Investing in a Sports Team - Looking at Ownership Actions from Their Perspective

Owners in professional sports are easy targets, particularly in the populist environment post-Occupy Wall Street.  They are already richer than many of us can imagine, yet they constantly insist upon separating fans from their last dollar through exorbitant parking rates, expensive beer, and Personal Seat Licenses.  As fans, we want our owners to be empty suits who sign paychecks and bring in championships, yet we rarely, if ever, look at things from their point of view.  With that in mind, I’d like to take an opportunity to walk a mile in the expensive wingtips of a professional sports team’s owner.

[caption id="attachment_68" align="alignright" width="334" caption="Dallas Maverick's owner Mark Cuban"][/caption]

In terms of my credibility here, I work at a private equity fund where I am responsible for investing large pools of capital from wealthy individuals and institutions (e.g. an endowment for a university or a public employee retirement fund).  As such, I look at investments in the same way that a discerning owner would and, having worked with wealthy individuals, am generally versed in their approach.

I’m not here to defend all ownership actions – there are quite a few owners who have blatantly betrayed the trust of their fans with actions that make Gordon Gekko seem altruistic.  Furthermore, while many investment decisions for a Private Equity fund like mine are generally rational, many ownership decision are inherently irrational starting with the reason to purchase a team – some are ardent fans who want to be closer to the team (think Mark Cuban), while others want the caché of owning a professional team.  For these owners, there are many intangible benefits that I cannot judge with pure returns analysis.

Arguably the most significant tool used for investment analysis is Internal Rate of Return (IRR).  For a more detailed explanation of the concept, please see the note at the end of this article.  To keep things short, just know that IRR measures the success of an investment, a higher IRR is better, and, in the long-run, the stock market in general generates about an 8-to-10 percent IRR.  Now, let’s look at a few owners that have made some noise in the past year to see if they’re being rational, irrational, or just plain greedy.

Mike Ilitch

The owner of the Detroit Red Wings suffered the ire of Grantland’s Charles Pierce during the recent NHL lockout for his new proposed $650 million stadium deal.  Pierce refers to the deal as a “naked swindle” that will be financed by public money.  This is probably a reaction to Jeffrey Loria’s stadium deal in Miami (we’ll get to him), but the attack is unwarranted.  In the article about the deal that Pierce linked to, the price tag covers not just the stadium but an entire entertainment district centered around a multipurpose arena.  Furthermore, ignoring the general economic benefits that come from rehabilitating urban areas through new stadium projects, tax dollars wouldn’t fund the whole project – the article states there would be significant private investment.  While it’s still the early stages and the financing has not been finalized (all the more reason NOT to deride an owner), Ilitch’s history here would indicate that he would probably fund a good portion of the balance, since he paid 60 percent of the cost of the Tigers’ Comerica Park.

Pierce mentions in passing that Ilitch originally bought the team for $8 million in 1982 and that it is estimated to be worth $346 million now, hinting that this gain should be part of the discussion.  While this is an impressive dollar gain, if we look at this through an IRR perspective (ignoring any dividends he may have taken out) it comes out to 12.9 percent.

That is a pretty solid return over 30 years, but let’s looks at his alternatives.  A general representation of the market, the S&P 500, grew at an 8.2 percent rate over the past 30 years.  So Ilitch beat the market as a whole pretty comfortably.  However, Ilitch made his money founding Little Caesar’s Pizza Treat, which was growing pretty well at the time he bought the Red Wings. So what if, instead of buying the Red Wings, Ilitch had invested the money in his pizza empire?  Since his restaurants are private, we don’t have financial information, but we can look at a competitor – Pizza Hut.  Pizza Hut was originally owned by Pepsi, so let’s look at how Ilitch would have done if he had invested his $8 million in Pepsi instead of the Red Wings.  Pepsi’s stock closed at $2.03 on January 4, 1982, and it was worth $68.43 at close as of December 31, 2012, good for a 12.0 percent IRR (again ignoring dividends).  This is pretty close to the type of returns Ilitch got on the Red Wings, so maybe he didn’t get such a sweet deal there.

