Franchise Finances (Last revised 7 Oct Go Twins!)

Franchise finances: An introduction Why we care: –(1) To draw a conclusion about the health of the industry (MLB), we need to know about the health of individual firms (teams). –(2) Issue of whether the small-market teams can afford to field competitive teams. Low-revenue teams are at a disadvantage. If too many teams cannot compete, then demand for MLB will tend to fall.

MLB’s 2000 report concluded that... (1) 27 of the 30 MLB teams had cumulative operating losses in (2) Small- and mid-market teams can’t compete, because they can’t afford to field very good teams. Caveats: –Independent researchers did not believe (1). –That was eight years ago. MLB officials say the picture is much brighter now.

Computing team profits OPERATING PROFIT = total revenues - total costs same as “operating income” what’s usually focused on reported in Forbes (1997-), Financial World ( ) PRE-TAX PROFIT = operating profit - interest costs* - “player depreciation” ≤ operating profit declared to IRS (* interest costs could be from purchase of team, stadium debt…)

Ways to hide a team’s profits Tax loopholes (to reduce pretax profit) –Claim “depreciation” of your players as a loss (over 5 years, up to 50% of what you paid for the team; legal under U.S. tax law; a.k.a. the “Bill Veeck loophole”). –Deduct the interest paid on team-related loans. “Creative accounting (to reduce operating profit) –Related-party transactions: If you own another company that does business with the team, overcharge your team (or pay it too little) in those deals. –Featherbedding: Pay yourself (and friends and family) an excessive salary and claim it as a cost.

Breakdown of team revenues (Forbes, 1998) 40% tickets & suites 34% broadcasting 12% food, merchandise 7% ads, sponsorship 6% other

Breakdown of team costs In descending order of importance Player salaries (~50% over last 20 years) –Only 40-45% in Scouting & player development (farm teams…) Team operations (front office, manager, coaches…) Marketing, publicity, ticket operations, admin. Stadium operations (MLB revenue-sharing and general fund) –(A cost for rich teams, income for poor teams; net = 0)

What is the return on owning a baseball team? Operating profits are almost irrelevant… As with a stock, most of the return comes from the long-term increase in the value of your asset (team).

Desirable properties of investments (1) High return, including –Short-term interest, dividends, or earnings –Long-term capital gain (can resell at profit) –Favorable tax treatment (2) Low risk of loss (3) Liquidity & cash flow –Liquidity = ease of resale; convertibility into cash –Cash flow = yearly stream of earnings (profits)

Desirable properties of investments, as applied to MLB teams (1) High return – excellent –But, over , NFL franchise values grew much faster, and NBA franchise values grew a little faster. (2) Low risk of loss – excellent –Teams typically earn very high overall returns, with very few exceptions. (3) Liquidity & cash flow – poor –Not liquid: costly and time-consuming to resell a team –Cash flow is small: yearly return on assets (operating profit as % of assets) is tiny, usually positive but < 2%

Calculating a team’s (one-year) return on investment (ROI) ROI = % increase in estimated team value + (operating profit as % of team value) Note well: Because operating profit is usually a very small fraction of team value, ROI will usually be very close to the one-year percent change in team value.

To calculate ROI from the Forbes table The example below uses the data from the May 2006 Forbes ($1026 M value, a one-year change of 8%, operating income of -$50 M in 2005) to compute the ROI for the Yankees

Estimated one-year return on MLB teams (source: Forbes)

Estimated one-year returns, cont’d

Quick notes on the Forbes numbers MLB was doing great in –The recession in 2001 didn’t seem to hurt MLB at the time. The “recession hangover” (high unemployment, consumer anxiety) of did hurt MLB –Negative operating profits (still small as %) –Slight increase in revenues, team values MLB entered a boom period in 2004 – : big profits, big gains in revenues, team values –2008 (recession year): profits still high, but average team value up only 1%

A very dated question: Is the sky falling on MLB financially? Even Selig and the owners don’t think so now, but-- Until about 2004, that’s what they always said. –Selig: for 2001, a $232 M operating loss & $519 M book loss –several MLB teams were for sale in , few buyers NO, say most independent researchers What Forbes, Zimbalist, et al., said in response: –Forbes: for 2001, a $75 M operating profit –sluggish economy explains poor resale market in franchises normally sell at big profits; high rates of asset appreciation

Media ownership of teams Ownership of teams by media companies, esp. TV stations, complicates the profit picture. –Media companies often buy teams as programming content, not as separate investments; synergy strategy. –Large operating losses may be OK if media company’s own profits go up. Does this strategy work? Hard to generalize. –Past success stories include Ted Turner’s Atlanta Braves (TBS). –Yankees’ YES network, Red Sox’s NESN look successful. –Some media companies are selling, some are buying. (Fox) News Corp. sold Dodgers, Disney sold Angels, Time Warner sold Braves. Liberty Media Co. bought Braves.

How has the current recession affected MLB? Recession officially began in Dec –Many did not realize we were in a recession until late 2008 when NBER made it official. MLB ticket prices for 2008 rose 10% on average –Attendance fell just 1%. Change in demand? –Forbes: Revenues up 5%, team values up 1%, (but operating profit still relatively high) –Ticket prices flat on average (excl. NY teams) –Attendance fell 7%.  Demand fell.