How Much is Your Team Really Worth?

April means many things to many people—mostly the start of a renewed hope as the season kicks off. For students of the business aspect of our national pastime it is also when Forbes releases its take on the economic health of the game.

The news this year is nothing short of startling. According to Forbes, in 2004 the 30 major league teams combined for an operating loss of $57 million. In 2006 they earned a collective $496 million, with only one team, ironically the Yankees, the most valuable, posting a loss. Incredible! I’d suggest incredulous as an alternative adjective—something here doesn’t quite pass the sniff test. What has changed so fundamentally about the game that has resulted in this astonishing transformation?

For the record I’ve written about these issues before here and here as part of a four-part series —parts three and four are still pending and will make an appearance presently!

Some Simple Analysis

To save you from clicking on to the Forbes website, here is the list of the 30 teams with associated value, revenue and EBIT this year and last.

                          2007, $m                        2006, $m
 Team                     Value     Revenue   EBIT        Value   Revenue EBIT
New York Yankees          1200      302       -25.2       1026    277     -50
New York Mets             736       217       24.4        604     195     -16.1
Boston Red Sox            724       234       19.5        617     206     -18.5
Los Angeles Dodgers       632       211       27.5        482     189     13.4
Chicago Cubs              592       197       22.2        448     179     7.9
St Louis Cardinals        460       184       14          429     165     7.9
San Francisco Giants      459       184       18.5        410     171     11.2
Atlanta Braves            458       183       14.8        405     172     27.6
Philadelphia Phillies     457       183       11.3        424     176     14.8
Washington Nationals      447       144       19.5        440     145     27.9
Houston Astros            442       184       18.4        416     173     30.2
Seattle Mariners          436       182       21.5        428     179     7.3
LA Angels                 431       187       11.5        368     167     -2.6
Baltimore Orioles         395       158       17.1        359     156     21
Chicago White Sox         381       173       19.5        315     157     21.7
San Diego Padres          367       160       5.2         354     158     13
Texas Rangers             365       155       11.2        353     153     24.7
Cleveland Indians         364       158       24.9        352     150     34.6
Detroit Tigers            357       170       8.7         292     146     3.5
Toronto Blue Jays         344       157       11          286     136     29.7
Arizona Diamondbacks      339       154       6.4         305     145     21.8
Colorado Rockies          317       151       23.9        298     145     16.3
Cincinnati Reds           307       146       22.4        274     137     17.9
Oakland Athletics         292       146       14.5        234     134     16
Minnesota Twins           288       131       14.8        216     114     7
Milwaukee Brewers         287       144       20.8        235     131     22.4
Kansas City Royals        282       123       8.4         239     117     20.8
Pittsburgh Pirates        274       137       25.3        250     125     21.9
Tampa Bay Devil Rays      267       134       20.2        209     116     20.3
Florida Marlins           244       122       43.3        226     119     -11.9

The dramatic change in profitability is clear. Even the Yankees halved a $50 million loss from 2006. It is helpful to look at this graphically. The bars in the graph below represent the swing in profitability between 2006 and 2007, and the y-axis is ordered by (ascending) value.

The data are skewed by the Marlins, who last year slashed payroll and stashed the loot. That aside, we see a reasonably mixed picture with some teams growing profits and others not. However, among the big boys we see more consistent profit growth. The top seven have all boosted profit; the top three dramatically so.

What does this tell us about valuations?

Those who read my earlier columns on the subject know that the value of an asset (eg, a ball club) is calculated by working out the present value of all future cash flows. In essence we can boil down value to two factors: How much money the club pockets today, and what its earning potential is in the future.

Without the benefit of detailed financial statements it is tricky to answer either of these questions. Fortunately there are a couple of tools at our disposal that will help us: namely, using revenue and profit multiples to compare team values. Because ball clubs are subject to the same economic environment and constraints we’d expect them to have similar multiples.

Go Forth and Multiply

Here are revenue multiples:

Looks interesting! All teams appear within a multiple band of 2-4x. Is this sensible? It’s difficult to say as revenue multiples aren’t a great tool to use to compare values. This is because revenue has very little relation to value. Imagine if I sold you a gazillion dollars for a gazillion dollars. My revenue would be huge but I’d make no money—my company would be worthless. Still the fact that clubs are within a similar range (if you ignore the Yankees—more on them later) is reasonably encouraging.

Back to the graph. The x-axis is ranked in order of total value. The Yankees are worth the most, and the Marlins the least. Re-examining the graph there seems to be a systematic relationship between revenue multiple and value: namely, the higher the value, the larger the revenue multiple. Why should this be so?

To answer, remember our earlier statement that value is driven by current earnings and future earning potential. The Forbes data are saying one of two things: either large clubs are run less efficiently than small ones and can increase profits more quickly, or larger clubs have a higher growth potential. No. 1 is clearly not true—why would it be? No. 2 is more intriguing but illogical. Given the closed, cozy world of baseball why would the Yankees have a higher growth potential than, say, the Tigers, Reds or Braves? I’m not sure they would. What Forbes is implying is that the gap between the haves and have-nots will continue to widen. I think this is wrong.

As noted at the top of this column, the huge swing in profit since 2004 inspired this column so now take a look at profit multiples:

The first thing that jumps out is that there is much more variance than there is for the revenue multiples. There are a couple reasons for this. First, calculating profit is much harder than working out revenue as more accounting shenanigans come into play. And second, profit has a much higher variance as evidenced by the ability of a club to magic a loss into a profit in 12 months. This happens because it is far easier to influence profit—the Marlins, who slashed payroll, are a textbook example.

