I am loath to close. We are not enemies, but friends. We must not be enemies. Though passion may have strained it must not break our bonds of affection. The mystic chords of memory, stretching from every battlefield and patriot grave to every living heart and hearthstone all over this broad land, will yet swell the chorus of the Union, when again touched, as surely they will be, by the better angels of our nature.
-Abraham Lincoln First Inaugural Address Monday, March 4, 1861
We seem to be at an impasse.
All the numbers seem to illustrate that the NBA is a profitable enterprise. The league is vehemently claiming otherwise.
To quote from the NBA statement:
- “Those financials demonstrate the substantial and indisputable losses the league has incurred over the past several years.
- The league lost money every year of the just expiring CBA. During these years, the league has never had positive Net Income, EBITDA or Operating Income.
- …. Forbes’s claim is inaccurate. In 2009-10, 23 teams had net income losses. The losses were in no way “small” as 11 teams lost more than $20M each on a net income basis.
- … Our net loss [ for 2009-2010] for that year, including the gains from the seven profitable teams, was -$340 million.
- “Forbes’s estimates – a $183 million profit for the NBA in 2009-10, and those issued by the league, which claim a $370M loss…”
- ¶ Forbes’s data is inaccurate. Our losses for 2009-10 were -$340 million, not -$370 million as the article states.
Given that the league would not – and cannot – legally lie on its financial books and tax returns without getting in a whole heap of trouble, they must be losing money. I guess we owe them an apology.
Not so fast.
They may be losing money on paper but they’re really and truly making a profit.
How in the world is that possible you might ask? It’s all about the tax breaks.
The tax break in question is the Roster Depreciation Allowance (RDA –see here). To put it very simply, the RDA allows you to claim the value of your franchise as a loss in your books over a period of 15 years and in essence save 35% of that amount on your tax returns (this is know as the 15/100 Rule of thumb see here for more detail). You can claim that loss in whatever schedule you like. You want to claim 90% in Year 5? Go right ahead. No loss claim in Year 11? Good for you.
I want to caveat this by saying I’m not a tax lawyer but my interpretation of the rule is that you get the right to this exemption by buying a franchise (like the Nets or Golden State) or by creating a new fiscal entity to own the franchise (like say for the Knicks or Hawks). The exemption would be at the purchase value of the franchise or the declared value. A quick and dirty example would be:
- The Golden State Warriors, purchased in 2010 for $450 million dollars, can claim a $450 million dollar exemption over the next 15 years. If we assume a 35% Tax bracket that translates to a real reduction in money owed to the IRS of $157.5 million dollars over that period. This is what we call a tax shelter.
By my count, from the publicly available data anywhere from 50% to 75% of the current value of NBA franchises ($5.5 to $8.3 Billion dollars) is available for this exemption as of now. What this means in practical terms is that if you assume the owners are using this exemption linearly anywhere from $370 million to $550 million of their paper losses are due to this exemption (and are actually gains of $130 to a $190).
Again, we don’t know the exact numbers but we know enough to simulate it by putting together all the available numbers:
Keeping in mind that in certain scenarios the owners would have an incentive to increase the amount of the exemption (like say cashing it out if you were selling the team or negotiating a new Collective bargaining agreement) and the Forbes estimate of a $183 profit for the league, I lean towards a 50% to 55% scenario with some teams up for sale boosting their claims.
Despite claims to the contrary, the NBA in its worst year and in the worst possible economic scenario generated anywhere from $150 million to $210 million in real revenue for their owners (about $5 to $7 million per team) under the current CBA.
Some interesting addendum to the idea of a players’ league from this:
- Running a professional basketball league entitles you to a $750 million dollar a year tax exemption.
- You’d be operating a monopoly protected from antitrust laws with access to public money for major capital projects.
It’s very hard not to conclude from this that the NBA is a lucrative and attractive financial venture. Further evidence of this is that the average value of an NBA franchise has increased 78% since 2000 (see page 26 of this report). Here are the teams sold under the current CBA (from here adjusted for inflation) :
- OKC 2006 $378.6 Million
- Bobcats 2009 $279.5Million
- Washington 2010 $550 Million
- Warriors 2010 $450 Million
- Nets 2010 $200 Million
- Hornets 2010 $300 Million
- Pistons 2011 $400 Million
Sales prices line up to what would be expected from the report (and the Forbes numbers) except for the Nets deal (and that deal is quirky to use a polite term).