Now this is a rough approximation, but it does show that the growth in value of the Red Wings over Mike Ilitch’s hold period is by no means an outlier, or even particularly noteworthy compared to similar investments.  Ilitch’s financial success with the Red Wings should not earn him any more scorn than the local Detroit firemen’s pension fund that invests in the stock market.

[caption id="attachment_56" align="alignright" width="390" caption="Joe Louis Arena, home of the Detroit Red Wings"][/caption]

This also ignores the success the Red Wings have enjoyed under Mike Ilitch.  Part of the reason Ilitch was able to buy the team for $8 million was the fact that it was underperforming to the point of being referred to as the “Dead Wings” – they were coming off a ninth straight losing season and had not been to the playoffs since 1978.  Under Ilitch’s term, the franchise has won four Stanley Cups and has been to the playoffs in 26 of the 30 seasons, including an active 22 year streak.  This is the kind of success that fans want and should support.

As a final aside, Ilitch’s recent history with the Tigers should also acquit him of negative press.  After his significant personal funding of Comerica Park, the Tigers have rebounded as a franchise and have been to the World Series twice since 2006.  In the 2012 off-season, Ilitch greenlit a monster deal to bring in Prince Fielder.  As the link notes, Ilitch has a record of spending money to help get his teams to the title, and it paid off as the Tigers went to the World Series in 2012.

Ilitch’s history makes him pretty clearly an ideal owner for a fan – willing to spend money and stay out of the way of the smart guys he brings in to run the team while not making many headlines for himself.  It’s a shame that he was wrongfully tarred during the NHL lockout.

Verdict: Rational

Guggenheim Partners

For those of you scratching your head, Guggenheim Partners is the money behind the ownership group that bought the Dodgers.  Most people think of Magic Johnson, the front-man, but Guggenheim has the money (and the power).

Of course, the amount of money they have dedicated to the Dodgers is often a source of confusion for many baseball writers.  Even the normally brilliant Jonah Keri makes it seem like the Dodgers have billions at their disposal (his first sentence in point 13 on Brandon League indicates that the Dodgers have $160 billion). While it is true that Guggenheim has $160 billion, that is the amount of the whole trust, which is split between investments in stock, bonds, real estate, etc.  Even if they had financed the entirety of the $2 billion Dodger purchase, it would only represent 1.25 percent of their fund.

Guggenheim’s $160 billion is not available to the Dodgers.  Most likely, after their initial investment to purchase the company, Guggenheim may have some “dry powder” allocated to the Dodgers for additional investment (e.g. they probably funded some of the $100 million renovation of Dodger Stadium), but the skyrocketing payroll is not being actively funded by Guggenheim.

So where’s the money coming from?  Some of it is coming from ticket sales – attendance in 2012 rose to 3.3 million from 2.9 million in 2011 – but that is a relatively minor portion.  A more significant chunk of that comes from the team’s new television deal - $7 billion over 25 years.  While it likely steps up over the course of the deal and the portion the Dodgers keep is up to some debate, it’s likely around $150 million annually at the beginning, a $110 million increase over the prior deal with Fox.

The new owners have been investing virtually all of their new revenue streams into the team itself, with payroll ballooning by roughly $100 million.  From an investment standpoint, this seems a bit ludicrous – with a $2 billion investment at a high multiple, Guggenheim will have to pull out significant dividends and have a rich exit to achieve any meaningful return.  It’s hard to pull out dividends when you’re spending all of your money on contracts to the point of running out of positions to put expensive players.  This is probably an initial splurge to jolt fan interest and buy some goodwill, but it certainly seems irrational from an ownership perspective, even if it is still too early to tell.  Of course, that’s a huge improvement for fans over the previous owner.

Verdict: Irrational

Frank McCourt

Calling Frank McCourt greedy and a terrible owner is like calling water wet – it’s just a fact of life.  Giants fans were actually sad to see him go.  However, just how successfully greedy was he?

[caption id="attachment_57" align="alignright" width="275" caption="Ex-Dodgers owner Frank McCourt"][/caption]

It is nearly impossible to chronicle the various transgressions of the McCourts (though some websites have done a fantastic job of listing many) and quantifying the dollars that Frank and ex-wife Jamie took out of the Dodgers through personal trips, excessive compensation, and other perks is nearly impossible.  However, we can use some publicly available information to get to an IRR that conservatively estimates how well Frank McCourt did (ItsAboutTheMoney has an exhaustive documentation).

