Wednesday, August 14, 2013

Baseball Expenses

A recent post discussed Major League Baseball revenues and near the end made the following profound point:

There's a big difference between revenue and PROFIT
There is no shortage of reporting on the revenues professional leagues generate--this is one set of revenue estimates  for each major sports league:
The $9 billion number for the NFL was much discussed during the 2011 labor issues and 2012 official strike, and I've heard numbers as high as $7.5 billion for baseball, but the exact number isn't as important as the magnitude--no matter what, it's still a substantial amount of money.

But that's revenue--how PROFITABLE are these sports, and in particular baseball? That's much more difficult to determine, since these are privately held businesses with no incentive or rationale to report their financial results. That's why what Deadspin reported three years ago was so significant because it showed detailed accounting breakdowns of team revenues and expenses. My previous post focused on revenue, and this one will investigate the expense side of the ledger.

For those with no patience for income statements, don't sweat it--one WILL be shown, but the conclusions won't depend on detailed accounting knowledge since mine fills a small sentence. Like every other statistic I use, I focus less on the numbers as much as what the numbers describe--in other words, I'm far more interested in the story of the number than the number itself.

Deadspin showed the income statements for 5 teams--this chart adapts that information:

Using the Angels as an example, they had revenues of around $241 million, expenses around $229 million for an operating income of around $12 million. Other income and expenses turned that into a net income of around $11 million, or about 4.6% of revenue. I don't pretend to understand all of the expense categories, and the very real possibility exists that different teams use different verbiage to describe the same activity--for example, some teams may lump scouting in with minor league operations, and what teams place in the general category could be extremely varied. This is merely my attempt to try to put five different income statements in one place for relatively easy comparisons.

Major League Operations is essentially payroll, which may or may not include coaching salaries as well. No matter what, the range in salaries is evident. The key is understanding that a big market team like the Angels is also a big spending team. That big revenue does NOT generate a tremendous profit--in fact, one or two free agent signees at around $5 million a year would turn those erase any profits.

I'm not naive enough to suggest that these numbers true revenue and expenses--without knowing better, I suspect these are merely numbers related to the operation of the baseball teams. For example, Wrigley Field hosts concerts, and I highly doubt that income statements from the Cubs reflect that income--it's not material to the Cubs operations. Every team in baseball has other ways to monetize their assets that may not be reflected in income statements, so to truly know how much revenue a team generates is difficult. The Forbes valuations are a good starting point but don't give the depth of data that the Deadspin income statements give. The ultimate point is that whether teams make or lose money is a difficult notion to pin down.

But one thing IS certain--even the teams with the highest revenues don't post significant operating profits. This is adapted from the Forbes data from the 2012 season:

The key column is the Op Inc, or operating income. The Yankees have an insane franchise valuation of $2.3 billion, which is broken down by the four columns in the middle:
1. Sport--the inherent value of the sport
2. Market--the value of the market, both in size and fan attitude
3. Stadium--not just the worth of the stadium but the income potential
4. Brand--a tangible measure of the intangible, how valuable the name is and a fascinating concept in multi-team markets

It's pretty clear only about 10 teams have brand value to speak of. The Payroll and Gate columns show how much teams spent and how much revenue was earned through ticket sales (and I'm pretty sure it does not include merchandise or concessions). Compare this with some historical data (all from Forbes):

The bottom line shows the difference in values from 2003 to 2012. Franchise values have increased dramatically, but like any market, a franchise is worth only what someone will pay for it. I'd be very curious what the Rays would get if put on the market, but according to Forbes even their value has increased from $152 million to $451 million--an increase of 300% for a franchise that draws 20,000 fans even when they make the playoffs.

But notice what had the slowest growth--ticket revenue and total revenue both almost doubled and yet salaries lagged behind. Part of this is the realization that 9-digit salaries for hitters over 32 is paying for past performance and not likely to bring value, and another part is a renewed emphasis on homegrown players that can deliver wins cheaply. The Cardinals, A's and Rays have had success with this route, with the Cubs, Astros and Royals in various stages of getting there. By utilizing rosters with players on first contracts or still within their first three years of arbitration, teams can keep payroll down, and more teams are going to choose that route going forward.

If we accept that gate receipts are ticket sales only, then gate receipts account for around 33% of team revenues, giving a good hint of the value of local and national TV contracts. Even with steady revenue growth, operating income stayed relatively stable, right around 5% of revenues, and I'm pretty sure that would be EBITDA, or Earnings Before Interest, Taxes, Depreciation and Amortization. The income statements shown at the beginning suggest the ITDA is about half of operating income, leaving the average team with a net income of around $6-7 million, and that looks pretty stable over time.

It's always nice to see the complete picture before making grand pronouncements regarding the future of baseball. I don't claim to be some kind of baseball savant, but until some new revenue source is found, I see no basis for statements suggesting that mountains of new money are poised to enter the game. As I finish this oddly-connected set of three posts, I see three trends, all of which I discussed (sometimes even coherently):
1. Free agency as a primary method of player acquisition will diminish, if indeed it ever existed--only about 5% of free agent contracts are for four years or longer, suggesting that free agency is used more as a band-aid than a way to make a splash. Go back and look at the list of big-ticket free agent signees and see how many really made a significant impact on their teams.
2. New TV revenue is a pipe dream. It MIGHT happen for the Cubs, but how about the White Sox? The Astros signed a big TV deal (this is a Wall Street Journal article that may be behind a pay wall) that looks like a mistake almost before the ink was dry on the contract. Maybe 10 teams can expect big local TV contracts--the rest, not so much.
3. Teams are changing the way they build their teams and pay their talent.

All  of these trends are happening concurrently, making it difficult to see the individual effects of one by itself, but it is happening. It will be discernible when free agents are signed for lower yearly amounts AND fewer years, local TV deals (except for big markets) don't yield huge bonanzas (RIP, Gary in Evanston) and teams reallocate money previously spent in free agency to international signings and farm systems. It will be as much fun to watch as to see it misinterpreted or completely ignored by the media.

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