Forget Salary Cap, Baseball Needs a Profit Cap

Scott Boras set off a firestorm – like only Scott Boras – when he issued a doctrine about team spending and use of revenue sharing funding. It’s not a new debate, but more pertinent given the timing, at the start of a free agent period when teams may start to reign in payroll, thus cutting into Mr. Boras’ commission checks.

That aside, Jayson Stark wrote an interesting editorial outlining the facts and calling for a salary basement as a resolution, pointing the problem at the lower spending teams, similar to Boras. They both are right, but understanding the problem is one thing, solving it a completely separate story.

The Yankees, Red Sox, Mets, and Cubs are not the problem here. They play in big markets, maximize revenue to the best of their ability, then reinvest in the product on the field. They also play by the rules, paying a substantial tax on their earnings, similar to the US government taxing the rich more than they tax the poor (or at least that is how its supposed to work). Most people agree it’s the Pirates, Royals, Marlins, et al, who cash the “stimulus” checks, but stash the money in savings that hurt the baseball economy.

Ending revenue sharing is not the answer. Smaller market teams need some of the big market revenue to stay in the game. Its not feasible to think a team in Pittsburgh will earn the same local media revenue, sell as much merchandise, or get the same level of sponsorship as any team in a market with a substantially larger population and healthier economy. It’s just not possible. So some sharing is necessary.

As an aside, the fact the Florida is considered small market is a joke. Look at Miami-Dade County in terms of size, spending power, per capita income, television market, and almost any other statistic relative to Milwaukee, Pittsburgh, Cleveland, and others, and explain how Miami is small market. The Marlins problem is management, and the fact that the city will not support a baseball team, and that responsibility falls to MLB to fix or change.

Back on topic. The deeper problem is not that team salaries are low relative to the amount collected from revenue sharing, its that these teams are among the most profitable in baseball. MLB VP of Labor Relations Rob Manfred is correct that player development and team operations is a major expense that the public does not consider when looking at the face value numbers, but those expenses should still go into the P&L, so how do these teams end with a profit?

Salary minimum’s are tough since teams do not to rebuild, may flush money into player development (i.e. future investments), or it could force teams to make poor spending decisions because they are forced to spend. An alternative method is a profit minimum. First, teams need to submit to more transparency with the league office (not necessarily the public). Use projected revenue numbers for the season, including MLB central fund contributions, and do not allocate any revenue sharing money until a small market team exceeds that forecasted number – whether its on player development, team payroll, or organization spending. At that time, teams eligible for revenue sharing can only collect when they have incur an expense. For example, Pittsburgh needs to sign a free agent, then it will receive the revenue sharing money to cover that players salary. Each team can continue to draw from this revolving credit line up to the amount they would receive under the current system.

Anything above that amount, the owners need to fund, similar to today. If they don’t exhaust the funds, then the money goes back into the central fund for redistribution to all teams – NOT into the owners pocket. Sports ownership is not a profitable business annually, owners know that coming in, the big profit comes when you sell a team whose value appreciates.

It’s not perfect, but another idea to put on the table. In the end, the only way to truly satisfy the public and the ancillary stakeholders is with full transparency, which I would not hold my breath waiting for. In this scenario, at least it takes the profit out of the hands of the owners and forces some transparency.

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Rangers Become MLB’s Version of Citi and BofA

Multiple sources report that Tom Hicks has borrowed at least $15mm from MLB to cover operational expenses this year. Though Hicks has tried to position it as essentially short-term revolving credit, given the dreary state of Hicks’ personal finances, plus the amount he has tied up in illiquid assets (mainly other sports franchises), this loan is unlikely to be enough. Sound familiar? Think Phoenix Coyotes and the NHL – though the NHL mangled the ownership situation, which magnified that problem. Better yet, it’s not too dissimilar from the US government funding large banks to keep them solvent and protect the industry from the ramifications of bankruptcy – obviously at a much smaller, and less critical scale.

