moment for the private equity industry to reinvent itself. I would argue this episode is a prime example of what that looks like on the ground. If you haven't heard this episode before, I highly recommend you stay with us. I actually have always been drawn to complicated situations, non-obvious situations, and that's been a big part of my career, my entire career. That's Ian Charles, the managing partner at Arctose Sports Partners. Over the past few years, Ian and his team have been buying minority stakes in sports franchises in North America and Europe. When we started the firm, only one league of the five North American sports leagues had changed its rules and allowed for this kind of investment activity. His portfolio now rises and falls with the success of entire leagues. The demand for access to our operational capabilities are value added services and our capital to execute on a vision of growth is something that we really underestimated early. And about half of our deals to date have been growth capital, opportunities and partnership with some of the most innovative owners in all of sports. Today on Dry Powder, Ian will take us inside the world of sports investing. What you're about to hear is a master class sector specialization in advanced analytics and value creation. I'm Hugh McArthur, chairman of Baines Global Private Equity Practice, and this is Dry Powder. Well Ian, you and I have known each other for a long time and I really wanted to thank you for taking the time to stop by and beyond the show today. I'm happy to be here. You're a good friend and I've got a tremendous amount of respect for everything you and your team have done for the ASIC class for a long time. So I'm excited to be here. I really wanted to start by talking to you. Actually, this will get thread. I think through our entire conversation about innovation because I think of you as kind of a pioneer in a lot of the things that you've done in your career. And I'm particularly interested in one of your latest innovations, which was your foray into sports investing, which began several years ago. How did you actually find your way in this sports investing and why sports versus anything else? Well, like you said, we've known each for a long time. So you know, I'm kind of a nerd. And I studied the North American sports market as a secondary strategy about a decade ago. And I was drawn to it because of its unique beta factors and beta characteristics. I was part of a team that had a lot of data and a real research had agreed. We could not replicate the performance of North American sports assets using all of the data available to us. And for a nerd, that's a pretty interesting thing. When you can't replicate an asset. And when you find an asset that is at the same time a return enhancer and a risk producer, that's where nerds get pretty excited. And so I studied the asset class for about six months. But this is a regulated industry. And the regulator is called BLEG. None of the North American leagues allowed institutional capital, really, of any kind to own equity in their clubs. And so I was very interested in this industry and this secondary's opportunity. But it was not executable 10 years ago. That started to change three years ago when Major League Baseball changed its constitution to allow for a very specific kind of fund who invests across its league. And we had an opportunity to build the first firm to do that. And as an entrepreneur in illiquid markets, I know the value of the first mover advantage in this space. And I knew that we could build a really compelling offering if we had the courage to go for it. That's why they call it innovation. You have to be able to have the nerd to actually back up your ideas of concordated asset classes and things that you can't explain through traditional data and traditional analytics. And when you did venture out and formed this first sports fund, I know you we've talked about this before. You had impeccable timing. It was kind of 2020. Now while you're raising the fund and everybody's sitting in that living room with their basement or wherever people are sitting and you're trying to raise a first time fund and a first time sector kind of from scratch, which I'm sure is how you drew it up in the on the old whiteboard. But when you started, what was the strategy going into the sports sector in terms of the ecosystem as it broad as it now there's lots of different sports related businesses out there and talk a little bit to me about the initial thought, the initial strategy as you began ART-DOS and then how that's evolved over the past few years. I don't think people appreciate how unknowable our strategy was when we started the firm because only one league of the five North American sports leagues had changed its rules and allowed for this kind of investment activity. And so when we started the firm, you had to really underwrite several risks. Could we build a world class team to execute this strategy? Would the other North American leagues open up to institutional capital? Would we be allowed to offer value added services and capabilities to the clubs that we partner with? Is this industry really durable and non-correlated or was that just sort of some weird statistical kind of phenomenon or echo? And to your point, there were literally no sports happening anywhere in the world, which is like not not a real compelling part of the pitch early. Those were all big unknowns that our early investors had to underwrite. And to their credit in the last three years, I think we've actually been able to prove each of those VCs to be correct. So if you boil it down at the very beginning, what you were providing as a service was really liquidity to minority owners where it was allowed for sports teams where there was no natural liquidity path for them. So it was a way to monetize essentially their investment. And you're left with a bunch of minority stakes in a bunch of different sports teams and different leagues, depending upon who changed their rules to let you commit an invest. Beyond that, were you surprised by the level and