Article written by Justin Levine (@JustinLev)

This article is a continuation of an ongoing series at my website, Fadeaway Finance.

With the NBA set to resume in less than a week, it felt it was an appropriate time to assess the impact the COVID-19 pandemic has had on the United States, the league and Houston Rockets. Much has changed since I wrote Part 2 of this series back in April for my site, Fadeaway Finance. First and foremost, the COVID-19 pandemic has unfortunately worsened. In April, estimates for total deaths in the United States were 60,000. Since then, cases have spiked in several states that saw very few cases during the two-month lockdown in March and April. Most notably, Texas, California, Arizona and Florida have seen an unfortunate rise in cases. While the rise could be contributed to increase mobility and economic activity that began in early May following the the country’s gradual re-opening, the small positive is that deaths per 100,000 in these four states are nowhere near the level reached in New York, New Jersey and Massachusetts. The United States has certainly not fared as well as other countries with regards to its management of COVID-19, but it has done a job on par with most Western European countries.

United States in red. Sources: IHME, John Hopkins University (as of July 9, 2020)

Further, the daily death rate as a whole in the United States is dramatically less than what it was back in April. Still, in light of these unfortunate recent developments, the projected total deaths in the United States has reached a sobering 208,255, as the country has already logged 134,000 deaths. Meanwhile, an early economic recovery that began in May has stalled due to rising cases predominantly in the four states mentioned above. As a result, the quick, “V-shape” recovery several economists had hoped to see in the United States does not appear to be in the cards. More likely than not, the United States and the world, for that matter, will be battling waves of COVID-19 for the foreseeable future.

It is because of this uncertain reality that, in order to remain economically viable, the NBA most likely needs to finish the 2019-2020 season in Orlando bubble, because it may very well have to play the 2020-2021 in the same bubble or very similar, fan-less conditions. Essentially, the NBA will be using the next 90 days to validate this proof of concept. While 25 out of the 351 NBA players entering the Orlando bubble have tested positive for COVID-19, the NBA budgeted over a month between testing and the resuming of the season to allow those players that tested positive to recover from the virus prior to entering the bubble. While nine players have opted out of continuing the season in the bubble, including Houston Rockets forward Thabo Sefolosha, some of the rationale was due to personal or injury-related issues rather than COVID-19. This is an encouraging sign that players want to play despite the circumstances.

As it relates to the owner of the Houston Rockets, Tilman Fertitta, I argued in previous posts on Fadeaway Finance that he has been more adversely impacted by the COVID-19 pandemic than most team owners. Mr. Fertitta’s business all require in-person consumption to generate revenue, and while restaurants in Texas are now operating at 50% capacity, this is not enough to generate any meaningful profit, as restaurants typically can only suffer a 20-30% drop in revenues before they start to be in the red. Headlines were made when Mr. Fertitta in April took out a $300 million loan with a 13% interest rate to help keep the Landry’s businesses afloat, but, in reality, this type of loan proved to be a more favorable outcome when compared to the other type of financing that was made available to restaurateurs. Specifically, most lenders have been unwilling to lend to restaurants, forcing many to raise equity, which is more expensive from a cost-of-capital perspective and dilutes existing ownership. Mr. Fertitta, never shy to extol the virtues of not having to give up ownership in his businesses, was able to raise additional money without doing so.

In May, the Houston Chronicle ran a piece that gave a snapshot into Landry’s capitalization and income, which, would only be typically accessible to Landry’s bondholders, since the company is private.

In 2019, Landry’s was sporting a 19% EBITDA (earnings before income, tax, depreciation and amortization) margin, markedly better than the 13% median in the restaurant business. Even with $5 billion in debt and $250 million in annual debt service, the company’s free cash flow was strong at $300 million. While the $300 million loan Mr. Fertitta took out to help Landry’s weather the storm during COVID-19 was at a 13% interest rate, this only results in increasing the annual interest rate on Landry’s debt from 5% to 5.5% and the annual debt service from $250 million to $289 million. With Landry’s being a a relatively strong free-cash flowing business, the company has some room to weather the precipitous decline in revenues as a result to COVID-19. Even assuming a 50% decline in revenues, a worsening EBITDA margin of 12% and complete elimination of capital expenditure programs, Landry’s free cash flow is only slightly negative. This is not to say this reality will happen, but it sheds light on how Landry’s can still break even despite COVID-19.

More positively, Landry’s has become one of the exclusive caterers in the NBA bubble:

By finding an avenue to provide meals to NBA players in the bubble, Mr. Fertitta has helped hedge his losses from his dine-in restaurants and casinos. This new revenue stream will not match the losses from those businesses, but it will certainly help. In addition, the tactic can be almost written off as a marketing expense – Landry’s concepts will be front-and-center among 500 NBA players, team staff and officials, which will prove to be a fruitful investment in improving the company’s future business opportunities and brand awareness.

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