Financial Flexibility- What are the facts?

[Quail]

As I sit here in Florida this morning, very grateful that my wife and I successfully weathered the effects of hurricane Hermine last night, and especially grateful to have not lost electricity like so many thousands of others in central Florida, my thoughts naturally turn to my favorite baseball team. Perhaps it is the proximity of a natural disaster like a hurricane and its resultant low pressure or maybe just the hangover from that 3 game beat-down that the Cubs put on us this week that got me to pondering on the serious and contentious matter of the Pirates' front office concern/obsession with 'Financial Flexibility'.



Of course this issue became a headline recently in the much discussed 'trade' of Francisco Liriano to the Toronto Blue Jays. On the surface of it that deal looks a lot like the Pirates, desperate for financial flexibility, leveraged a salary dump by preferentially giving up two prospects instead of retaining salary. It was a deal that for the first time gave a pretty clear indication that for all of the Pirates stated valuing of their prospects and some would say over-protective attitude regarding their developmental talent pool they value financial flexibility more.



Some contend that 'Financial Flexibility' is just corporate-speak for being cheap. Others believe that it represents the savvy thriftiness of a successful MLB franchise. Unfortunately when this issue is discussed it ends up being much more an argument about beliefs than a discussion of comparative facts.



In an effort to try to come to an informed rational opinion on this matter I did some research into MLB finances. I found a couple of resources that were most helpful. This one: http://www.forbes.com/mlb-valuations/list/ in Forbes magazine had the best organized info. It looked at 5 financial parameters:



1. Current Team Value

2. 1 Year Team Value Change- what percentage value gained/lost in the past year

3. Debt Value- percentage of debt to team value

4. Revenue- earnings before interest, taxes, & depreciation

5. Operating Income- discretionary income before taxes- spending money and/or profit/loss



So what does Forbes say about the Pirates?



1. Current Team Value- they rank 18th in MLB at $975M- the team was purchased in 1992 by the Nuttings for $92M

which means that they have assured themselves of a tidy profit of $883M on their investment over the past 24 years for an average of $36.7M return on investment per year.



2. The 1 Year Team Value Change from 2015 to 2016 was 8% which ranks 10th in the league and amounts to an increase of $78M (more than double the 24 year average increase). The team is now becoming more valuable more quickly.



3. Debt Value is at 10% which ranks 16th in MLB (0% would rank 1st) so their debt is $97.5M



4. Revenue for 2016 is $244M which ranks 17th in MLB (tied with San Diego)



5. Operating Income is 9th in MLB at $35.3M



When viewed in a vacuum these numbers seem to indicate that the Pirate ownership has made a wise and very lucrative investment in purchasing the team. That the investment is growing at a rate that is accelerating. However, they do owe more money than the original purchase price of the team. They also generate a bit less revenue than the average, but nowhere near the bottom of MLB teams (even with their TV revenue in the bottom 20% of the league). And remarkably that their operating income is $35.3M placing them 9th in MLB.



In a larger context here are some things to ponder:



Payroll-



The Pirates rank 25th according to http://www.spotrac.com/mlb/payroll/ with a payroll of ~$102.5M. Compare this to another rising small market competitive team, The K.C. Royals who rank 15th with a payroll of ~$143.2. Why are the Royals able to spend $41M more on payroll than the Pirates? Let's look at the Forbes financials for both teams to see if there may be some clues in the numbers.



1. Team Value- Pirates: $975M (18th) Royals: $865M (25th)

$975M - $865M = +$110M Pirates



2. 1 Year Team Value Change- Pirates: 8% (10th) Royals: 24% (2nd)

$78M - $207.6M = +$129.6M Royals



3. Debt Value- Pirates: 10% (16th) $97.5M Royals: 7% (11th) $60.5M

$97.5M - $60.5M = +$37M Royals



4. Revenue- Pirates: $244M (17th) Royals: $273M (11th)

$244M - $273M = +$29M Royals



5. Operating Income- Pirates: $35.3M (9th) Royals: $39M (8th)

$35.3M - $39M = +$3.7M Royals



Crunching the numbers we see that the Royals possess an $89.3M advantage in these financials for 2016. More than enough for a business to justify a $41M higher payroll than the Pirates.



Also worth noting is that the Royals ownership purchased the team in 2000 for $96M resulting in a return on investment of $769M over 16 years or an average return of $48M per year. So the expectation of more return on investment can also be considered a factor which mitigates some of the Pirates advantage in their current team value.



continued...

