Arturo Galletti is the Co-editor and Director of Analytics for the Wages of Wins Network. He is an Electrical Engineer with General Electric in the lovely isle of Puerto Rico, where he keeps his production lines running by day and night (and weekends) and works on sport analysis with his free time.
Editor Dre’s Note: Arturo has written a great piece for you with a killer twist ending. I like to play spoiler though. So here’s flipping to the end of the post:
- Recap – The owners are likely lying on their books and actually earning a profit of hundreds of millions rather than losing millions.
- The owners Stand to make hundreds of millions of dollars even if they lose a season if they change the BRI rate (even to the players’ proposed level)
- If the owners stand firm they could gain over a billion dollars over the next six years if they win the lockout.
- And of course here’s a great Arturo graph to sum it up!
And now like an episode of Lost I’ll let you see how this surprise twist came to pass!
Follow the money. Always follow the money.
-All the President’s men
In 1998 at arguably the height of its popularity , the NBA locked out it’s players. At issue was a clause allowing NBA owners to cancel the contract with the player’s if more than 51.8 percent of “basketball-related income” (BRI) went to player salaries. The NBA, at the time, claimed 15 of the 29 teams posted losses that season. The NBPA claimed that only four of 29 lost money. The NBA went to a vote after the season and locked its players out.
Tony Kornheiser summed up public perception by describing it as a labor dispute “between tall millionaires and short millionaires.” Much like nuclear war it was a short, unsatisfying conflict which nobody won.
Fast forward to this year
On June 30, after arguably it’s most successful season since 1998, the NBA locked out it’s players. At issue was the fact that 57 percent of “basketball-related income” (BRI) went to player salaries. The NBA, at the end of the season, claimed 22 of the 30 teams posted losses . The NBPA has disputed this claim. Negotiations took place between The NBA and the players union but both sides failed to reach an agreement prior to the expiration of the CBA .
Four months later and at the risk of losing an entire season we seem to be at an impasse. The NBA and its players seem to be locked in a deadly stalemate which no one can win.
Weirdly, this all sounds eerily familiar.To quote Karl Marx: History repeats itself, first as tragedy, second as farce.
Pundits are frothing at the mouth decrying the folly of a possible lost season. How, they ask, can the NBA even consider throwing away what had all the potential of being a historic season? Why in the world would the NBA want to go through this crucible of torment again?
The answer as with most things comes down to the incentives. To put it simply, by tearing up the CBA, the NBA stands to make scads of money even if they lose the entire season.
For the NBA this is a financial no-brainer. Let’s prove that shall we?
Let’s break down the money first. The league claimed a loss of $300 million for 2010-2011. I’ve in gone over these numbers in detail before (see here, here and here if you’d like to peruse them) and what I’ve come up with looks like so:
So a claimed loss of $300 million becomes a profit of about $200 million. Now that we know the numbers for 2010-2011 we can work out the effect of the lockout on the finances of the NBA owners. Let’s start with numbers using that NBA claimed loss of $300 million:
If we use the league’s own numbers, by locking it’s player’s out and lowering the BRI by any amount the owner’s stand to make money even if they lose the entire season. If the players had accepted a 47/53 split they’d stand to make an additional $380 million a year (or about 2.2 billion for six years even if they lost the season). At a 50/50 split the numbers are $267 million per year and $1.6 billion for 6 years. Even the player’s counter offer for 53/47 has the league making a tidy profit of $153 million per year and $1 billion for 6 years (and all this is without accounting for a new, increased tv deal for the 2016-2017 season) .
What if I use my corrected numbers for the league with a $200 million profit for the NBA teams for the 2010-11 season?
Again, the league comes out ahead in all the proposed BRI split scenarios even with losing the 2011-12 season. The player’s 53/47 proposal nets them $563 million over 6 years, A 50/50 split nets them $1.1 billion over 6 years and their own 47/53 proposal has them netting $1.7 billion over 6 years.
