The profitability of a team depends on how you look at it
When it comes to money, it's never as easy as it seems
St. Louis Cardinals’ owner and chairman Bill DeWitt Jr. was on St. Louis’ 590 The Fan this week and talked about the business side of baseball and the ongoing negotiations with the MLB Players Association as they work to find a way to get back onto the field and play the 2020 season. During the interview, he dropped a bomb that caught a lot of flak on social media from fans.
“The industry isn’t very profitable, to be honest. And I think (the players) understand that. They think owners are hiding profits. There’s been a bit of distrust there,” said DeWitt Jr.
The fan reaction is always quick when billionaire team owners play poor in the media. Most reactions pointed towards the rise in investment value that the St. Louis Cardinals’ have seen over the 25 years that the DeWitt-led ownership group has owned the 11-time World Series champions.
It’s difficult to nail down exactly how much the DeWitt group paid for the Cardinals because of varying reports. What we do know is that they purchased the team, a couple parking garages, and some real estate holdings for $150 million in 1995, and then flipped the parking garages and real estate holdings for somewhere between $50 million and $100 million the next year. Which means their net cost for the team was possibly as low as $50 million.
Currently Forbes estimates that the value of the Cardinals is $2.2 billion. Not a bad investment.
That means that the ownership group has seen an increase of somewhere around 4300% on their investment in the Cardinals. Using compound annual growth rate, that comes out to as high as a 16.3% annual return. How good is that? Well, Bernie Madoff had promised the clients of his pyramid scheme annual returns of 10%.
Additionally, the S&P 500 had a 4.6% compound annual growth rate over the last 25 years. Meaning the difference between buying the Cardinals and just putting their money in the stock market was about $1.8 billion.
But it is important to understand what DeWitt Jr. is talking about when he says baseball isn’t profitable. Just because the franchise itself has seen its values increase at an astronomical rate, doesn’t immediately translate to cash flow and money to spend. The value of the team is unrealized gain until the team is sold.
Teams do often borrow against their own valuation for purchases and expansion projects. Scott Boras pointed this out in his open letter to his clients, suggesting that the team owners’ financial issues are their own problems for borrowing money to finance stadiums, real estate developments, and even team purchases through leveraged transactions (when you borrow against the team’s future earnings to buy it). The Cardinals are one of those teams that has debt service on their stadium.
Depending on how leveraged an ownership group may be, it will cost them more to borrow and that would affect long-term cash flow, which is the most important thing when it comes to player salaries.
So, I think it is important to acknowledge that DeWitt Jr. is talking about profitability on a year-to-year operational basis rather than overall investment gains. And he’s probably not even talking about direct cash profits, but rather audited accounting statement profits, which are a different discussion entirely.
Luckily for us, we can get a glimpse inside the audited accounting statements of a Major League Baseball team since the Atlanta Braves are owned by Liberty Media, a publicly owned company. As such, Liberty Media is required to file their financial statements with the Securities and Exchange Commission. I took a look inside their most recent annual filing for some interesting insight into how they view and operate their baseball team, as well as the debt load that they are under.
On their December 31, 2019, annual filing, Liberty Media notes that the Braves generally fund their operating activities through cash flow from operations (i.e., ticket sales, merchandise, etc.) and credit. That suggests that the Braves do not generate enough cash flow from baseball to pay all their bills. They also noted that at the end of the year they owed $45 million on their operations line of credit plus an additional $514 million on the construction of the new Truist Park, the development of The Battery (their Ballpark Village-esque development), and their spring training facility.
All told, the Braves owed $560 million on a Forbes estimated value of $1.8 billion. In the filing, Liberty Media warned that their expenditures on debt have increased and may impact the organization’s creditworthiness going forward. The less creditworthy you are, the more it costs you to borrow money.
On their income statements, Liberty Media reported that the Braves received $476 million in revenue in 2019 and reported an operating loss of $39 million. Given that we’ve learned that the Braves didn’t bring in enough money from operations to fund the organization, this isn’t very surprising. However, if you dig a little deeper into the financial statements, you will find that they also report a $49 million adjusted operating income before depreciation and amortization, also called “OIBDA.”