[Quail]

Now none of the above is to suggest that the Pirates can't afford a higher payroll. Lots more number crunching and comparing with other teams financials and payrolls will show that some teams (the Dodgers for instance) are perfectly willing to go into the red in a given year in order to increase payroll in hopes of a championship. Can the Pirates afford to spend more? How much more? Should they spend more? I hope that the financial numbers I've linked in the original post will get more folks understanding where the Pirates stand in the context of MLB and their "desire" to win.



Please discuss...I look forward to reading what the good folks here think.

[SammyKhalifa]

The Dodgers of course are a bad example (but I totally know what you're saying). Of course you can buy anything you want when you have billions of television dollars coming to you in the next few years.

[Quail]

7C4E42425664474E4346494E2F0 wrote:



The Dodgers of course are a bad example (but I totally know what you're saying).  Of course you can buy anything you want when you have billions of television dollars coming to you in the next few years.


You're absolutely right. The Dodgers are not representative of MLB in general. No other team can expect to have an average $330M in TV revenue every year for the next 28 years like the Dodgers do. Still they decided to go ~$72M in the red this year. We don't have to look at this as an example of a badly run business though some might argue that it is. I think you're view is right that this is simply a delay of gratification with the guarantee of future revenue giving them the freedom to spend like there's no tomorrow.



The Pirates by the way are not in a terrible position with TV revenues. By this I mean they're only locked into their current deal ~$25M per year through 2019. Many of the teams not named Dodgers, Yankees, and Angels have deals not much better than the Pirates and the contracts go for much longer. The Pirates will have an opportunity in 2019 to renegotiate and hopefully increase their revenues somewhere closer to league average.

[JollyRoger]

Quail: Thank you very much for your research. I hope this opens some eyes with the ownership supporters. I have been saying for a long time that you must look at the yearly increasing value of the franchise because that is where the greatest equity is realized. With the 78M increase in team value and a 36M increase in operating profit; Nutting made a very nice 114M increase in his portfolio.



No one denies him the right to make money. However; your data supports the theory that there is absolutely no reason why the Pirates cannot support an average ML Payroll other than the owners reluctance to invest at that level.

[Bobster21]

Is team value really relevant? That money isn't realized until the team is sold.

[Ecbucs]

7D505D4C4B5A4D0D0E3F0 wrote: Is team value really relevant? That money isn't realized until the team is sold.


it is a little relevant as it can impact line of credit. Also that it is trending in the right direction by going up which is what owners would want to see.

[rucker59@gmail.com]

Quail - really good work, thank you. Of course I'm sure the FO would say your #s have no basis in reality and that makes any debate more difficult, some might say any debate is moot. But I'm guessing there is some truth in Forbes work. So...



I'm not sure you can use KC as a comparison in the way you did. Not surprisingly the Royals value sky-rocketed after the WS. They may not experience any material growth this year.



A better comparison, it seems to me, is the 2014-2015 Royals verses 2014-2015 Pirates. 2014, the Pirates would have a much larger value compared to the Royals and I'm going to guess revenue and operating income much closer to, and very possibly greater than, the Royals.



In other words, 2014-2015 the Royals made an investment into the team that would appear to be an outlier compared to their historic financials.



If I'm right, why and how did the Royals outspend the Pirates in 2015?



Also, why is the pirate debt so large??

[dogknot17@yahoo.co]

Still doesn't mean teams should over spend for players because the money is there. For example, the Liriano deal was great at first (3/39) but it turned out bad this year. So, they found a team who would take him. I do find it funny any time they deal a high priced player it was because of money and not talent (the return or decrease in talent).



Good work, Quail.



I also agree with Bobster. Not until the team is sold do we know how much it is worth. Go try to sell your car for the Blue Book Value, you won't get it.

[Quail]

486568797E6F78383B0A0 wrote: Is team value really relevant? That money isn't realized until the team is sold.


I haven't checked every team's last sale date, but my guess is that Forbes used some formula based on the most recent sales of baseball franchises to help estimate current value. As to why it may be relevant I think it might be considered the same as stock ownership. On any given day a stockholder can see the value of a share of stock that they own. When going to sell that share the value may be a bit different at the particular moment of the sale but it's usually pretty close. I think MLB owners get a fair idea of how their investment has done by looking at sales of other franchises. When they do sell it may not be for the exact amount predicted but it's probably in the ballpark (pun intended). As EcBucs pointed out the perceived value of the team will be what lenders will use when issuing credit so it gives team owners financial leverage which could be a help in other businesses in which a baseball owner is involved (ie Newspapers, resorts, etc).