nature of engagement that you had with the control owners of those franchises? Let's sort of take that layer by layer. So the lens that I brought to the table was my background in unlocking ill-equity premium predominantly through the secondary's market, you know, across asset classes, et cetera. So when I looked at it, this was North American sports called 200 platforms. It was sort of a $450 to $500 billion tam. On average, there's like 10.7 minority owners per club. So I viewed it as 2000 fractional owners of assets that had a combined aggregate value of almost a half a trillion dollars. To me, that looked very, very similar to US and European buyout aggregate NAV in 2007 held mostly by about 2000 limited partners. So I came with a very tactical secondary's execution framework. And we hoped that we would be able to provide growth capital. We weren't sure when that would emerge. But growth capital, like we used to provide through-pref and GP stakes types transactions and operational capabilities from my colleagues who have run teams worked at these leagues, worked at operating companies that serve franchise owners and league partners. We hoped we would be able to provide this growth capital value creation layer. But I really came at this three and a half years ago with the secondary's. And we totally missed the appetite for growth capital. The North American leagues do not let their owners use a lot of leverage on these businesses for a lot of reasons. And the lack of institutional capital historically has created a pipeline of high ROI opportunities for these ownership groups. And what they've had to do is just roll their pre-cash flow back into those opportunities and sort of pick which opportunities to fund. And that means their potential growth has actually been much higher than their actual growth. The demand for access to our operational capabilities are value-added services and our capital to execute on a vision of growth is something that we really underestimated early. And about half of our deals to date have been growth capital opportunities and partnership with some of the most innovative owners in all of sports. The other half has been that tactical secondary liquidity execution strategy. And so it's been a really unique list for us. But in order for the growth strategy or growth opportunity part of a franchise's full potential to be realized and for actors to participate, you can't merely, as you said, he and just be a liquidity mechanism for a minority owner, but you actually have to get access to the control owner and get their attention and your belief that you can help. How did that actually work? Did you know going in the control owners wanted to talk to you or did this happen more organically? How did that come about? One of the of the pillars of my career has been using data analytics and really applied research at scale to position my team and I as a thought partner for decision makers. We've built the same kind of data science business several times and we knew that if we built something similar for this industry which has nothing like that. There's really no applied research platform providing insights services and tools for the decision makers and owners of these assets. We knew we could build that because we've done that for. We knew we could enhance it with operating advisors and full-time executives as part of our leadership team and if you could wrap all of that experience around this sort of data backbone that would drive regular engagement on a repeated basis with the decision makers in professional sports. That's exactly what we have. That business is called Arctose Insights and it drives regular engagement using data and what that does is create repeated opportunities to show our capabilities to owners to help them understand the most important topic to them right now. What the right path might be for them around that particular topic and how we can provide capital to help them navigate that uncertainty or take advantage of that opportunity and when you marry that up with our growth capital capabilities with our secondary liquidity capabilities that is a very powerful combination that is hard for someone else to replicate. So now that you've actually created somewhat of a, like I could use the term up playbook for repeated success, do you expect that the pace of this innovation because of the platform you've created is going to accelerate from here? It is accelerating. So we have this flywheel effect because now that we have this market position as the partner of choice for owners that want to grow, they are engaging with our team around the topics that matter most to them. So the research initiatives, the data science initiatives, the value-added capabilities that we're building, the pace of that innovation is accelerating rapidly and we get more data and more perspectives and more questions the more our portfolio grows and the more time that we have. It starts to compound exponentially and what's really cool is we're able to bring all of these relationships and connectivity from the sports industry and all of our relationships and connectivity in the global alts community and under one roof and so when our owners are asking about ways for them to invest in ESG, we actually have lots of friends and partners right at the tip of the spear on the innovation that's happening in that world and we're able to help them collaborate with the owners of some of the most important brands and the most important communities in North America. And there's all this really unique opportunities to leverage those two sets of relationships under one roof and that also helps accelerate that flywheel effect. So Ian, all the innovation sounds really exciting and what's going on in sports and also the crossover to some of the other types of all investing that you do that I'm going to ask you about in a few minutes. Is there one single thing or idea you can talk to our audience about the gifts as a sense of like what some of this innovation really looks like? Well look, you and your team helped coin this phrase like the right to win