The facts paint a clear picture: the owners are not seeking to negotiate in good faith.
I want to make a point very clear: I am not an enemy of the NBA but I am a professional basketball fan.
My take is that the current situation is not conducive to there being a 2011-12 NBA season and it is the owners and not the players who are clearly at fault. The owners locked out the players because:
- They believe they can get away with misrepresenting their financial position (i.e. no one is smart enough to figure it out).
- They overvalue their importance to the enterprise at hand.
Their goal is to use that leverage to defraud the talent and get a bigger profit. My incentives are a little different.
By doing this, I’m trying in a very small way to bring this labor impasse to a quicker resolution. I believe that is the quickest and simplest road to having the game back in my living room. Since the owners believe that they have nothing to lose and everything to gain from this situation, disabusing them of these notions publicly and clearly is the best lever at my disposal to try to move the owners to come to a deal that is amenable to both sides and guarantees the upcoming season.
The aim is to shatter the illusions and flimflam that the league is selling, and to hope that by doing that we can help them find the better angels of their nature.
Only time will tell if we made any difference.
-Arturo
P.S. For those asking for evidence:
From the Nets 2005-2006 Tax Statements.
The Smoking Gun
Wages of Wins Journal 
wiLQ
July 7, 2011
> I’m trying in a very small way to bring this labor impasse to a quicker resolution […]
> Only time will tell if we made any difference.
Even though I admire that… how will you know who made a difference? ;-)
Whenever and whatever resolution will be made I’m pretty sure owners will make it look as their decision/gesture and they won’t make a statement “yeah, those bloggers really killed us” ;-)
A.K.S.
July 7, 2011
Sorry to say it, because it seems like a lot of hard work went into it, but this entire article appears to me to be incorrect. It is based on the false premise that the financials include the roster depreciation allowance. But the evidence is that this is not the case.
First of all, the NBA says it isn’t true. From it’s statement to the Times: “We do not include purchase price amortization from when a team is sold or under any circumstances in any of our reported losses. Put simply, none of the league losses are related to team purchase or sale accounting.” The NBA gave a similar statement to Deadspin, after Deadspin’s Craggs published the article on the Nets losses. (The Deadspin article was substantially incorrect.)
Second, you rely on the Dagblog discussion of the roster depreciation allowance, but that discussion is incorrect. For example, it asserts that, of the Nets $27 million loss in 2004, $25 million resulted from the RDA. That is simply untrue, as the correction to the Deadspin article makes clear. The $25 million loss resulted from the Dikembe Mutombo buyout (among other things), not the RDA. In fact, none of the leaked financials of NBA teams show any roster depreciation allowance, as far as I’m aware. (Can you point to any of the leaked financials that actually does show use of the RDA in the manner, and to the extent, you are claiming?)
You are making the assumption that “the owners are using this exemption linearly”, so that “anywhere from $370 million to $550 million of their paper losses are due to this exemption (and are actually gains of $130 to a $190).” The assumption is not supported by any evidence, and the NBA claims it is false. I’m not sure why I should believe it to be true.
Finally, I note that the audited Net Income figures have been leaked to Forbes. (They can be found here: http://blogs.forbes.com/sportsmoney/2011/07/06/audited-numbers-show-nba-lost-over-1-5b-over-last-five-years/ .) The Forbes article notes that they are different than, and more comprehensive, than the numbers that the Times article used (which are based on other Forbes estimates).
Hope that helps your analysis. I’m interested to know if you have any evidence that the roster depreciation allowance is actually used by NBA teams to any significant extent as part of the claimed losses.
Arturo Galletti
July 7, 2011
AKS,
I’ll point you to:
http://seattletimes.nwsource.com/html/localnews/2002911235_ownertaxes05m.html
Click to access veeck.pdf
http://goingconcern.com/2011/06/who-wants-to-comb-over-the-new-jersey-nets-financial-statements/
http://forums.realgm.com/boards/viewtopic.php?f=15&p=28552631
Oh and the kicker:
http://www.scribd.com/doc/59074529/Nets-0506 scroll to page #10.
The Glove fits.
