Show Me the Wins

Posted on April 28, 2007 by

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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

Posted in: Sports Econ