Similar to how the government began imposing restriction on salaries, bonuses, and operations of banks that it took equity in, MLB now has a say in business matters for the Texas Rangers. The team made no substantial trades at the deadline to boost their playoff chances and failed to sign its first round draft pick. This creates a conundrum – on one hand the team obviously does not have the resources to increase expenses so MLB is right in not letting them spend. On the other not investing in the team, especially with increased fan interest from the pennant race, punishes the fan base and could lead to lower revenue (decreased ticket sales, merchandise, etc.), effectively increasing financial losses.

Hicks dug his own hole – starting with the egregious A-Rod and Chan Ho Park contracts, right through the enormous investment in EPL soccer. Other MLB owners should not have to cover Hicks’ mistakes. If so, it would incentivize teams to spend beyond their means and assume good old MLB will make everything better. Clearly, not feasible. The consequences of letting it fail come from many angles – how to find 50 new jobs to appease the MLBPA, stadium lease issues, a deserted fan base, a full minor league system of players and affiliates, and that’s without even getting to the legal bankruptcy issues.

The situation has no right answer to appease all parties. MLB’s best protection against this is to prevent it in the first place. Teams should be required to show evidence of liquid funds in excess of opening day payroll before the season starts. Further, when major free agent contracts players are added during the season, the team should again post evidence it can afford the payments. If MLB intends to operate as a financial support system, financial reporting must become more transparent. Maybe it already is within the closely held MLB offices, but this situation should never arise in season unless substantiating circumstances occur. Baseball should not allow owners to field a team without funding lined up to make payroll for the entire season. If they can’t, auction the team, or force new equity partners upon them. However, unlike the NHL, put regulations around the process to prevent the Coyotes situation.

This topic probably warrants a full-length report, but the short summary is that MLB (and all pro leagues) need to prevent teams from reaching this situation in mid-season. Whether that means approving each contract above a certain value, or providing proof of finances to fund payroll, it needs to happen. Akin to applying for a mortgage or apartment rental – the buyer needs to show proof of income to get the keys. Baseball needs to require proof for teams to get the players.

CBA Talks Start to Hit Stride – What to Expect

SBJ last week did a cover story on the upcoming CBA negotiations for the four major sports, each whose contract expires in a different quarter in 2011, making 2010 a big year for negotiations. Less linked to the big four, but still worth watching, MLS enters what could become a ground changing CBA negotiation this winter.

The story gave a high-level background on each league’s situation and some overarching issues. First, don’t expect anything to get done easily or any earlier than after the league’s complete their next full season. Early indications are the NFL will lead in rhetoric – but big talk does not buy you anything. Football is the most interesting, and likely to be most watched labor talks since they have new leaders on both sides in DeMaurice Smith and Roger Goodell, the owners already declined to renew the current deal setting up a potential uncapped 2010 season, and NFL players have the shortest careers and non-guaranteed contracts. Though, as Peter King pointed out recently, the uncapped year carries many additional stipulations that actually benefit the owners.

Putting aside sport specific issues, expect a few macro-level concepts to emerge. Financial transparency is a major issue as more owners publicly proclaim losses, and commissioners claim few teams achieve profitability. Players expect to see proof if they are expected to make concessions to benefit leagues. Less critical to the negotiations, fans should expect to see proof as to why their teams slash payroll and never put a winning team on the field in certain markets. David Stern openly stated the NBA would be as transparent as needed, while the NFL is the antithesis, saying players have no need to see the books. Given that manipulating financial books and lack of transparency contributed to the current financial crisis, and federal government has made a move to increase filings by public companies, it makes sense for sports to follow that path – unless you have something to hide.

Hockey may have the most to lose. It already teeters on the brink of obscurity, but it finally picked up some momentum recently with the Winter Classic, a great playoff, and two emerging young superstars. With off ice ownership problems permeating multiple franchises, another strike could obliterate the sport domestically. Further, as the lowest paid players of the four sports, its players can least afford a stoppage. It may be painful, it may be the last move in Bettman’s marred tenure, but both sides need it to happen.

Another overarching theme that should pervade is convergence among the deal structures within each league, perhaps other than the NFL since its revenue skews more towards national than local. Collective bargaining in sports is a mature process and both sides now have many years of data and experience to pull from. Each league sees what works and doesn’t work in their own league and in other leagues. That said, expect to see more parity develop between leagues. The NFL and MLB will discuss draft salary slotting, a concept the NBA perfected, the NBA and NFL may implement revenue sharing closer to what MLB does, while MLB will revisit the salary cap, which the other three leagues all use differently. Never will all four converge, but they may start to look and smell similar, with different percentage allocations and small concessions depending on the leverage in each situation.