A.K.S.
July 7, 2011
Arturo,
Not sure why you say that the page of the Nets finanicials you cite is a “smoking gun”. It doesn’t have any reference at all to a roster depreciation allowance.
It does refer to normal course intangible asset amortization, of things like contracts and leases. That’s not roster depreciation (see Coulson and Fort). And the value of the franchise is not amortizable (it is subject to impairment analysis under SFAS 142).
Will VanderWyden
July 7, 2011
This is fantastic.
Arturo Galletti
July 7, 2011
AKS,
That page is the application of the RDA (which is exactly the intangible asset amortization allowed at 100% of intangible asset value over 15 years as of 2004).. The real funny bit is that you can tell they were planning to move the team (they’re cashing in the full amortization of their franchise). The new owners are guaranteed to have re-started the clock on this.
A.K.S.
July 7, 2011
Arturo,
But, as you can see, the Nets were not amortizing 100% of intangible value over 15 years. They are amortizing certain intangible assets over 2-6 years, and the “franchise” intangible asset is not amortized at all. I don’t know where you get this idea that this shows the “application of the RDA”.
Arturo Galletti
July 7, 2011
AKS,
The rule is that the team can amortize their intangible assets and that they cannot exceed 100% of the total value of the franchise over the course of 15 years. The team in this page is laying out their amortization schedule. Please note that the schedule shown works out to an amortization of about 240 million from 2005 thru 2010 (I’m assuming the remaining 120 mill exemption was intended to be used over the next nine years initially).
So that’s 240 million in paper losses that lead to a reduction in taxes owed of $240*35% = 84 million over six years or $14 million dollars per year. In real terms it means the reported earnings or losses for the nets are off by $54 million in an average year.
For one team. If it’s half that for the rest of the league, the total would be about $14mill*15teams =$210 million per year. So a $600 million dollar claimed loss for the league would be a $210 million dollar real gain. This is a difference of $810 million dollars.
A.K.S.
July 7, 2011
Yes, companies can amortize (some) intangible assets. Just like they can amortize tangible assets. Are you saying that the idea of amortization of assets, which is something that every company in the world does, is “flimflam that the league is selling”?
Note also that you are mixing up financial accounting and tax accounting. They are two different things, designed for different purposes. Financial accounting is governed by generally accepted accounting principles (GAAP), which is promulgated by the Financial Accounting Standards Board (FASB), which tax accounting is governed by the Internal Revenue Code and the regulations thereunder. You can’t simply take numbers from financial statements and try to plug them into tax accounting. Your comment, above, that the Nets financials are “Tax Statements” is simply wrong. The tax statements would be set forth on an IRS Form K-1.
In general, this entire discussion seems to be driven by people who know little, if anything, about the relevant accounting and tax rules, or even how to read financial statements. I tried to point out some errors in your analysis, but I freely admit that I’ve never read the Treasury Regulations governing any roster depreciation allowance. I doubt you have either; certainly the folks who have been driving the conversation (such as Deadspin’s Tommy Craggs) know virtually nothing (witness the correction to his article – he could tell the difference between a roster depreciation allowance and Mutombo’s buyout – which correction makes the article completely moot). Your article implies that you actually know something about the relevant tax and financial accounting rules, where in reality it is pretty clear your don’t.
Arturo Galletti
July 7, 2011
AKS,
I think the data is clear. The league claims loses on their financial statements. Those losses include line items (depreciation on intangible items) which are perfectly kosher for the IRS but questionable when dealing with the players.
The Nets franchise claimed a reduction in value of 81 million dollars in 2006 which while perfectly legal is completely ridiculous in practical terms.
A.K.S.
July 7, 2011
Except that, nowhere in your post do you explain why you think depreciation and amortization is “perfectly kosher for the IRS but questionable when dealing with the players”. These are normal non-cash items that every company has. So why is it that, for NBA teams, they are “completely ridiculous”? Seems to me perfectly obvious that the value of a player’s contract depreciates over time – after all, Deron Williams with one left on his contract is a lot less valuable to the team than Deron Williams with 5 years left on his deal. That’s no different than noting that a 5-year old car is less valuable than a 1-year old car you purchased for the same amount.
