July 31, 2012

Bizball

Inefficiency Becoming the Norm with Veteran Contract Extensions

by Maury Brown

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Money has a way of making people do funny things. A lot of it can alter your perception of what is (and is not) extravagant.  It certainly changes how you approach purchases, and in MLB, it’s no different.

The times were different and the circumstances far removed, but I can’t help but recall former commissioner Peter Ueberroth speaking to the owners on October 22, 1985. As I said, the topic was far, far different (collusion), but nothing (maybe ever) has changed about owners being hyper-competitive. As outlined in John Helyar’s seminal book, Lords of the Realm, Ueberroth was quoted as saying:

If I sat each one of you down in front of a red button and a black button and I said, “Push the red button and you’d win the World Series but lose $10 million.  Push the black button and you would have a $4 million profit and you’d finish in  the middle.” You are so damned dumb. Most of you would push the red button.  Look in the mirror and go out and spend big if you want, don’t go out there whining that someone made you do it.

The point is this: owners, when given opportunity, will spend to win… if they have the resources to do so.

And, so here we are. Just shy of 26 years after Ueberroth’s quote, the song remains the same. The difference is that under Bud Selig’s tenure controls have been put in place to curb that spending appetite. Whether it’s the Competitive Balance Tax (better known as the luxury tax), debt limits on clubs, or the new luxury tax on draft bonuses, the ability to get “spend fever” in order to win a World Series has become harder.

Don’t think that it doesn’t happen, though. Not for a minute. Not for a split-second. With media rights money from regional television deals and through MLB Advanced Media, clubs are raking greenbacks in. Even if they don’t have greenbacks, some are willing to go into debt to get there. Along the way, getting creative with how contracts are structured gets around that nasty luxury tax. In the midst of all this, some clubs find themselves inking deals that they have to know are bad due to exceptionally long length. In that, I mean, they’re inefficient.

Let’s get back to the luxury tax and how money can burn a hole in ownership’s pocket. It all ties into the free agency market and compensation. A good example was the Winter Meetings of 2010. On the Sunday before they got started, Mike Rizzo and the Washington Nationals made headlines by inking Jayson Werth to a seven-year, $126 million deal. His WARP with the Phillies the year before was 5.8, and he earned $7.5 million for the season. In the first year of his deal with Washington, his WARP was just 1.9 as he pulled in $10,571,429. He’ll make $13,571,429 this season, $16,571,429 in 2013, and $20,571,429 each year from 2014 through 2017, when he’ll be 38 years old. Washington’s Lerner family, one of the richest in all of baseball, had decided that it was time to drop the hammer and go for it all after years of pinching pennies while they waited for their young talent to mature. The problem is that as his salary increases, Werth figures to be in decline. His PECOTA-projected WARP for the 2017 season is a mere 0.4.

While the Nationals didn’t come right out and say it, if you want to win the lottery, you have to play. If the Nationals wanted to get serious about winning, they had to tangle with Werth’s agent, Scott Boras. And, if you want to tangle with Boras, you can end up overpaying.

The issue becomes the ability of agents to drive hard bargains and clubs trying to make the money work. You can’t have $126 million come out in, say, a four-year deal. Do that, and you have an average annual value (AAV) of $31.5 million. No, the only way to extract sums that large is to get into long-term contracts, and that wreaks havoc on efficiency when you’re talking about players that are hitting free agency.

When the Werth deal went down, it sent ripples through the meetings, particularly in regard to fellow free agent Carl Crawford, who signed a seven-year, $142 million deal with the Red Sox a few days later. Crawford’s agent Brian Peters got a deal structured like this: 2011 ($14 million), 2012 ($19.5 million), 2013 ($20 million), 2014 ($20.25 million), 2015 ($20.5 million), 2016 ($20.75 million), and 2017 ($21 million). The difference between Werth and Crawford is age (Crawford will be 35 at the end of his deal, as opposed to 38 for Werth), but the projected WARP is pretty much the same (Crawford’s 2017 PECOTA-projected WARP is 0.5 compared to 0.4 for Werth).

The granddaddy of all deals, however, has to be Albert Pujols’ with the Angels. Here’s the breakdown of money to projected WARP over the life of his 10-year, $240 million contract that runs from 2012 to 2021.

The Pujols deal is a perfect example of a club with extra money to burn via media rights revenue trying to meet the demands of a player and his agent while keeping under the luxury tax. Pujols will earn $29 million and $30 million from ages 40 to 41, when he will be in full decline. Jerry Dipoto isn’t an idiot. He knows full well that the Pujols contract will be an albatross around the Angels’ neck at some point. It isn’t a matter of if; it’s a matter of when. But with the AL West becoming an arms race with the Rangers (who now also have a massive television media rights deal), Arte Moreno wanted to make a statement, and he did.

What you reap now, however, is something you have to deal with later. Unloading a player in the throes of decline that is making a king’s ransom isn’t easy to do. Don’t believe me? Ask the Houston Astros and what they just did with Carlos Lee. A regular habit of clubs is eating dollars just to get these mammoth contracts off the books. Clubs who are so hot to get key veteran talent in the door now, only to be stuck with an aging, underperforming player later, will be dumping players for little or nothing in return left, right, and sideways.

While we haven’t received the details yet, Cole Hamels will surely fall into this same category. Ruben Amaro Jr. isn’t Pat Gillick. In that I mean, Gillick had a policy of not offering more than three-year deals to pitchers. Amaro Jr. doubled that with the Hamels deal, giving him a six-year, $144 million contract that starts in 2013. It currently ranks as the second-highest ever given to a pitcher behind only CC Sabathia ($161 million).

The issue with Hamels’ deal is something Gillick understood: pitchers are risky. He could easily get injured, and his performance could wane much faster. But with the Phillies reportedly already over the luxury tax threshold (though that could change depending on what happens at the trade deadline), to keep Hamels in the fold, you had to offer more years in order to garner the high dollars. The AAV would kill the Phillies in terms of the luxury tax. Here is Hamels’ deal minus the as-yet unknown salary-by-year over the life of the contract:

Compensation data via Cot’s Contracts

What this all boils down to is that the bottom line for all the clubs is growing. All 30 clubs will see a significant bump when the national television contracts get renewed, and the Dodgers are already spending money in advance of their regional deal that could be between $3.5 and $4 billion. The Phillies see their TV deal expire in 2015, which may explain how they were able to do the Hamels deal (after all, they are one of nine clubs that were reportedly out of debt compliance). When the new television deal is inked, the Phillies will be infused with new revenues.

As a result of all this, ten-year deals will increase in frequency, and not just for position players; it’s just a matter of time before pitchers get in the mix. Inefficiency is becoming the norm with veteran contract extensions. I wonder what Pat Gillick would say about that?

Maury Brown is an author of Baseball Prospectus. 
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