and a manager's right to win in their strategy. There's lots of different things that that can feed into your right to win but if you have a right to win and you execute it manifests itself over a long horizon in non-market excess return right which nerds call alpha and part of my early career was working with some really smart people to sort of help create and commercialize alpha diagnostics for GPs right what are you actually really really good at? And we have pioneered the development of a very similar alpha diagnostic tool to help sports owners understand where excellence mathematically verified excellence exists in team operations and business operations and if you can isolate excellence on the execution side of the business of sports just like isolating excellence on the execution of ill-equipped investment strategies. You have a right to win and harvest non-market return through talent identification, origination, pipeline filtering and that's a really cool area of applied research for us right now is taking the alpha diagnostic framework that is now becoming pretty standard in ill-equipped assets and driving its utilization in North American sports that's pretty cool. So we're talking about sports but it actually sounds like we could be talking about any number of sectors when it comes to alpha generation and the approaches that you describe. Are there other examples that you can talk to our listeners about around innovation that goes filling into these other sectors beyond sports? Absolutely one of the things that we're spending a lot of time and I'm sure all of your listeners are reading about and thinking about is the applications of machine learning, natural language processing. It has huge applications for alternative assets. It also has huge applications in professional sports. So as one example, in a world where everyone is consuming highly customized individualized content, there's only one form of content that will be communal where we will have a shared experience and where that experience will be unknown as we begin to experience it together and that's live sports. So helping our sports owners understand what generative AI is going to do for the rights to their media properties and how there's tremendous upside as we move into a environment where content is produced by machinery adapted to our personal preferences. That's an area of focus for us. If we can be the group that helps drive innovation like that within our industry, that just enhances our value as a potential partner when we can help our owners think about how to optimize their brand in their community using machine learning and AI tools to do a better, faster, cheaper. If we can crack that code for our owners, that's huge value. You know, it's really fascinating and to hear you talk about growth potential, innovation, technology, data, analytics being used in very different ways, all focused on sports and teams and franchises, which is really, as you pointed out, not been done before. But the other thing that I think is interesting to marry up to that is that you wind up as a major sports investor having positions in different teams in the same league. And so there's an opportunity here to think through value creation at the league level. You're not merely interested in an individual franchise, although of course you are, aren't everywhere that you're invested, but the value of a league when you have multiple positions in different franchises and the league is also quite important to Arctos. So how do you think about providing ideas and creativity in the same kind of growth mindset to a league office as well as a franchise? That's a great question. And we really do position ourselves as a partner to the leagues in which we invest in North American sports, which is unique in global sports. Every club owns an equal pro-rata share of its league. And so as we build our portfolio and we pick our partners at the local level, the operators at the local level, we're also aggregating meaningful ownership at the league level. And so we are regularly conversing with our league partners about their priorities, or we might be able to help them either with capital or resources. It is a big part of our long-term value creation plan, but the league beta is such a unique and valuable part of our strategy. And the leagues do a really good job of monetizing this intellectual property globally and nationally. There are areas where the opportunities to collaborate are obvious, right, around strategic investments about international growth, about reconciledating local media rights into a national level product. All of those things take capital, they take resources, and they take very specific domain expertise. And we may be able to bring all three of those to the table and partnership of the league. So it's a big part of our overall strategy. You know, Ian, I grew up here in Massachusetts, the Die Hard Boss in Red Sox fan, and the critique of the Red Sox when they were so far in between Winnie World Series, which is many, many years ago, of course, now was they were 25 guys, 25 camps. They didn't have a tight clubhouse. They weren't all pulling together. for the benefit of the overall franchise. And it strikes me when I expand that metaphor to a lead level, is you describe it. You've got a lead owner who's really 130 or 130 second or whatever the number of teams has to lead, but they've got that kind of an interest in the lead. And then most of their mindset, their mind share is on their own franchise. And so thinking across the entirely is something that you're uniquely well positioned to do because in many instances, you do have multiple investment positions within a lead. So you can take a broader view of what's great to the league is great for every franchise. And that's great for obviously investors in every single franchise. How do you think about that? And how do you think about some of the bigger ideas at the lead level that might generate even more value than a one franchise could consider on its own? Yeah, it's another great question. And there are some league level