February 16, 2017

Flu-Like Symptoms

The Profitability Canard

by Rob Mains

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Jeffrey Loria, as you may have heard, is selling the Miami Marlins. Nothing’s finalized, but it appears that one of baseball’s most, um, notable owners is going to receive $1.6 billion for a team that cost him $158 million in 2002. (I know, it didn’t really cost him that. Hang on, I’m getting there.)

This has been reported as a tenfold return on investment, but that’s not really the way to look at it. If I buy something—a portfolio of stocks, a suitcase full of rare baseball cards, a really pretty rock—for $158 million, hold it for 15 years, and sell it for $1.6 billion, my annual return is 16.7 percent[1]. Put another way, if you take $158 million and grow it 16.7 percent every year for 15 years, you’ll wind up with $1.6 billion.

So Loria earned an annual average return of 16.7 percent during his Marlins ownership. Now, about the $158 million purchase price. That’s kind of bogus. Loria, you’ll recall, was the majority owner of the Montreal Expos. The National League bought the Expos from him in 2002 for $120 million at the same time he bought the Marlins. So he really paid $38 million to buy the Marlins. And while the club bore a bit of the $600 million cost to develop Marlins Park, the team received annual revenue-sharing checks as an offset.

But let’s ignore those aspects of the deal and assume the Marlins had cost Loria $158 million at the start. Had he paid the full price for the Marlins, he probably would’ve had to borrow some money. Let’s say he paid half down and borrowed the rest at 11.05 percent[2]. That’s $79 million down and annual interest payments of $8,729,500. If you pay $79 million for something, with annual cash outlays of $8.73 million, and sell it after 15 years for $1.6 billion, your annualized return is 18.7 percent.

So Loria, had he financed the Marlins purchase with 50 percent debt (and not refinanced, even as interest rates fell), would have generated a return on his investment of 18.7 percent per year. That’s a pretty good return! The Standard & Poor’s 500 index had an annualized return of 6.65 percent from the beginning of 2002 to the end of 2016. Loria would’ve nearly tripled that.

So how does that return undermine baseball’s ownership? Well, Loria’s sale of the Expos and purchase of the Marlins wasn’t the big off-field story of 2002. Rather, it was commissioner Bud Selig’s “contraction” threat to shut down the Montreal Expos and Minnesota Twins, two perennially money-losing teams. Twins owner Cal Pohlad said, “I’ve furnished a team here for 15 years and put $150 million cash into it, and I’m not going to do it anymore.”

Let me interject at this point that there is no way of verifying Pohlad’s, or Selig’s, or anybody’s claims of losses (or, for that matter, profits). Baseball teams are not required to file audited financial statements for public review. And even if they did, the numbers they’d release may or may not tell the entire profit story. Several teams own all or part of regional sports networks, or stadiums, or parking lots, or other related companies whose results may not be included in the financials of the baseball team. Maybe for tax or other reasons they shift profits to one of these non-team entities and away from the ball club. Publications like Forbes list helpful estimates of teams’ value and income, but they’re only estimates.

Anyway, let’s say that Pohlad was telling the truth and he plowed $150 million into the Twins over 15 seasons through 2002. That’s an average of $10 million per year. Let’s further say that Loria did the same thing with the Marlins, operating the franchise at a loss of $10 million per season. (He didn’t, but follow along with me here.) Take the model I presented above—$158 million purchase price, financed half by borrowing at 11.05 percent, sold 15 years later for $1.6 billion—and layer on a loss of $10 million per year. That’d reduce Loria’s annual return from 18.7 percent all the way down to ... 15.4 percent. Still double-digits.

If the loss was $20 million per year, his return would still be outstanding, 12.6 percent. His loss would have to exceed $31.2 million per season—more than the Marlins’ player payroll in several seasons—in order to knock his return on investment below 10 percent. On the other hand, if we assume the Marlins made a modest $5 million profit per season, Loria’s 18.7 percent annual return jumps to 20.6 percent.

The point is: Loria made a ton of money on the Marlins—a 16.7 percent annual return based on the 2002 purchase price, 18.7 percent if he’d borrowed money to buy the team—even if the team earned no profit during his ownership. Every dollar of profits boosted his returns beyond that stratospheric level. Even if he lost a fair amount of money operating the Marlins (which, again, he didn’t), his annual return by the time he sold the club would still be substantial.

So when owners complain about losing money on their clubs, Loria undermines their argument. You make money owning a team, in a case like Loria’s, the same way you make money owning your house or gold bullion or 100 shares of Twitter: By plunking down your money and selling it at a future date at a nice profit. Intermediate cash flows? They’re not part of the picture.

Speaking of pictures, nobody understands this better than Loria. He’s a very wealthy man from a career as an art dealer. That’s a business in which you pay money for something, suffer modest cash losses (for storage and insurance) every year that you own it, and get made whole and then some when you eventually sell it. That Picasso you’ve got in a climate-controlled vault isn’t going to make you rich every year you own it. It’s going to make you rich when you sell it.

So while the traditional model of an asset—that it represents the discounted value of future cash flows—still applies for baseball teams, the shape of those cash flows, one could argue, has changed. Loria did exceptionally well by investing in the Marlins, but not because of the profits that he generated each season. It’s because of the $1.6 billion check he’ll cash when the deal closes.

Now, some of you are saying, “Wait. Owning a baseball team isn’t like owning a collectable. Not every owner’s looking to flip their investment after a few years.” That’s true—in some cases. The Yankees have been controlled by the Steinbrenners for decades. But they’re the exception. Here’s a list of teams by tenure of ownership:

• 30 or more years: Yankees (44), White Sox (36), Phillies (36), Twins (33)
• 25-29 years: Rockies (25), Tigers (25), Giants (25), Mariners (25)
• 20-24 years: Orioles (24), Cardinals (22), Rays (22), Diamondbacks (22), Pirates (21)
• 15-19 years: Indians (18), Royals (17), Blue Jays (17), Red Sox (15), Marlins (15), Mets (15)
• 10-14 years: Angels (14), Reds (12), A’s (12), Brewers (12), Nationals (11), Braves (10)
• Fewer than 10 years: Cubs (8), Rangers (7), Astros (6), Dodgers (5), Padres (5)

Only 16 teams, barely over half, have been owned longer than Loria’s owned the Marlins. The long-term ownership group, justifying its investment in a team by the profits it makes every year, is becoming an anachronism. For better or for worse, Jeffrey Loria, personal style issues aside, is the model for contemporary ownership. And contemporary ownership’s economic interest is less like a conventional small business, seeking to earn a profit every year, and more akin to Loria’s interest in one of his Henry Moore sculptures.

Thanks to Chad Vanacore for research assistance.

Rob Mains is an author of Baseball Prospectus. Follow @Cran_Boy
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