Guest blogger Steve Walters is back. For those of you with extremely short memories, Steve teaches economics at Loyola College in Maryland but remains a fan of his hometown Red Sox, Celtics, Patriots, and Bruins.
What would you do with a half billion dollars or so? Would you put that money to work on Wall Street and try to parlay it into a full billion, and that billion into two?
Aw, hell no. The fact that you’re spending time reading a stimulating sports blog tells me you’d probably have a much better use for that kind of moolah: you’d buy a team, of course. I sure would. And once we did that, we’d very likely blow our kids’ inheritance—or a large chunk of it—trying to win a flag or trophy or a garish ring.
Of course, you might think that the sports biz, like pharmaceuticals and tort law, is typified by obscene profits. That’s a widely-held view, and Forbes magazine’s latest guesstimates of the values and revenues of the 30 big-league baseball teams seem to confirm it:
Based on these numbers, the mainstream media have run with the following story line(s):
– Big league clubs are now rolling in dough, with 29 out of 30 teams in the black and franchise values soaring;
– Some of the most sorry-ass franchises (Pirates, Rockies, D-Rays) are among the most profitable, suggesting that mediocrity pays in MLB;
– Other franchises (Marlins, we’re lookin’ at you) are, whilst rolling in said dough, nevertheless crying poverty and expecting the taxpayers to build them a spanking new ballpark.
Of course, the clubs themselves have dismissed Forbes’s figures as “pure fantasy.” But most commentators have simply dismissed their dismissals, pointing out that the owners (a) have lied to us before, (b) have a strong incentive to continue to lie about this in order to fleece the taxpayers and keep the players’ union on the defensive, and (c) might even be socking away more money than Forbes imagines, via the accounting trick of having their subsidiary regional sports networks underpay for broadcast rights in order to keep money away from the revenue-sharing system now in operation.
What’s the truth of the matter? I asked my friend Sal Galatioto, president of Galatioto Sports Partners LLC (“The Sports Bankers”) in New York. Sal has facilitated some of the biggest deals in pro sports and inspected a lot of teams’ books—the real ones. His summary: “Most teams are making a reasonable profit, but you’d never invest in a franchise because of its cash on cash return. You’d do a lot better putting your money in Treasury Bills—and have zero risk.”
Just so. What Sal is pointing to—and what the media pundits invariably overlook—is the economic concept of “opportunity cost.” Tying up your wealth in the hometown team requires you to forego you the opportunity of holding it in stocks or T-Bills, and the Forbes numbers show that’s a very costly proposition.
Take my Red Sox, a premium franchise worth $724 million. Put that amount into a diversified portfolio of stocks like the S&P 500, and you’d have earned a 15.8% return last year, or $114.4 million (see, e.g., State Farm S&P 500 Index Fund)
Instead, per Forbes, the Sox generated operating income (before interest, depreciation, and taxes) of a mere $19.5 million.
In other words, Sox owners John Henry, Tom Werner, and Larry Lucchino squandered almost $95 million of their kids’ inheritance last year for the privilege of owning a third-place team.
What about capital gains, you ask? Aren’t team values rising so fast that these clever owners will recoup their foregone gains by finding a bigger sucker down the road? Fuhgedaboudit. Washington State U. economist Rod Fort, in his well-regarded text Sports Economics, has run those numbers, and except for pro football in recent years (thank you, compliant union and hard salary cap), the total return on investment in sports teams is never close to that on common stocks.
But that really shouldn’t surprise us. Sports teams are no longer a way of making a fortune. They’re a way of enjoying a fortune. They’re a hobby, an ego trip—or, if you want to be Pollyannish, a way of “giving back to the community.” Once you buy in to this industry, you’re probably in it to win, ‘cause holding up a trophy on network TV is much more fun than smiling pleasantly at a healthy statement from your hedge fund.
And the pursuit of wins can get expensive fast. For the Sox owners, third place was, evidently, unacceptable. It led to a wild off-season spending spree that included over $100 million for a Japanese gyroballer.
Sal Galatioto sums it up best: “Things look good right now only relative to what they were, which was terrible. But let’s see if, over time, the owners can restrain themselves from giving all of their profits (and then some) back to the players. If history is any indication, they won’t be able to control themselves.”
–SW
Wages of Wins Journal 
Peter
April 28, 2007
As always, Steve nails it. And he’s one of the biggest sports fans I know. I gave up about they started playing World Series games at night, when turf replaced grass, and Roberto Clemente died.
dan
April 28, 2007
Steve,
nice job…..how about the Yanks? do you think they are wasting money this year?
Dan
Steve Walters
April 28, 2007
At least the Yanks are getting a nice return on A-Rod this year, Dan, given Tom Hicks’s contribution to his salary. But they’re quite clearly over-invested in very old and/or injury-prone pitchers.