Though unlikely, it’s always intriguing to see if any unions will decertify and challenge the league’s anti-trust exemption. That would cause some fireworks and be the equivalent of going all-in in poker.

New Era of Draft Contracts Impact Expectations, Player Development

Strasburg set the contract record for a draft pick, no matter what way you slice it, but it’s the overall trend that raises more concern. Strasburg could very well become the A-Rod of this generation of draft picks, or the Brien Taylor, either way he is one player. For a minute, let’s set aside the argument on the implementation of baseball’s slotting system, and if it should enforce a system similar to the NBA. With draftees controlling the leverage, more and more top picks are earning major league contracts for mid-range free agent dollars.

Given the reverse draft order, the worst teams, usually with a correlating low payroll, wind up selecting the players demanding these major-league contracts. Thus, the same teams who have cut back free agent spending and cut payroll through trades now must spend some potential free-agent money on draft picks who will not immediately contribute, historically not contribute the next two seasons, and may never earn what they are paid. Further, these contracts leave the bad teams handcuffed come next off-season. The draft has essentially become another free agent spending period. Washington signed two Top 10 players, each of whom will earn enough to make the top ten on their current payroll. The Padres traded Jake Peavy to reduce payroll below $30mm, then committed a significant percentage of the current payroll to an unproven draft pick.

Low payroll teams inevitably need any big money players they have to perform. Inserting draft picks among the highest paid players on the roster, not dissimilar from how the NFL works, incentivizes MLB teams to push recent draftees to the majors ASAP. The NFL overcomes that problem because every first-round pick makes the roster and gets a crack at playing almost immediately. If baseball intends to continue pumping this level of money into the draft, teams will by virtue push players toward an NFL model – demanding immediate contributions. The once systematic MLB development system will get turned on its head, as top draft picks are rushed to the majors in months, not years, and arrive with marketing programs, ticket packages, and media hoopla attached to their names.

My question, which requires additional research I have yet to do, is if these contracts have a marked effect on how fast players reach the majors, and how many reach the majors. Are teams short-circuiting their development, taking a ready-or-not, we need you to earn that money now, approach? Further, what are the long-term effects of rushing players to the majors, a study that may require years of data on long-term career trajectory before we can answer. It’s not the Evan Longoria’s or David Price’s or A-Rod’s, all player’s that lit up the minor leagues and earned a call-up that deserve attention, it’s the players that don’t perform in the minors yet teams must call-up because of the salary. What comes of those players, and how do teams handle them given the percent of team budgets they now invest at the top of the draft?

I’m in favor of a slotting system, more stringent negotiation timeframe, international draft, and trading picks all because it makes having a high draft pick a benefit rather than a concern. Until then, we see the impact on team budgets, but how that will affect player development remains an interesting question.

Ripe for Financial Trouble, NBA and Other Leagues Must Step In

One year ago, Utah was the team ready to take the next step in the NBA Western Conference after a deep playoff run. Now, it will likely lose arguably its best player in Carlos Boozer, have ticket sales trending down almost 10%, and need a bank loan to prevent losing a second starter. To say fortunes have changed is an under statement. You can point to the economy, the free agent landscape, the impact of a disappointing season – or all of the above.

The most troubling piece is the need to take a loan to fund a matching 4-year, $32mm offer sheet for Paul Millsap. This on the heels of rumors that the Texas Rangers missed payroll recently, the Phoenix Coyotes required all sorts of help from the NHL to get through the season, and even some NBA teams may have need a boost to finish up the season.

Admittedly, I don’t have all the figures, since most teams hold financial data privately. Let’s look at the logic here though, a debtor must receive approval for a loan based on credit worthiness, which includes payment history, current debt ratios, projected revenues, riskiness – essentially your history in paying back and debt and the likelihood you will pay back in the future. Utah is already over the cap, thus will owe the league luxury tax above the salary expenses, and announced off-season ticket revenue is tracking 10% lower year over year. Given that, its likely the teams top revenue source will decrease for the full season, while expenses will increase with more salary and the tax. I don’t see any substantial new revenue sources available for Utah, considering they have lost a top player making the team less marketable, and are unlikely to make a deep, profitable postseason run since the team is not appreciably better.