opportunities that are great for all of the owners, for the players. And it's just whether or not they're big enough priority and a capital need and a timing is right. We think it could be incredibly valuable for some of the North American leagues to build their franchise in Europe. Huge market, huge opportunity, tremendous fandom. It's the source of some of the best talent in the world for a couple of these leagues. Could you start a feeder league or a sister league under the brand of a North American league in Europe? Could you, could you some to expand and have franchises in Europe that are part of the league? Those are all things that they get talked about in the ecosystem regularly, but they do require capital and a partner to kind of help execute. We would love the opportunity to do that someday. There are also decisions where not every owner and every ownership group is on the same page that what's good for the league is good for them, right? You have big market, small market. These kinds of tensions, one of the opportunities for Major League Baseball, the NHL, the NBA is to re-aggregate the local TV rights under one product for all of their consumers and how to get there, when to do that, how to finance that, how to bundle the rights of the big market teams with the small market teams and the globally relevant brands with the locally relevant brands. That's not an easy algorithm to figure out and the leagues are working really hard to do it. And for some of those solutions, it will require capital. And those are other opportunities where we can collaborate with the leagues and the ownership groups. A very small way that we help the leagues and the owners is by mathematically measuring the impact of all the decisions that they're making in the narrative around their business. So if you use natural language processing models to read all of the sports business literature about baseball, for example, last year, mid-March to mid-May, the narrative around baseball was challenging, right? You got a labored spew, games were taken too long, baseball needs to be fixed. And it just, it wasn't a great narrative for the sport that is America's past. But in one year, with a couple very small rule changes to improve the pace of the game and the amount of action in the game, the narrative, mathematically, the narrative about majorly baseball for the same time period this year is totally different. Fans love the new pace of the game, the amount of action that's in the game. Attendance is up about 10 to 12%. Ratings are up 10 to 15%. Just with some small tweaks to the rules and showing that mathematically to owners and the leagues, I think this is super powerful, right? Just small tweaks around the edges to the product that you're delivering to the fan can have a massive impact on engagement, fandom, and so on wallet capture. - It's interesting as you were talking to you and I was thinking that there's been such tremendous levels of innovation and analytics and new ways to measure things in sports over the last years. But almost all of it is at the player and performance level. Not much of it, if any of it has been at the team franchise performance and lead level. And what you're doing is bringing the same level of rigor that people are using to try to figure out, how do I get somebody else to bat 400 or get there on base percentage of 50? I'm trying to get the on base percentage of a team or a lead up by using similar approaches, which I think is fascinating and very much in line with the way that analytics has kind of grown up in the whole industry, it just takes it to another level. - Well, what's interesting is taking that thread on the team building side team ops, right? It's kind of a zero sum game. You have to be good or else you're gonna finish last, right? If you're good, you set your roster and then it's really bad execution and a little bit of luck, right? But it is a zero sum game. On business ops, it's not a zero sum game. And there is actually tremendous payoff for investing in really high quality talent, really high quality tools and perspective, zero sum game on the revenue generation side. And that's something that mathematically we've been able to start to show to our partners and that's powerful. - So Ian, we've been talking a lot about franchises and leagues and new ways of thinking about getting to growth and unleashing growth potential in both. What is your vision for the growth of ARC-DOS in sports in the years ahead? - We have positioned ourselves as the partner of choice for the best entrepreneurship groups in North American sports, global sports, really. - What we need to continue to invest in and emphasize is how we add value to these franchises. For our owners that want to acquire and grow, we are their outsourced M&A team. For owners that want to just organically grow, how do we help them be at the cutting edge around ticketing, around sponsorship, around real estate, around venue optimization, around tech, innovation and adoption. And whether that's building those capabilities inside of ARC-DOS, which we're doing, partnering with category leaders, or investing in category killers, businesses that serve the leagues and the teams in some important way. If we continue to focus on those areas, that will enhance the flywheel around our applied research and data science business, ARC-DOS insights. It'll make us an increasingly more valuable partner to the ownership groups that we want to partner with. And so for ARC-DOS, continuing to invest in great human beings, great technology and value added services to serve our partners in the ownership and the leagues, that's what we've got to focus on and continue to do. That's what we've been doing for three years now. And there's no reason to let up. - On the next episode of TriPotter, World Eye Vigilians pioneering work in the secondary market. I remember it at conference probably six or seven years ago. My opening line would be, I think, secondary suck. Even though I serve my entire career and I think it's a tough business. - I'm Jim MacArthur. Thank you for listening. (upbeat music)