Rich Team, Poor Team – Part I

by on January 4, 2011 · 14 comments

Scratch.  Moolah.  Dough.  Coin.  Benjamins.  Paper.  Opulence.  Rich teams has it.  Poor teams want it.  In baseball, it’s all about revenue or revenue gap to be precise.  Revenue gap often translates to talent gap, or it at least translates to differing margins of error.  There are exceptions, and it’s technically possible to field a competitive team with a relatively small payroll (A’s & Rays).  It’s also possible to field a bad team with a huge payroll (Cubs & Mets).  However, the latter two teams can afford to make a mistake on a $5M/yr contract that might sink one of the former teams.  Revenue-sharing attempts to help address this problem by compensating for local market variance, but it’s not nearly enough to adequately address all income constraints and competitive challenges.

Revenue-sharing fails, because it oversimplifies the revenue equation by limiting its scope to the local market size.  The basic premise is that huge markets like New York and Chicago have appropriately huge local market revenues, and smaller markets have proportionately smaller revenues.  To help create some semblance of balance, MLB instituted a revenue-sharing system via the CBA (Collective Bargaining Agreement).  Under the current agreement, all 30 teams pay 31% of their local revenues (ticket proceeds, local broadcast monies, vendor concessions, and parking fees) into a centralized “pot” each season, and the contents of that pot are split among the 30 teams.  While each team receives the same amount in dollars, the teams with the higher local revenues are still benefiting from the differential between 69% of a big market’s local revenue versus 69% of a small market’s local revenue.  Beyond that difference, there are some additional considerations that create disparity.

Let’s use an example that includes some income constraints and special considerations, shall we.  Consider San Diego (17th largest market at 2.485 million) and St. Louis (2.211million).  The market numbers represent the approximate number of people who live in the media markets which are regions defined by a shared set of television (media) offerings.  Regular people talk – If we have the same crappy tv channels, then we live in the same tv market.  The actual number of people living in each city depends on what source you use to obtain information and how you define the populace.  Based on “metropolitan area”, San Diego is 17th largest at 3.053 million people, and St. Louis is 18th largest with 2.829 million.  (FYI – The metro area numbers were obtained here.)

Given that San Diego is bigger by both population and media market, how do you explain the Padres starting 2010 with a payroll of $43M versus the Cardinals opening day payroll of about $93M? As you might expect, the answer is complicated, but it has to do with money. 

Jeff Moorad’s ownership group paid approximately $100M in 2009 to purchase 35% of the team, and the group announced that it would complete the purchase within 3-5years.  As part of the purchase agreement, Moorad’s group agreed to assume $200M in debt service associated with the construction of Petco Park.  $145M of that amount is secured by 8% bonds which are restricted by an agreement that prevents prepayment.  According to the annual “Business of Baseball” article section for the Padres published by Forbes (highly recommended read), the Padres’ 2009 total revenue was $157M with an operating income of $32.1M and gate receipts of $42M.  Average ticket price for 2009 at Petco Park?  $20.  Based on the 2010 paid attendance of 2.132 million, the Padres’ gate receipts may have increased only marginally year over year.  The real albatross for Moorad’s ownership group is the $145M in cash that the group must pay the Moores family in the next 3 years to finalize the purchase.  Based on some quick math, it’s fairly obvious that the new ownership group is simply using all positive cashflow to fund that final $145M cash payment. 

As for the Cardinals, Bill DeWitt Jr. purchased the team back in 1995 for what must seem like a bargain price of $150M.  The existing debt on Busch Stadium only requires about $15.9M a year to service, and the team is managing that just fine.  According to the Cardinals section of the same Forbes article, the Cardinals’ 2009 total revenue was $195M with an operating income of $12.8M and gate receipts of $94M.  Average ticket price for 2009 at Busch Stadium?  $29.  The Cardinals had a paid attendance of 3.301 million, so it’s likely that they pushed gate receipts closer to $96M for 2010.

Maybe now the fundamental reasons behind the payroll differential are clear.  Until the new ownership group finalizes the purchase, the Padres are operating at a severe disadvantage compared to much of the rest of the league (even the Cardinals).  Even after that last payment is made, the local market value will have to improve significantly to help them narrow the revenue gap with a team like the Cardinals.  The actual size of that disadvantage is difficult to measure, but I’d guesstimate it at about $40-45M/yr.  Ownership changes defnitely represent an exceptional circumstance, but that still shouldn’t result in a competitive disadvantage that lingers for 5 years or more as in the case of the Padres.  If you didn’t know already, at least maybe now you understand why the Cardinals appear to be a “rich team” next to the Padres which for the moment appear to be a relatively “poor team”. 