McCourt bought the team for $430 million at the end of January 2004, and initially had $421 million of debt, with $9 million of equity (he eventually shuffled debt and parking lots around, but we’ll use the $9 million for the initial investment).  Over the course of their ownership, Frank says they took out $109 million while Jamie says they took out $141 million.  Frank has an incentive to understate, while Jamie has an incentive to overstate, so we’ll take the median (again, this does not account for the other benefits that they received) of $125 million, and say that they got it all at the end of December 2011 to be conservative.

How much did Frank get when he sold the team?  He had to buy out Jamie for $130 million, and he had to pay off the debt on the team ($525 million at the end of 2010 according to Bloomberg).  Assuming additional debt accrued until the end of March 2012 when the team was sold, let’s put the total obligations out the door at $900 million.  That means that Frank McCourt walked away from the $2.15 billion sale of the Dodgers with about $1.25 billion.

Factoring in 40 percent for taxes on the sale, we still get a whopping 75.6 percent IRR for Frank McCourt.  That’s insane.  If you had invested $1,000 at that rate, in 10 years, you’d have over $280,000.  Simply unbelievable.  And the team was suffering greatly, particularly at the end.

Verdict: Greedy

Of course, McCourt looks like a saint compared to the next guy, right?

Jeffrey Loria

Depending upon your view of him, Loria is either cheap, greedy and traitorous or a genius akin to a Bond villain.  His performance as an owner has led to problems for the local football team’s renovation of its stadium.  Fans are staying away in droves to the point that the local scalper community is suffering horribly.  Despite winning a World Series in 2003, Loria’s tenure is looked at as a complete failure by fans and they cannot wait for him to leave.  In most businesses, alienating your customers and angering your employees is a recipe for disaster, but Loria has been fantastically successful from a financial standpoint.

Loria first appeared in the MLB ownership ranks in 1999, when he bought a minority position in the Expos for $12 million.  Through additional investments totaling $18 million, he ended up with 94 percent ownership of the club by the time it was being threatened with contraction in 2002.  During that offseason, Loria was able to sell the Expos to Major League Baseball for $120 million (with roughly $113 million going to Loria), then buy the Marlins for $158.5 million, with the league loaning him $38.5 million interest-free.  The net result for Loria is about $7 million of additional investment to swap the Expos for the Marlins.  The trade worked out pretty well since the Marlins won the World Series the next year.

Unfortunately, this did not usher in an era of winning and high payrolls.  Loria complained about the quality of his stadium and said he was losing tens of millions of dollars.  As a result, he had a fire sale in 2008 and dropped his payroll significantly, much to the dismay of fans.  While Loria still complained about losing money, Business Week notes that the team made $29 million in 2008 and the Miami Sun-Sentinel reports that he made $48.9 million combined in 2008 and 2009.  While attendance was low and the local television deal was one of the worst in the league, garnering only $16-to-$18 million per year, the team was taking in $70-to-$80 million per year in shared revenue and can expect a $25 million per year bump coming in 2014.  Because of these shared revenue streams, Loria can make significant profit by running a low payroll.  This arrangement worked for Loria until the local government called his bluff and backed up the Brinks truck to build a new stadium.

[caption id="attachment_58" align="alignright" width="350" caption="A very empty Marlin's Park in Miami"][/caption]

Marlins Park cost $634 million to build and the government covered most of the costs, leaving Loria on the hook for $125 million, about 20 percent of the total cost.  To finance this, the government issued bonds that will require a total payout of $2.4 billion over the next 40 years.  In response, Loria opened up the bank account and rolled out a roster with over $100 million in payroll (though the team ultimate only paid $89 million according to baseball-reference)  for a single year, then had another fire sale and reduced payroll to $49.3 million, a figure that includes $12.5 million for players no longer with the team.  Amidst the ensuing fan revolt centered around breaking the covenant of a publicly-financed stadium, we have to wonder – how well did Jeffrey Loria’s investment pay off?

