August 17, 2000

The Imbalance Sheet

Revenue Sharing

by Keith Law

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The subjects of revenue sharing and fixing the alleged performance disparity between "large-market" and "small-market" teams won't go away. This despite the stellar performance of the Chicago White Sox, Seattle Mariners and Oakland A's, teams once firmly entrenched in the "small-market" camp. Indeed, to listen to WEEI (the great sports-talk radio station in Boston), one would come to believe that Boston had suddenly dumped a half a million people into the Charles, because it, too, is now a small market in desperate need of shared revenue.

Here's a dirty little secret, wrapped up for Messrs. Steinbrenner and Angelos: revenue sharing is nothing but a euphemism for the other 28 teams coming after your money. Kind of like calling it "friendly fire" instead of "military f&^$-up".

For all the calls for revenue sharing, no one has given much thought to whether it's legal, feasible or likely to achieve the desired goals. Some in the media have thrown gasoline on the fire burning in "small-market" fan bases, and the movement continues to take on life of its own in the face of considerable logic.

First of all, is revenue sharing legal in either a judicial or an organizational sense? It sounds really wonderful to talk about Winning Big Stein's Money, but there's a significant question whether MLB can or should do so.

When investors purchase a major-league club, they do what's called due diligence. They get to see the books--the ones the teams won't open to the public, for fear we'd see the gigantic piles of smelly old money that even the Royals and Pirates have stacked up in their accounting offices--and determine how much the business is really worth.

For example, say that you were looking at buying a small manufacturing business that generated $100 million in revenues and $10 million in cash flows (those are profits, for the purposes of this discussion) every year, with no growth or decline expected. At a discount (interest) rate of 7%, that business is worth about $10MM/.07 = $143 million. So if you buy the business for $130 million, you've gotten a pretty good deal.

Now say that a year after you buy the company, the National Association of Big Honking Manufacturers comes along and says that it's going to take 1% of your revenue every year to support smaller manufacturers in related industries. That 1%, or $1 million, comes out of your revenues each year, but since your costs don't change to reflect it, it also falls straight through to your bottom line. Now the business only generates $9MM in cash flow each year, so it's only worth $9MM/.07 = $128.6MM. And your $130-million investment is suddenly a loser.

What's worse, if you try to grow the business to recoup your investment, the association will take another penny of every extra dollar of revenues you earn, thus penalizing you for your success.

Let's return to baseball. Plenty of owners have recently bought teams at substantial prices, and they'll suddenly see their teams' values drop if a revenue-sharing program goes into place. Do you think they'll take that lying down? When the government does it, it's an illegal taking of property. When baseball does it, prepare for the mother of all lawsuits.

In fact, any revenue-sharing program put into place will need to garner the support of a supermajority--probably 3/4, or 23 owners--and thus will end up taking money from no more than seven teams. That won't result in enough cash to make any sort of a difference in payroll disparities.

Next week, I'll tackle some of the reasons "large-market" teams are expected to go along willingly with this sort of larceny.

Keith Law can be reached at klaw@baseballprospectus.com.