Sadly for the fans of the game of basketball, while a bad karmic decision the lockout is an incredibly sound financial decision NBA owners.
To quote scripture: “The love of money is a root of all kinds of evil”
-Arturo
Wages of Wins Journal 
A.K.S.
October 20, 2011
I am trying to understand your charts, but I’m afraid they don’t quite make sense to me. Using your chart of the NBA’s own numbers (I’ve commented on one of your earlier posts as to my disagreements with your calculation of “your numbers”, so it doesn’t make sense to get into that again), I don’t understand how you get the “revenue increase of the next 6 years”, nor what the current TV contract has to do with anything. It looks to me like you are calculating the increased revenue for the owners as compared to the current 43% and multiplying that by 5 (for 5 years after this season), and adding it to an assumed $300 loss avoided this season. But it’s hard to tell. Even if correct, I think it is ignoring several important things. First, it ignores that the owners will likely not avoid the entire $300 million loss this season (there remain operational expenses even if the games are not played). Second, and more importantly, it ignores that revenues and expenses increase each year after the games resume. And we know neither the projected revenue increases (I’ve heard 4%, but who knows) nor the projected expenses increases. It seems to me that these are material parts of the analysis that are missing.
Arturo Galletti
October 20, 2011
AKS,
The chart with the Red heading uses the league numbers.
Revenue increase the next six years is the loss of this years income + the increased revenue from a redone CBA using 2011 dollars. I am assuming league revenue remains flat when adjusted for inflation as that’s what it’s done for the most part and that we remain under the current tv deal. I’m also assuming league expenses remain flat with inflation as well. They won’t but I covered that previously.
I’m aware The owners won’t avoid the entire loss but they’ll also recoup the lost dates and be able to write off a lot of the losses. I figure it’s a wash.
At the end of the day, the owners increase the real money available to them at minimal risk to them.
Patrick Minton (@nbageek)
October 20, 2011
I think your points are great Arturo, and I am always among the first to call out the owners on their bullshit rhetoric….but I would point out that any concessions the players make is their own fault, and therefore any gains the owners make are hardly “theft”.
As David pointed out so eloquently in his Huffington Post piece, the players have been foolish by taking their “wait and see” approach, rather than actually USING their leverage by striking in the playoffs, or signing IMMEDIATELY in Europe rather than just sitting on their butts until Fall to “re-evaluate”.
The players have really brought knives to a gun fight, even though many of them own howitzers at home. How fast would this lockout have ended if the top 20 win producers all signed European contracts within days of the lockout (which was well within their bargaining power), or if they had immediately gone out and found a couple of dozen sponsors for a new league?
As much as I despise the owners rhetoric, it’s mostly on the basis of not feeling happy about being treated like an idiot. I don’t actually blame them for ruthlessly taking advantage of the bargaining position that the players keep handing over to them.
Arturo Galletti
October 20, 2011
Patrick,
Wasn’t actually my original title. The whole point of the piece is that we can’t blame the owners for acting in their best interests.
Dre
October 20, 2011
Arturo and Patrick,
I think the title is awesome. . . I may be biased :)
emuhd
October 21, 2011
As little as I want to side with the owners, you are flatly wrong when it comes to the roster depreciation allowance. Multiple NBA teams and their accountants have plainly stated that their financials with respect to their claimed losses and these negotiations (and for all purposes besides tax) do not include either RDA or purchase price amortization. In fact, AKS was 100% correct in the prior post you linked; RDA is NOT amortizable for accounting purposes and the Nets’ footnote plainly stated that its amortization had nothing to do with the RDA franchise asset — it was for other intangible assets. Now, in the Nets’ case you could argue that they are in fact amortizing their recent purchase price allocation in excess of tangible assets (NOT the same as RDA), which is not economic, particularly with no evidence that the franchise is actually losing value. However, the NBA has explicitly said that they are NOT including even this purchase price amortization in the financials when they talk about losses in these negotiations:
“In the three years you addressed, the Nets’ cash losses were $20 million in 2004, $27 million in 2005 and $40 million in 2006. Those cash losses have continued since then.