History tells us that for an industry with good growth prospects (and a monopoly to boot) an EBIT multiple of around 20-30x is in the right range, and this appears to be the median for the Forbes data. However, the variation around this median is huge, and some teams, like the Yankees, can make a whopping loss year after year and still see value rise. That flies in the face of all economic logic.

One of three things is going on. Either earning potential is a much more important indicator of value than current profitability is, or Forbes has got its profit numbers screwy, or Forbes has bungled its valuation methodology.

Actually the second and third assertions are closely linked. Let’s briefly dip under the hood of Forbes’ valuation methodology. Forbes bases its value on revenue multiples adjusted for stadium deals, so profitability is less of a concern when Forbes computes a valuation—this is a flawed approach. Some examples will bring to life these flaws.

Forbes and the Yankees

Let’s look specifically at the Yankees as we know if they were put up for sale a $1.2 billion price tag wouldn’t be outrageous (based on the Red Sox sale in 2004 and the chat surrounding the price the Tribune Company may achieve for the Cubs). How is this possible if they are losing money each year?

The main reason is the TV contract. Forbes doesn’t factor this into a team’s revenue and profit calculation. Effectively the Yankees “sell” their TV rights at a huge discount to YES Network. YES is part-owned by the Yankees but it keeps money away from the beady eyes of the revenue sharing police. It also distorts Forbes’ valuation. As a case in point, the Sports Business Journal reports that YES will distribute $250 million to its partners, one of whom is the Yankees. Does this appears in Forbes’ profit or revenue estimate? No.

To compare apples with apples TV contracts for all clubs should be treated equally. The rights are owned by the Yankees and they should be valued at fair market value, not some fuzzy, obscure off-income statement discount.

Baseball clubs are entertainment vehicles. Back in the early 20th century the main revenue stream was ticket sales. Increasingly it is TV and other new media (e.g., the Internet). To maximize revenue, profit and value, teams will look to optimize their income across all media. This is likely to result in a proliferation of RSNs or some sort of IP delivered local content. Irrespective of the technology the fact that Forbes excludes these from its valuations is wrong.

The TV contract is but one issue with Forbes’ methodology. A look at the Marlins reveals another.

Forbes and the Marlins

According to Forbes in 2007 the Marlins were worth $244 million on $122 million revenue and $43 million profit. That’s a revenue multiple of two and an EBIT multiple of 5.5. That EBIT number is also the highest in the league. How can the Marlins make the most money but still be worth the least? Assuming that the Marlins continue to operate on a similar level of profitability for five years (why not?). Then at a 10% cost of money the owner would pocket $180 million! That’s almost 75% of the value of the franchise that the owner can take out in five years.

Compare that to the Red Sox. During the same period the Red Sox owners could take out $83 million, which is 11% of the franchise value. Now, while the TV contract and NESN play a role, on a comparable basis the Marlins are egregiously undervalued. Actually the Marlins could sell the contracts of some of their star players for probably in excess of $100 million. The foibles of revenue-sharing economics mean that they’ll still make a ton of money.

Miami is also a fundamentally attractive market. If the Marlins get a shiny new stadium their value should leap. Heck, if they relocate to, say, Portland or San Antonio, their value should leap (from attendance and inducements). This opportunity needs to be factored into the valuation. The Marlins have the potential to be mid-table on this list and are undervalued by Forbes. To put it into perspective the next lowest EBIT multiple (ignoring the Yankees) is 13—more than double.

To the Original Question

At the top of this column I remarked on the astonishing leap in profitability from 2004 to 2007. Although we’ve talked about some interesting issues we haven’t directly answered this question. So what has driven this remarkable change? Here are some thoughts:

• Base revenues continue to grow led by higher attendance, rising ticket prices and more lucre from TV (both local and national)
  
• Stadium redevelopment continues at a healthy pace. This also allows clubs to drive incremental revenue by attracting more fans (both for the novelty factor of a new park and because it is more fan friendly) and getting them to spend their hard earned greenbacks on concessions
  
• MLB is aggressively growing its Advanced Media division. This is directly owned by all 30 clubs so revenue will accrue to the teams
  
• Times of labor peace are generally more prosperous for baseball as the MLB and media can focus on the product rather than back-office bickering. Not only does this make fans more likely to come to the park but also keeps sponsors and TV stations happy—the relatively benign negotiations over the CBA should ensure this continues
  
• The competitiveness of teams makes for a more exciting season. The wild card has kept interest up for longer—in many seasons over half the teams have a realistic shot of a playoff berth, and also the fact that the World Series isn’t being dominated by a select few clubs means that fans genuinely believe success is attainable
  

No-one is disputing that profitability has increased. Even taking into account rising player salaries there are good reasons to believe that incomes have grown—this is a golden age for baseball. What is in dispute is whether the MLB financial situation in 2004 was as dire as Forbes makes out. Based on the easy obfuscation of profit and the fact that MLB is a cosy, successful monopoly, I’m a fully paid-up member of the skeptic clan.

Final Thoughts

Forbes should be congratulated for having the wherewithal to tackle tricky valuations and shining a light on the opacity of baseball franchise value.

I just ask two things. One that the baseball community doesn’t blithely accept the Forbes numbers at face value. We question many other analyses so why not this? And two, that Forbes becomes more open about how it arrives at valuations and what specific factors result in the difference in valuation between two teams.

References & Resources
A big thanks to Forbes for doing this exercise for the last umpteen years.