To summarize, less revenue, higher expenses, not enough liquidity to make a contract offer – this seems like a high risk credit offering. In this case, its less of a lender problem and more of a league problem. Utah has signs of financial instability and these decisions can lead to franchise failures, most of which the league keeps behind closed doors and must sink central funds to keep the franchise running. The NBA and other major leagues should step in before this happens. Many smart people work at the league, with access to more financial detail than we will ever see, so we’d assume they consider this, but then why are leagues swooping in to help franchises meet payroll more and more.

A loan for Lebron or Wade is one thing, since those players can directly impact revenues. Paul Millsap will not have much, if any effect, in fact there is no guarantee he will make the team better. How many mid-tier players fall off the map? Is he worth this contract? Perhaps. Is Paul Millsap worth a team stretching itself financially? Not the Millsap I’ve seen.

The leagues need to institute better financial oversight, similar to what the government is doing to financial companies, except in the sports landscape of cartels, private ownership, and striving to serve the best interests of the league, less conflict of interest exists than in the case of GM. Think rationally, is Paul Millsap worth financial risk?

NBA Warning Signals Premature

The NBA fired off the first Class of 2010 free agent salvo, one year before the festivities begin, with a warning about a lower salary cap. It’s SOP to issue a forecast in the annual league memo, and it’s obvious where the warning stems from, but these projections seem premature.

Flash back to last year, same time, same memo, could anyone have predicted the economic situation 3, 6, 9, and now 12 months later. No way. I think the same holds true now, its unpredictable. The recession has definitely affected sports more than past economic slow downs, and 2009-10 will be the first full NBA season played since the financial crisis, however in sports flat could be the same as down.

Of the major items that contribute to BRI, the league has all major national TV deals, and teams have most, if not all, local TV deals locked in. While harder to come by, most major league and team sponsorship deals are multi-year contracts, guaranteeing that revenue. Plus, the NBA is not the LPGA, renewals continue to occur. That’s a significant amount of BRI that will increase next year due to annual escalator clauses in long-term deals.

Ticket sales, and related income such as parking and concessions, represent the wild cards. Despite the problems, the NBA posted strong attendance numbers last season, right near the record setting pace of the past few years. Off-season transactions thus far indicate a growing disparity in the league, a few teams getting stronger, many teams choosing to rebuild. Attendance figures should follow that, with the good teams filling the house every night (Cleveland, LA, Orlando, Boston, San Antonio), while bad teams in bad markets see attendance drop (Sacramento, New Jersey, Indiana). It’s the middle of the road teams that will swing revenue, mostly coming down to performance.

A few perennial disasters with renewed hope could give the league hope, and stabilize BRI. Memphis finally has some players to get excited about, the Clippers took the only prize from the draft, while Denver has room to grow after a deep playoff run, and Washington should bounce back from a poor season. Charlotte even has some hope. To put a spin on the negative teams, Indiana, Sac-town, and NJ can’t go much lower, so if they find a way to stay flat, and a few other teams get a lift it should off-set the lower overall ticket prices.

My point here, it’s all hypothetical. The NBA’s projection, my scenarios, Wall Street experts, everyone. Another key component, the NBA CBA is the most convoluted in sports, making it easy to manipulate. Heck, even Larry Bird has a rule named after him. Finding ways to exceed the salary cap are not difficult. If it comes to that, teams will find a way – the Knicks have done it the past decade for players not even on the team, I think they can find a way for Lebron and whoever else they want.

As a league, the NBA should not take to defusing the anticipation of next year’s free agent season. If it plays out well, it could be the tipping point to catapult the NBA to become the prominent league in US sports. It has the potential to be that big. They should go out of there way to make sure the media gives it front page coverage for the whole season and then every day next July, leading into the biggest Opening Night in league history. All the cards are in place, the league should do everything it can to leverage it. Not to mention that stirring the pot with the union for a possible strike/lockout standoff the following off-season could be debilitating.