We did not include purchase price amortization in the financial data that we gave to the players and all of the net loss numbers we have used both with the players union and disclosed publicly do not include purchase price amortization. Put simply, none of the Nets losses or the league losses previously disclosed are related to team purchase accounting.
Using the conventional and generally accepted accounting (GAAP) approach, we include in our financial reporting the depreciation of the capital expenditures made by the teams as they’re a substantial and necessary cost of doing business. And like every other business, our teams are seeking to make a profit rather than hope that there’s some future tax benefit that may or may not be realized.”
Now, I can think of many other arguments to make against the NBA in this respect. For example, interest expense is seemingly being subtracted as an expense based on the statement above. Interest expense should be irrelevant because capital structure should be irrelevant. NBA teams should not be allowed to claim to be less profitable simply by recapping (borrowing a lot of money and paying a dividend to the owners). Interest cost are an argument that NBA teams don’t earn their cost of capital, they should not speak to whether the underlying capital is profitable on an operating basis. And temporary changes in working capital should also be irrelevant (they are includws in the operating cash flow figures cited above by the NBA for the Nets but they are NOT included in the losses cited by the NBA). The nets actual operating losses in 2004 and 2005 based on their financials should probably be roughly $7 million and $15 million respectively.
Finally, there is of course the important point that yield on NBA assets is either non-pecuniary or shows up somehow on the P&L of ancillary businesses run by the owners — as evidenced by consistently rising franchise values — which does weaken the owners’ argument. But this RDA stuff is a red herring.
Arturo Galletti
October 21, 2011
And yet, the owners and teams continue to sell or spinoff teams to shell corporations once the RDA runs out.
emuhd
October 21, 2011
Yes, because the RDA is very real when it comes to the tax code. It mimics the 15-year amortization available for most indefinite-life intangibles including goodwill for other taxable asset acquisitions. Of course, amortization does decrease the buyer’s tax basis and thus increases the tax burden of selling. Still, this is almost certainly a less than a perfect offset to the net amortization benefit, both because of timing and the opportunity for clever tax planning. But the capitalized benefit to franchise value is not as simple as 1/15 * .35 * franchise value because of the reduction in tax basis from amortization. Even more difficult is how to think about this benefit relative to other businesses which generally have similar section 197 15-year amortization available upon a standard 338 sale. It would be unusual to try to adjust annual profit of a business by allocating a fraction of the estimated total capitalized of its tax treatment versus some other hypothetical tax treatment — especially when its tax treatment wasn’t obviously (in this instance) abnormal. In any case, this unusual after-tax adjustment would be entirely different (and much, much smaller) than the pretax *accounting* amortization add-back you’re improperly suggesting.
WC (@wcrimi)
October 22, 2011
The thing that persuades me that many of the anti owner forces don’t understand business is they seem to think the criteria for success or failure is “any profits” when it is actually an appropriate risk adjusted return on capital. And given the size of some of the investments it’s actually “a lot of profits”.
WC (@wcrimi)
October 23, 2011
“Finally, there is of course the important point that yield on NBA assets is either non-pecuniary or shows up somehow on the P&L of ancillary businesses run by the owners — as evidenced by consistently rising franchise values — which does weaken the owners’ argument. ”
The problem I have with this argument is that owners of all businesses try to find synergies between businesses that make the whole more profitable than the individual parts could be on their own. That doesn’t mean the theoretical stand alone businesses are making more than they are reporting. It just means that some owners are smart enough to maximize their returns on the entire investment. Ancillary businesses have their own capital invested in them and it also has to generate an adequate return.
One might say that sneaker deals, clothes lines, TV appearances etc.. are a comparable way for players to brand themselves and make money over and above their basketball salaries. For purposes of evaluating basketball income though, those millions are irrelevant. That’s just smart players finding more ways to make money on what they do.