Check out my next post for some suggestions on how to fix the current system. 

TIDBIT:  The luxury tax and revenue-sharing are completely separate systems.  The luxury tax penalizes teams 17.5% for going over the cap the first time in a five-year period, 30% for the second time, and 40% for the third, fourth, and fifth times.  Taxes collected are split into various pots.  The first $5M is set aside for possible refunds in case a team ends the year at a lower payroll point than when they were taxed.  Once MLB determines that no refunds are to be paid, then the money is reserved for the Industry Growth Fund (IGF).  50% of the remaining money funds player benefits, 25% funds baseball programs in developing nations that lack high school equivalent programs, and 25% goes into the IGF.

Cardinals fan since I could hold a fishing pole steady. Accidental blogger. Opinionated. I could care less about what you think of me. Constantly confounded, bemused, and confuzzled (ie I'm a pc and a mac). I'm an IT infrastructure analyst with a penchant for breaking tech toys. I ate a sabermetric primer for breakfast. I love playing "All-powerful GM of MLB". The 2010 Cardinals represented a good, practical definition "cognitive dissonance". The 2011 version got by on duct tape and a prayer, and I'm fine with that. They just need new tape for #12 in 12.
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PH8 January 4, 2011

I remember reading similar things about the Cubs and the Ricketts’ family’s purchase of that franchise.

Not that they are as cash-strapped and can’t maintain a larger payroll, but that the debt service on the cash they borrowed *against* the team they were purchasing is high and effectively moves their ~$140mm -ish payroll closer to the ~$200mm mark (if you want a place to “put” that money, to calculate it that way).

Again, not saying that it necessarily straps the Cubs the way it does the Pads, but it’s certainly a consideration – with all those big contracts over there already, will be curious to see how much the Ricketts’ will spend until that is paid down.

Dennis January 4, 2011

Yeah, the situation for the Ricketts family is slightly different, though. You could argue that they simply paid a lot based on brand value, but they didn’t have debt service on a new stadium like the Moorad ownership group does. In that regard, the stars are aligned differently, and the Cubs have a lot easier time digging themselves out of a hole, even if the hole is deeper. Besides, the Cubbies can bring their payroll into reasonable shape within the next 2 years, if they want to work at it. The Padres have already done so, and they may simply have to work on a value-based approach for a few years. The A-Gon deal did return some talent, so they could be really good in 3 years, if they are patient.

PH8 January 4, 2011

Perhaps I’m being dense, but what’s the difference between debt service on a new stadium and debt service on a loan taken out against your new asset – used to purchase said asset?

They both still owe money off of their bottom lines. 🙂

Dennis January 4, 2011

I’m not saying there’s a difference based on the nature of the debt. The options for financing those debts differ greatly, and those options may have different short term versus long term impacts. The real difference is that in the case of the Padres, the Moorad group jumped into the middle of an existing stadium financing deal. The Ricketts family did not.

cariocacardinal January 4, 2011

How a group chooses to finance itself is an economic choice that is based on many factors such as other opportunities and tax considerations. Research shows though that the financing decision (debt or equity) has little effect on the value of the business. The Padres ownership group could easily add more equity to their business if they so chose to do so and pay off the debt easily without affecting operating cash flows. They have chosen not do that. Their choice. The real issue is that they dont want to invest in their business (again, their choice) but that shouldn’t leave them crying about no money due to debt payments. The same goes for the Cardinals.

Dennis January 4, 2011

I never mentioned that the Moorad ownership group was crying for anything. They actually acknowledged years ago that it could take 5+ years, before they would see a single penny of profit from the deal based on their choices. I’m just making the point that their choices had an impact on their short term ability to compete. The comparison is made, because outwardly the two teams/cities may seem quite similar to the casual observer who knows nothing about the way the Moorad group went about buying the Padres.

cariocacardinal January 4, 2011

“The basic premise is that huge markets like New York and Chicago have appropriately huge local market revenues, and smaller markets have proportionately smaller revenues. ”

I disagree with that being the premise. If it was, revenue sharing would be based on market size not revenues. It is more of a tax on success I would say. Those teams that are able to charge more for tickets, advertising, and local broadcast rights get penalized — regardless of market size. The ability to charge more for those things often has to do with team success not market size.