If we look at the cash flows we know about – the operating cash flows are tough to gauge since this is not a public company – Loria made out pretty well.  His $37.2 million investment spread out between 1999 and 2002 has turned into a team that is worth $520 million with 29 percent debt, putting his equity stake around $369 million.  In the meantime, we know that he made $48.9 million in 2008 – 2009 and invested $125 million in the new stadium that opened in 2012.  While he often claims to be losing money, reports and back-of-the-envelope calculations make that assertion suspect.  To be conservative, we’ll assume any operating gains were cancelled out by losses in other years.

Based upon the assumptions above, Jeffrey Loria has managed a pretty solid 18.0 percent IRR on his investment; particularly robust considering that the S&P 500 has managed only a 1.1 percent annual growth rate over the same time frame.  While this may not be as dramatic a return as McCourt, Loria has done this over a longer period of time and looks primed to significantly increase his return in the near future considering the new stadium, cheap lineup, and upcoming increase in shared revenue.  Regardless of his position relative to McCourt, Loria’s actions have shown little regard to the product on the field or the team’s reputation in the community.  For his continued tear-downs of teams to cut payroll and his violation of the unwritten covenant that comes with public money for a new stadium, it’s hard to come up with any other ruling for Jeffrey Loria.

Verdict: Greedy

Across this look at some of the more notable owners in the recent sports landscape, I hope to have shed some light on the thought process of owners.  While some actions, like Mike Ilitch’s Detroit stadium proposal, may seem aggressive, if you dig in behind them and look at the big picture, the owner does not look as bad.  It is important to remember that even some of the more avaricious owners profiled here are just a small portion of the pool – most owners try to field a good team while also making money and do a good job of it.  I doubt the good people of Miami would agree with me, though.  Hopefully they can repeat the Dodgers’ luck with their next ownership group and bring in owners who care about the community as much as their bottom line.

IRR Explanation

This calculation essentially determines the annual growth of an investment.  To illustrate, if you invested $100 today in an investment that earned a 10 percent IRR, in one year, your investment would be worth $110.  [Note: I understand that this and several other explanations are overly simplified and do not encompass the entirety of the concept or investing.]

IRR is primarily influenced by two factors: 1) the amount of cash you receive and 2) the time period for receiving that cash.  The amount of cash you receive is obvious – if you invest $100 and get $120 back in one year as opposed to the $110 we mentioned earlier, that’s preferable and the IRR would be 20 percent - double the previous IRR, showing it as a better investment.

In terms of the time aspect, think of Wimpy in Popeye.   He always wanted to pay you back on Tuesday for a hamburger today.  If it was Monday and Wimpy was just asking to borrow $5 for a day, most people would be OK with that.  If it was Wednesday and that meant you were going to be without the $5 for a week, you might be less OK with that.  Now imagine that Wimpy was actually asking to borrow $5 today and he wouldn’t pay you back for a year – you would be pretty unhappy about that situation.

This is because a dollar is actually more valuable today than a year from now and much more valuable than a dollar two years from now.  Think about what could happen in two years – in an extreme scenario, what if the United States dissolved into warring republics that no longer gave credit to the dollar as a currency?  All of the sudden that $5 that you gave Wimpy, which had value (he exchanged it for a burger), is completely useless when he pays you back.

IRR captures the time nature of an investment.  If you were investing $100 and you were going to get $110 back in one year, you would have a 10 percent IRR.  If you didn’t get your $110 back until two years later, your IRR would actually be 4.9 percent.

Now what if we’re looking at two investments that have different cash values and time horizons?

-       Investment A will cost you $100 now, but you will receive $110 in one year.

-       Investment B will cost you $100 now, but you will receive $115 in two years.

-       Investment C will cost you $150 now, but you will receive $200 in three years.

IRR can take these different investments and reduce them to easily comparable numbers.

-       Investment A: 10.0 percent IRR

-       Investment B: 7.2 percent IRR

-       Investment C: 10.1 percent IRR

All things equal, Investment C is the best investment option (10.1% > 10% > 7.2%).  It may seem somewhat counterintuitive since it requires more money up front and will not bear fruit for three years, but it has the highest annual growth.  You could do Investment A with $150 three times, reinvesting the returns at the same rate ($150.00 --> $165.00 --> 181.50 --> $199.65) and you would come up just short of Investment C.

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