If there’s an old pitcher worth investing in, though, it’s this guy:
http://sports.espn.go.com/mlb/news/story?id=2850886
He’s rested and ready! Kudos to Dan and the Modi’in Miracle for honoring one of baseball’s all-time great guys.
John Beamer
April 29, 2007
Steve
The numbers just don’t stack up on your argument on capital returns. If you look at the transaction value of ball clubs over the last 20 years returns exceed the stockmarket (you’re look a shade over 10% compound).
If you believe the Forbes numbers (and for the record, I think there are serious issues with the methodology — see my article at it on THT) then capital appreciatio has been about 14% compound for EACH of the last three years. And as for investing in risk-free T-bills … what are the risks of owning a major league team. Given the cosy monoply at work I’d argue not a lot.
John
Phil Birnbaum
April 29, 2007
Re: John Beamer’s comment: yes, I think the comparison isn’t quite apples-to-apples … the index fund return is the change in market value, while the team value return is EBITDA.
But I agree with your point about the total return being poor … I compared EBITDAs to EBITDAs here .
Phil Birnbaum
April 29, 2007
There was a bit of discussion on this at J.C. Bradbury’s blog … JC said here that
“If owners are maximizing something other than profits, then I guess we just have to throw our hands up in the air.”
He’s right, isn’t he? If owners are maximizing some combination of profits and consumer surplus, then why would you expect Coase/Rottenberg to hold? And you wouldn’t expect such things as salaries to equal MRP any more, would you?
Doesn’t this invalidate much of the existing research on sports economics? Or does the literature take this into account already?
John Beamer
April 29, 2007
Phil
To analyze how sports teams do vs the market is difficult because sports teams tend to be closed shops with obtuse finances and little disclosure. One has to look at sports were finances are more open — which you might imagine to be a challenge but isn’t necessarily so.
Look at football (soccer, not NFL). In the UK a ton of clubs have been listed on the stockmarket and required to abide by UK accounting regulations. I haven’t got firm data to hand, but it is something that is worth more study. However, what you’ll find is that the mega-teams like Manchester United are valued on a multiple in accordance with the discounted value of future cash flows. People recognise that a sports franchise/team has a lot of potential and with the rise of new media a lot of value can be unlocked as has been done by soccer clubs and also baseball clubs.
Take the media rights. I don’t care two hoots whether they have been hived off to an RSN, or someone else, at the end of the day they have a value. A huge value — premium entertainment costs premium $$$. These numbers SHOULD absolutely be included in the valuations of these clubs. Does Forbes do this?
Anyway, to do a fair comparision one needs to look at total economic profit for sports teams and the general economy (bear in mind that cost of captial WILL be less for sports teams) and also capital appreciation. I’m not sure you’ll conclude that sports teams are a worse asset class.
John
John Beamer
April 29, 2007
Sorry to conclude my last post Man Utd outperformed the general UK FTSE 100/250 share index ….
Phil Birnbaum
April 29, 2007
Interesting. I’ll try to find some financials on Man U., etc. It seems to me that Forbes would likely have had to make some very large mistakes, though, for the numbers to work out in terms of discounted future cash flow.
John Beamer
April 29, 2007
BTW .. you’ll also find that the lesser teams are accorded almost no value. There was a bubble a few years ago when they came to the stockmarket but it soon burst when investors realized that those assets were essentially worthless … but the mega-clubs certainly have a ton of value .. as an entertainment brand, if nothing else
Phil Birnbaum
April 29, 2007
But in North America, isn’t every team worth quite a bit of money, even the ones that perpetually suffer losses?
Steve Walters
April 29, 2007
Great discussion, guys.
On John’s initial point about capital gains: Fort’s study is based on actual (well, reported) sale prices of franchises in the various sports. No matter how good Forbes’s valuation model might be, they’re just guesstimates, and calculating rates of return on year-to-year changes in those numbers doesn’t tell you much about what people are actually willing to pay. (Unfortunately, I don’t have Fort’s numbers at hand right now; I’ll try to be more specific tomorrow.)
On Phil’s point about whether utility-maximizing behavior by owners might invalidate some or much of sports econ research, that’d depend on the research question involved and the methodology used. For example, there’s little reason to suspect that win-obsessed owners would alter their pricing behavior from the “profit-maximizing” levels prescribed by economic principles. And no one is arguing that some owners’ pursuit of wins might be “at all costs”–merely that such owners (and we might have to except Loria and a few others) may be willing to go beyond the profit maximum in pursuit of greater-than-optimium wins (for their market size). Certainly, economic tools can provide some guidance even to firms willing to do that: e.g., by comparing returns on various alternative investments (that Japanese free agent vs. additional scouting that might raise the probability of effective drafting) and getting teams to go where they get the greatest “bang for their buck.” In sum, even the win-obsessed ought not to be indifferent to precepts of economic efficiency.
