The hunt for yield has taken investors to increasingly risky places. In the latest gamble, some are literally going up against the toughest defenses in the National Football League.
Since going public in late April, shares of Fantex Vernon Davis have risen an impressive 18 percent, far outpacing broad stock market indexes. The shares, which trade on Fantex's own market, represent a claim on 10 percent of all future football-related earnings from the San Francisco 49ers tight end, including endorsements and potential post-career earnings from activities such as broadcasting.
The shares appear to be a success with small investors, including fans who like the idea of having a stake in Davis's success. While the current stock price values Davis's future earnings at $50 million, the shares outstanding are only worth $5 million, making it hard for institutional investors to consider buying them.
What's required for the investment to be a winner? The bull case is that Davis continues to play, paying out money he receives from endorsements and the NFL. Indeed, Fantex has already declared a dividend of $0.70 a share payable in late August—a hefty 7 percent payout for investors who bought the stock at the IPO price of $10.
Fantex CEO Buck French told CNBC that if the company's estimates are correct, it's possible IPO investors could get a complete return of capital in about five years, leaving room for upside beyond that. The reason is that the IPO valuation assumed a hefty discount rate averaging 11.4 percent across future income streams, making it possible for investors to get all of their money back even before Davis's career ends.
Still, the vast majority of the implied value in Davis's stock depends on deals that haven't been signed yet. At the time of the listing, Davis's lifetime brand income was estimated to be worth $39.3 million after applying a discount to adjust for time and risk. Some $26.8 million, or 68 percent, of that related to estimated earnings from a potential new NFL contract, endorsements, and other post-career income.
The biggest single component of those earnings, of course, hinges on Davis securing another NFL contract, which Fantex estimates to have a gross value of $33 million. And that figure probably understates the significance of a new contract, given that Davis would struggle to win new endorsements without one.
In order for Davis to earn that money, he would need to have an exceptionally long career and continue to perform at a very high level. The tight end started in the NFL in 2006 and Fantex estimates his career will last 14 years, until he is about 36 years old.
Fantex justifies its assumptions using empirical data from a set of 212 tight ends. While the average career length in that data set was just 5.5 years, Fantex filters the set further using factors that historically contributed to longer careers. Given that Davis has achieved a very high number of receptions, yards, and touchdowns, along with factors such as his participation in a Super Bowl and selection for a Pro Bowl, Fantex calculated a long career for Davis.
French recently spoke in greater detail about the structure of the investment and its assumptions on SumZero, a private network for analysts at hedge funds, mutual funds and private-equity firms.
While Davis has many strengths on his side and a relatively light history of injury in the last few years, any player is vulnerable. Two tight ends, in particular, have recently sustained injuries that look worrisome. Rob Gronkowski of the New England Patriots and former Green Bay Packers player Jerimichael Finley are both recovering and could be sidelined for several months or more.
And even if Davis's career stays on track, the structure of the stock leaves investors vulnerable to the risk that he doesn't make a payment under his contract with Fantex. The prospectus lists such a risk factor, saying that Davis "may choose to make payments to other creditors rather than us." Davis couldn't be reached for comment when his manager was contacted by CNBC.
For its part, Fantex has run credit checks on Davis and reviewed his financial position to ensure the risk of default is minimal. French also said Fantex is in the process of arranging to collect payment directly from the 49ers for Davis's regular salary, the most important source of income.
Assuming all of Fantex's estimates are precisely correct, shareholders who bought at the IPO will generate an annualized return of 11.4 percent from their investment. But as the stock price climbs and that potential return has begun to decline, it may only be die-hard Davis fans who stick their necks out.