Dennis January 4, 2011

By the way, thanks for reading and commenting.

I thought that the premise might be challenged, and I figured at least a few people would disagree with the semantics. I started researching this topic by going back to the Blue Ribbon Panel on Baseball Economics from 2000, and then I went back before that a bit. I still think the basic premise is/was that big markets had an advantage over small markets. It wasn’t until MLB got a few years into the process that teams realized that there was a few inconsistencies in that model that couldn’t easily be rectified. Fortunately, they had already accomodated for that inherently by using a simple formula, but they never assumed that a team like the Cardinals would have higher revenues than a team like the Astros. Many people at the time thought that the sheer size of the Houston metro area would give it a distinct advantage such as the one enjoyed by Philadelphia.

The original, flawed assumption was that big markets = big revenues, even if that big market was actually shared. The city/team that caught most off-guard was actually Cleveland. From 1995-1999, the Indians actually had the 2nd highest local revenue of any team in MLB. That caught pretty much everybody by surprise, and it almost upset the applecart.

I almost agree that revenue-sharing is a tax on success, but the parking revenue part is almost completely independent of success. St. Louis has been extremely successful, but it costs almost nothing to park near Busch Stadium (by comparison with other stadiums).

cariocacardinal January 4, 2011

DeWitt et al made their parking money when they sold the garages.

Dennis January 4, 2011

I wasn’t actually referring to revenue derived from parking. I was just suggesting that there isn’t much of a correlation between team success and parking revenues. Most people who were around St. Louis when DeWitt purchased the team probably have “fond” memories of the transaction and the final “net” cost once the parking garages were factored into the final number.

For those of you who weren’t around, the team was sold at a discount, AND the new ownership group spun off the parking garages to an investment group. The final effective price paid for the Cardinals ended up being closer to $100M than the $195M typically used in articles.

Deep Throat January 4, 2011

Nice initial cut.

However, BDW-Jr doesn’t make it easy for you to complete your analysis as one needs to understand the holding company vs Cardinals baseball franchise profitability.

BDW-Jr is operating & financial head of the investing syndicate arm which means they have other holdings besides just the Cards baseball club. For example, an equity stake in Fox Sports Midwest allows BDW-Jr & his investors to reap a higher margin profit associated with the growth of paid subscriptions revenues derived from Redbird’s telecasts including outside the metro STL area.

He also charges, via his separate legal entity, the baseball franchise for certain marketing & servicing fees which combined with the TV profits add up to a very significant, high margin profit windfall that’s outside of the baseball club legal entity.

A legal shell-game to minimize he & his investment group’s risks while maximizing their return as a hedge fund against the baseball club with their primary revenue source being ticket sales.

The shell-game also insulates him from having to provide any financial transparency to the league (thus player agent comps) such that he maintains plausible deniability on profits, thus limiting his public disclosure strictly to the baseball club.

With an investment group that held a $4 billion net worth several years ago that’s most likely increased due to the positive impact of continued high occupancy rate (90%+) of Busch Stadium ticket sales driving up FSM subscription & corporate advertising income that are significantly higher margin than operations of the baseball club.

There’s plenty of excess capital to invest in the club, but it’s not a BDW-Jr mandate to do so as it directly impacts the investment syndicate’s profit taking.

Dennis January 4, 2011

Thanks for following and the feedback as well.

The issue of transparency is a big one with the Cardinals, and it’s why I think the notion of “operating income” is an absolute farce when it comes to this team.

Andrew January 4, 2011

It should be considered that the Ricketts family is on the verge — even to the extent of listening to contractor bids — of financing significant changes to Wrigley. And I believe they bought the team with these changes in the fold.

Dennis January 5, 2011

Almost missed this comment from Andrew, and it raises an interesting point that is certainly unique to the Cubs. The Ricketts family basically loaned itself about $200M for working capital and the improvements. MLB doesn’t consider this debt, because that would push them past the debt ceiling rule maximum. That “loan” and the total debt load is currently putting a limit on the team’s payroll spending. Again, it’s the fans that ultimately suffer.

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