That raises an alternative hypothesis to me “teams-are-an-expensive-hobby” notion: that these guys are TRYING to maximize profits, and failing miserably at it. Behavioral economists (see, e.g., Richard Thaler’s book “The Winner’s Curse”) are making some headway in analyzing this question.
John Beamer
April 29, 2007
Phil .. yes. But that is because American teams live in a cosy monopolistic world, whereas soccer teams tend not to. However, the big European teams have an effective monopoly (barriers to entry are huge) and so are a good proxy.
The key in the US is the broadcast rights — I’m not sure Forbes have got these right. Take the RedSox … I think Forbes will ascribe too much value to NASN (not included in the value #) and not enough to the Red Sox.
Steve Walters
April 30, 2007
On closer inspection, I first should apologize for appearing to put words in Rod Fort’s mouth. Rod actually says (in contradiction to my flip “fuhgedaboudit” line), in his text and in “Pay Dirt,” that sports franchises are generally pretty good investments. (My bad; my memory mixed data on changes in expansion fees with that on all franchise sale prices.) I would note, however, that in baseball the numbers are, indeed, very discouraging on this front: in every one of the last five decades, growth in the S&P Industrial Index has exceeded the compound annual growth rate of franchise values.
John may be right about the ’87-’07 period–neither Rod nor I have run numbers for that exact period (though in the ’90s, S&P growth was 40% greater than that in MLB prices). I’d just note, however, that one must be very careful about how one interprets reported sale prices in performing such a comparison. It is sometimes the case (according to Sal G., for example) that a reported “market price” will include payment for accumulated debt, thus inflating the seller’s apparent return to some degree. Everybody likes to seem like a savvy investor.
I also appreciate Phil’s links to earlier discussions on this topic. To a very great extent, I’m in accord with his 11/24/06 analysis on Sabermetric Research, and his conclusion that “teams, as a whole, will never show a profit as good as other investments with equal market value. But it is quite possible that demand for teams is increasing so fast that there’s a lot of money to be made buying a team, holding it for a few years, and flipping it to the next bored billionaire.”
I might add just one other speculation about why pecuniary returns are typically disappointing in the sports biz: game theory. In effect, the low returns might be a simple result of a prisoner’s dilemma-type game in which the group fails to maximize collective profits because everybody is either (a) going after a bigger slice of the pie by chasing (and overpaying for) free agent talent or (b) protecting against their rivals doing same. This would be fully consistent with an assumption of profit-maximizing behavior, but disappointing results.
John Beamer
April 30, 2007
Steve,
Great to hear your comments — and to see you posting at this site. One interesting sports trend in Americans buying into UK football (soccer). This can’t be an emotional buy (at least I don’t think so). They must think that the assets are undervalued. I know I harp on about the same old example (Man Utd) but that is one of the few sports teams that used to be run as a business and was taken private by the Glazers for a juicy premium. Why would they buy unless they could see long term value?
Guy
April 30, 2007
Steve: Is growth in the S&P vs. franchise appreciation an apples-to-apples comparison? The team owners are also pocketing annual profits, so that needs to be accounted for as well. Of course, stockholders get dividends, but I assume that’s a considerably smaller %. Could you clarify?
Matt Festa
April 30, 2007
Dr. Walters,
I would venture a speculation here that sports franchises might actually be less profitable than they were in the past. Or, at the very least, no more profitable. I have no idea if this is true, but in the past baseball owners had a weapon they do not have today: The reserve clause.
If a Team like Kansas City drafted the next Barry bonds, they could sell him for millions of dollars to The Yankees (think the Babe Ruth sale adjusted for inflation). Now they would either just lose him to free agency or sell him for the next crop of prospects (and much less in cash value).
Further, during the 1980’s the owners successfully colluded to keep player’s salaries down, which I bet would increase their profits.
You have neither of those two forces acting in the owners interests today, but you do have free agency and a desire among the top teams (Red Sox, Yankees) to spend themselves silly in order to get the eg0-boost from a 3 game sweep.
Further, when we are talking about the universe of billionaire owners, the bar that the ownership of a team has to meet in order to generate returns is higher than the S and P 500. That is because the owners can invest in hedge funds, which are lightly regulated and generate returns in excess of the S and P 500. So if the team can’t even match the return on a t-bill, it certainly can’t match the return potential of a hedge fund.
Steve Walters
April 30, 2007
WoW, good points/questions…
John: Regarding “Man Utd…was taken private by the Glazers for a juicy premium. Why would they buy unless they could see long term value?” They might, indeed, see good financial value as well as wins/utility in Man Utd’s future. If I was going to buy a team, I’d look for “value”–a poorly-run or under-marketed franchise on which I might be able to realize both fun AND profit. I certainly can’t rule out that SOME franchises get that for ya–but the data for MLB, especially, aren’t too encouraging (thanks, in part, to the absence of a hard salary cap that the other leagues have won at some considerable cost).