This is where the difference between audited accounting statements and marketing your stock to shareholders in an annual report emerges, and it’s notable because an $88 million swing in profitability is a lot.
The reason is that when producing a business’ financial statements, an accountant will use the generally accepted accounting practices (GAAP), which are methods and rules accountants follow when classifying income and expenses and figuring depreciation and amortization and all that fun stuff. An audited financial statement will include all revenues, expenses, donations, long-term capital investments, asset depreciation and amortization, etc.
However, public owned companies also like to use a figure like OIBDA to make their company more attractive to investors. The argument is that if you strip away one-time or special incomes and expenses, depreciation, and amortization, you get a better picture of the financial health of the core business of the company. So, when businesses market their earnings report, they’ll use a figure like OIBDA, which is almost certainly to be higher than their audited profit or loss figure because of what it removes from the equation.
So, the Braves can hand their audited financial statements to the Players Association and say that they lost $39 million last year. And then turn around and tell investors that their core business made $49 million, so you should buy the stock.
And I feel like this is where the crux of the debate between the team owners and the players is.
The team owners provide the Players Association with audited GAAP-compliant financial statements that will reflect that lower profit number. But the players would argue that a non-GAAP compliant figure like OIBDA better reflects the profitability of the team’s baseball business without factoring in large capital investment projects like multi-use real estate developments around the ballpark that every team is trying to build these days.
Team owners can honestly say that their teams aren’t very profitable by the financial statements, but you need to realize why that is. It’s because they’re hiding baseball profits in non-baseball expenses.
The question baseball needs to answer is whether the 30 organizations that make up Major League Baseball are baseball teams or real estate developers. The team owners would argue that revenue from the real estate developments will flow back into the baseball teams once they’re built and everyone will profit from them. And the players would argue that these are baseball teams first and those are the numbers that matter when it comes to making sure players get paid. Real estate development is a secondary concern for a baseball team, so financial statements that reflect that aren’t representative of the baseball team’s financial health.
With collective bargaining talks around the corner after the 2021 season, these are the problems that the sport needs to figure out. If a team takes proceeds from their baseball team and builds a luxury apartment building next door to the stadium with a 30-foot-tall version of the Commissioner’s Trophy, is it fair to tell the players that the team isn’t very profitable?
The result is an impasse as the players and team owners struggle to figure out how to extricate themselves from this stoppage. Team owners are trying to reduce the immediate drain on their bottom like, while the players understand that they’ll be feeling this stoppage at the negotiating table for years to come. For the same reasons, both sides are trying to get as much as they can right now.
The difficulty here is that the team owners hold all the cards. They know what they make, and they know what the players make. And until the Players Association is put on equal footing, it’s going to be hard to find a deal that works best for everyone. They haven’t done that.
DeWitt Jr. wasn’t the only team owner doing sports radio hits this week. Diamondbacks’ team owner Ken Kendrick joined 98.7 FM Arizona Sports to lament that baseball is the only major sport without a revenue sharing model, which is why you don’t hear about the NHL and NBA having the same hurdles as Major League Baseball. Both leagues have an agreed upon revenue split spelled out in their collective bargaining agreements.
“What would be happening now—think about it—if this situation would have evolved and we had been in a revenue-sharing model? We would be acting as partners to get back together and get back on the field. The very lack of a revenue-sharing model puts us in an adversarial position when we really ought to be partners and advancing the game and building revenues because all would win in those circumstances,” said Kendrick.
The problem is that the team owners have never acted like they want to be partners with the players. Revenue sharing models come with salary caps and floors. While historically that has been something that the team owners have wanted, there are reports that they would reject the idea if the players offered them.
When the team owners made their first offer to the players to return to play, the Players Association asked for more financial information to help them make a better-informed decision on what the finances of the sport would look like in a shortened season. The team owners said no.
If the team owners want to be partners with the players, then they need to be partners. If you can’t come to the table as partners and willing to work together, you shouldn’t expect the other side to do it either.
And in the long run, the sport is going to be worse off for it.