(Note again that financial statements, like those of the Nets about which we are discussing, are not documents for tax purposes. That would be the Nets’ Form K-1. Financial statements are intended to present the financial picture of the company to others, like investors or the NBPA.)
I’ll also add that, if you think that cash is the only thing that is important, we can tell the Nets cash position from the financials too. The Nets cash flows from operating activities in 2005 and 2006 (eliminating an advance from an affiliate) were negative $31 million and negative $34 million. Which isn’t exactly a great deal for the owner.
Wayne Crimi
July 7, 2011
What everyone in the media is failing to understand is that the standard for success or failure of a business is NOT profitability. The standard is Return on Invested Capital. Even if a quirk in the tax laws allow companies that are cash flow positive to show accounting losses when they are actually profitable, that still does not mean they are doing well. The standard for success is earning enough money to justify the total investment.
What that threshold Return on Capital should be is debatable. But the very fact that the NBA can get itself into a lockout position means that owning a basketball team may have larger risks than just the economy and competition from other sports and entertainment etc…
Even in this low interest rate environment I wouldn’t accept anything less than 10%. I could easily buy a portfolio of attractively priced stocks with the money, earn similar returns at current prices, and not have any of the headaches and hassles of active ownership.
So look at the total value of all the NBA franchises. multiple that by between 13%-15% to make up for the extra risk and required active management, and that’s starting point for discussion about how the owners are doing. I suspect not so well.
Wayne Crimi
July 7, 2011
By the way, AKS is correct in pointing out that tax and financial accounting is different and that the depreciation and amortization of assets are standard non cash charges against earning used by all Americans businesses to reflect the fact that some of the assets of a business that was purchased may be losing value over time (in this case aging players with large contracts).
If you don’t think these players under contract have huge value just ask the owner of Cavs what his business is worth now that Lebron is gone. Free Agency is another risk to owners that justifies a higher risk premium when you are thinking about the ROIC threshold.
Arturo Galletti
July 7, 2011
The Nets in 2006 report (page 5 of the linked report):
100 Million in income and 155 million in expenses for a net loss of 54 million.
50 million is actually general depreciation and depreciation on player salaries which is worth 50*35% = 17.5 million to the bottom line of the owners.
100 million in income + 17.5 million in tax reduction income – 105 million = 12.5 million dollar net profit
The numbers are showing that owners are doing tax tricks like this. This makes a lot of the comments about losses for the league questionable.
Michael Atkinson
July 8, 2011
If I started a new basketball league today as an llc, how would I get a $750 million tax break?
Arturo Galletti
July 8, 2011
Michael,
Let’s assume you got financial backing, a commitment from the player’s union and the cities/venues and a television deal brokered . Congratulations! You are now the proud operator of Player’s League LLC (be sure to have a partner, I would be available of course). Professional Basketball is a proven venture in the US and you would now be operating a monopoly exempt from anti-trust laws. The value of your enterprise could be worked out in comparison to the current value of the NBA.
NBA valuation can be worked as follows :
Average franchise valuation in 2011: $369 million
Number of Franchises: 30
Total Value= 369 times 30 = 11.07 Billion dollars
Once incorporated you would declare the value of your enterprise at let’s say 11.40 Billion (11.07 times 1.03 the marginal rate of inflation).
Under the 100/15 RDA you could declare that full value as a loss thru depreciation over the next 15 years.
Assume a linear schedule an it works out to 11.4 Billion divided by 15 = $760 million dollar yearly tax break.
The net tax reduction would be $266 million dollars a year.
By the way, if you wanted to cheat the system? In Year five, you could declare the balance of the exemption (8.25 Billion) and sell controlling interest to your partner who could then form Basketball Management Partners LLC with a new valuation of 13.2 billion (11.4 times 1.03 the marginal rate of inflation to the fifth power). This new company would be eligible for an $880 million dollar tax break.
Owning a sports franchise is a good business.
Nicholas Yee
July 8, 2011
This is quite the discussion going on here, but for what it’s worth (I assume basically nothing since I am very ignorant to American tax accounting) I see both points here.
1) The NBA is not doing anything out of the ordinary, in fact, it seems safe to say they are following the “industry standard” when it comes to financial reporting.