Guy: As to whether this is “an apples-to-apples comparison,” probably not. Some teams make profits, some pile up debt (or dun their owners for regular “cash calls”), some reported sale prices are fictional or involve non-team assets. I don’t know that any outsider has done the green eyeshade work that would be necessary to REALLY compare apple to apples here. That’s why I quoted Sal G.: he’s been laboring in this vineyard quite a while, and he’s under no illusions about the financial returns in the sports biz. And he warns his clients that if maximum (risk-adjusted) wealth is their prime concern, it’s more likely to be found elsewhere.
Matt: You’re undoubtedly right that MLB owners had it all their way, payroll-wise, until the dark day (for them, at least) in ’76 when arbitrator Peter Seitz freed the serfs. OTOH, we fans cared a lot less back then, and so delivered a lot less revenue to the clubs. How returns have changed over time is, therefore, a question that we can’t answer without access to IRS documents over the decades…
Another interesting question is WHY a surge in fan interest happens to coincide with the free agency era. David Pinto, one of the Baseball Prospectus’s stable of excellent writers, has recently argued that free agency has introduced a “dynamism” element that was previously missing:
http://www.baseballprospectus.com/article.php?articleid=6087
It’s an interesting theory. It may also be, simply, that our incomes are soaring and we, therefore, demand lots more “luxury goods.”
John Beamer
April 30, 2007
If I was going to buy a team, I’d look for “value”–a poorly-run or under-marketed franchise on which I might be able to realize both fun AND profit. I certainly can’t rule out that SOME franchises get that for ya–but the data for MLB, especially, aren’t too encouraging (thanks, in part, to the absence of a hard salary cap that the other leagues have won at some considerable cost)
********
Steve — completely agree with this thought. One thing is for certain though — Man U is not a badly run team … I’d argue it is probably the best run sports team in the world (I’m not saying that you implied otherwise)
In terms of good value teams I think the Marlins are undervalued. If you look at Forbes data they are on a P/E of 6 — the next highest is 13. I understand the salary situation being a major contributor but that allows you to pay yourself some almighty dividends. Also, there has to be considerable upside if the Marlins get a new stadium, or indeed relocate …. Has Forbes accounted for that.
FYI — I’ll have a piece up on this at THT either this coming Monday or the Monday after
Matt Festa
April 30, 2007
Hi Dr. Walters,
I agree that the revenue generated by sports today is probably much greater than it was in the past. To give one example, having the games on local television allows the teams to extract more revenue from the fans. Back in the 1950’s there was probably less revenue extraction possible. Alternatively, the superstar economics (sports is luxary good) probably increases revenue capabilities as well.
But my speculation was the following. Say the owner of the Yankees was able to extract $1mn in today’s dollars from Babe Ruth. Today the owner would be able to extract $25-30mn. However, absent the very few players (Babe Ruth) that could leverage their amazing talent by simply refusing to play (like Marilyn Monroe’s husband ;), the owners got to keep most of this revenue.
My speculative thought here is that the player is now able to get back all of the additional marginal revenue he generates now (say A-Rod generates 30mn in marginal revenue, his salary would reflect that). If we were back in the dark days, maybe A-Rod could get $10mn.
In other words, the gains in sports revenue over the past 20 or so years has gone the players rather than the owners. I think this passes the initial test, but it may not pass the empirical test. And you have given ample reason to suggest the empirical test would be quite hard to come by, thanks to the accountants and IRS.
tangotiger
May 3, 2007
I’m late to the party, but I’ll add my two cents anyway.
Since the days of collusion, franchise valuations have risen at around 10% per year. As has revenue. As has salary.
The S&P has risen 7-fold over the last 20 years (which includes dividends reinvested). Wanna guess the compounded rate of return? That’s right, 10%.
The Forbes estimates for valuations are just that, estimates. But that’s the same like a house down the street. You don’t know exactly how much it’s worth, but you do your comparative market analysis, and you know how much it’s worth. Once a team is sold in some sport, you use that as an important indicator to determine the value of all the teams. Forbes constantly recalculates its valuation based on known sale prices, and they estimate complex transactions (like the Redsox), etc.
The present value of future earnings is likely close to zero, meaning it’s hard to believe that they capital appreciation is what it is. Since sports franchises have limited recurring operating income, owning a sports franchise is like owning a Picasso.
Arizona Home Owner Insurance
June 26, 2007
I would buy the Kansas City Royals with a billion dollars and rebuild the farm system and a once proud franchise. People don’t realize how midwest fans love their baseball.
Oliver Anderson
September 20, 2007
Hi guys,
just a note to let you know there are a few of us trying to apply sabermetric principles to soccer in the uk.
Just thought you might like to take a look.
http://www.thefootballreview.co.uk