2) The “industry standard” is sort of…shady? I’m not sure the exact terminology here, but this seems like a “sometimes” rule, that apparently is an “always rule”. As I stated I realize this is the standard, but this truly does not apply to all business. It certainly seems like one of the many financial tricks that can be abused (Obviously I speak for the little guy here).
As mentioned before a contract really doesn’t decrease in value. In all reality, rookies INCREASE in value in most cases. Assuming the peak age from 24-26. Some contracts increase in value. And as mentioned before, the average age in the NBA is something I suspect to be rather static, so the old less valuable contracts are naturally filtered out each year. So while the owners are technically reporting a loss, and while this is standard operating procedure for these sort of businesses, can we say that it’s not the player salary model that is causing the teams to lose money? Because it seems to me like it’s more a matter of projecting business loss, than actual loss.
At the end of the day, I think the majority of fans that I’ve spoken to, blame the players. But again, the players are the product. And noone has forced the owners to go OVER the soft cap. It’s been the owners themselves beating each other up, but going over the soft cap. If people think that the current model allows for “player movement that is unnatural” (consider LeBron James), the hard cap will be considerably worse. Take the Oklahoma City Thunder, who it appears, probably would not be able to keep their roster intact, if there was a hard cap. Westbrook, Durant, Ibaka, and Harden’s combined salaries are definitely going to approach the hard cap number. Why should OKC be punished by forcing themselves to get rid of one of their players, in the name of the cap? To me, the soft cap is the much better system. If anything, soft cap, with a hard upper cap instead of a luxury tax makes more sense. The soft cap would limit the ability for teams to “steal” (although in all honesty, I think free agency and player movement is fantastic) other team’s players, but the hard upper cap would limit salaries absolutely.
Another issue seems to me to be the mid-range player, and guaranteed contracts. While your Gilbert Arenas’ tend to be a huge problem, I think it’s the guys in roster slots 3-7 that tend to raise up the salaries more. Because “stars” (media-based) are about 50/50 (arbitrary numbers here, I’m getting a general vibe across) on earning their contracts, some are not worth it, and some are worth more. I think a more team-friendly buy-out clause would make a lot of sense. A sort of decreasing buyout scale. If 4+ years are left, the player is owed 50%, 3 years – 35%, 2 years – 20%, 1 year – 10%. It would allow teams to get out of bad-long term contracts.
Overall my point is this, the system is not BROKEN as the owners claim. It could probably use some tweaking, but, in reality, it’s already pretty slanted in the owners favour. It should be a free market system. So, I feel nothing for the owner’s losses financially. The players are already being exploited, and this just seems to be another step in the process of making that fact worse.
Arturo Galletti
July 8, 2011
Nick,
Let me try to address these.
I have no actual problem with depreciation. In fact, I use it all the time (all new capital equipment purchases get depreciated over a period of time). What the NBA is doing is perfectly legal. They do have an extremely sweet deal in being able to claim the full value of their business as loss over 15 years.
My current employer (GE-http://en.wikipedia.org/wiki/General_Electric) has a market value of $260 Billion dollars. If we could claim full depreciation of market value over 15 years that would represent a $17 Billion dollar write off. Net Revenues for 2010 would be 12 billion dollars. With that write off, we’d owe no taxes.
The point being made is that the owners have a rather large and legal accounting artifact to hide their revenues and the financial documents show this very clearly.
As for the salaries? The Owners are locked in to paying around 57% of Revenues to the players. Gilbert Arenas bad contract does not cost the owners a dime more than they would have paid. It cost all the other players by reducing their share of a fixed salary pie. The more you give to bad players the less there is for everyone else. Where the individual owners are losing money is because of bad revenue sharing.
Nicholas Yee
July 8, 2011
@Arturo:
But the loss would only be able to be claimed if GE was sold correct?
Maybe this is just my inner revolutionary speaking here, but this “rule” is definitely not cool. Shouldn’t this REALLY be evaluated on a case-by-case basis if this is acceptable? I understand with machinery the application of this…but humans are a self replenishing resource. Honestly, society continues to evolve, I would make the argument that each NEW generation of players (employees) are more valuable than the previous generation.
My final point is this…I want NBA basketball this season, and I really hope the players don’t have to add to their own personal exploitation to do so. Honestly though, I’d rather miss an entire season than have the Owners “win” the lockout outright.