Lock Out: Creative Accounting
There’s no Business like Show Business; but there are several Businesses like Accounting. David Letterman
December 30, 2021
In May of 2020, with the Co-vid pandemic threatening to wipe out the entire season, Major League Baseball Commissioner Rob Manfred (aka the Baseball Owners’ mouthpiece) estimated that Major League Owners could collectively lose 4 billion dollars for the year. In October of 2020, after the abbreviated season finished, Manfred claimed that Major League Baseball had operational losses of 2.8 to 3.0 billion dollars for the 2020 season and was loaded with 8.3 billion dollars in debt. In other words, the thirty [30] Major League clubs were averaging 100 million dollars of losses a year and deeply in debt. With that amount of yearly losses and outstanding debt, a normal business would be contemplating bankruptcy [restructuring if not liquidation]. In December of 2020, player agent Scott Boras responded to Rob Manfred’s claims. In a press conference that sounded like he was channeling boxing promoter Don King, Boras stated: “There’s no team in baseball that lost money last year.” Snidely, Boras pointed out that lost profits are not exactly the same thing as actual losses. Rob Manfred dismissed Boras’ claim, saying that the 3.0 billion dollars were actual losses, not just lost profits. With the Lock Out putting a damper on actual baseball news, I thought that I would look back at this bit of creative accounting. Who was telling the truth, Rob Manfred or Scott Boras?
Creative Accounting 101
Starting out the analysis by just shooting at the already dead fish in the barrel, let’s look at Manfred’s claim that Major League Baseball was an astounding 8.3 billion dollars in debt. That statement could very well be true. Of course, almost all of this 8.3 million dollars of debt is long term player contracts. But just simply looking at this debt without also looking at any offsetting income would be ridiculous. Currently, Major League Baseball has three long-term contracts for national TV broadcasting rights with 1) Disney [ESPN] FOR 3.85 Billion, 2) Fox for 5.10 billion, and 3) Warner [TBS] for 3.70 billion. With the caveat that these contracts were recently re-negotiated, that’s 12.45 billion dollars in guaranteed future income which can offset that supposed 8.3 billion dollars of future debt. It would certainly seem that Major League Baseball is not tottering on the edge of bankruptcy but is actually completely financially solvent and almost surely profitable. In other words, Manfred’s claim about Major League Baseball being 8.3 billion in debt, even if true, is just a bunch of baloney, signifying absolutely nothing. That would be strike one against the belief that Rob Manfred was truthful source.
Rob Manfred may be Pinocchio’s Cousin
What about Rob Manfred’s claim that Major League Baseball lost 3.0 billion dollars in 2020? If that statement was literally true, the 2021 baseball season should have been an exercise in industry wide belt tightening. However, in November of 2021, the Baseball Owners handed out a staggering 1.7 billion dollars in player contracts after the season ended. This wild spending spree demolished the previous monthly record. Of course, if the intervening 2021 season had produced record profits, the Baseball Owners would have had a good explanation for this behavior. But it was stated by Rob Manfred, their Commissioner, that profits for 2021 were down substantially. From all this, one can only assume that Manfred’s claim that Major League Baseball had actually lost 3.0 billion dollars in 2020 and his subsequent denial that it was just lost profits, is almost surely untrue. On the other hand, the assertion by Scott Boras that not a single baseball team lost money in 2020 and that the 3.0 billion dollars in losses claimed by Manfred are actually just lost profits is almost certainly a truthful statement. That would be strike two against any belief in Rob Manfred telling the truth.
But let’s do some actual math. In 2019, the Revenue of Major League Baseball was reported by Forbes Magazine as 10.70 billion [other sources report it as between 9.9 and 10.37 billion]. All this income reportedly came from: 1) Gate Receipts of about 4 billion; 2) Local TV revenue of reportedly 2.5 billion; 3) National TV revenue of about 1.8 billion; 4) Licensing of about 1.0 billion; 5) Sponsorships of about 800 million; 6) Concessions of around 500 million; and 7) other sources of 100 million. Of course, all of these numbers are estimates and are not being double checked by any reputable accounting firm [not that scandals such as Enron would give anyone much faith in so-called reputable accounting firms]. But the estimates are basically reasonable from all that is known and Major League Baseball has not disputed them. Forbes estimated that Major League Baseball made a profit of 2.5 million in 2019. Manfred and the Baseball Owners did dispute this. They responded that their actual profit in 2019 was exactly zero dollars. This deserves to be re-stated. The Owners claimed, with a straight face, that they made no money at all in 2019. It has to be presumed that, if asked, the Owners would also claim that their profits in 2021 were zero also. So the next question would be: was Forbes Magazine or the Baseball Owners telling the truth about whether Major League Baseball made any profit at all in 2019?
Steve Cohen is probably a very good businessman
On Friday, October 30, 2020, Billionaire Steve Cohen completed his purchase of the New York Mets for 2.475 billion dollars. The previous record price for a Major League Baseball team had been the Los Angeles Dodgers, sold for 2.00 billion dollars in 2012. Right before Cohen bought the Mets, the Kansas City Royals sold for exactly one billion dollars during the 2019 season. The Royals are always listed as one of the least valuable Major League franchises (usually with the two Florida teams). The New York Yankees are usually appraised as the most valuable Major League franchise. The estimate of the purchase price of the Yankees ranges anywhere from 5.0 to 7.0 billion dollars. So the current range in values for a Major League franchise goes from 1.0 billion on the low end to 5.0 (maybe even 7.0) billion at the high end. The median value would then probably be about 2.0 to 3.0 billion. From these numbers, it should be easy to estimate how much each team makes per year simply by using a cap rate formula. Cap rate [or capitalization rate] uses the annual Net Operating Income [NOI] of any business to determine its property asset value [PAV]. In other words, if a business being sold makes this much money per year, cap rate answers the question of how much you should pay for it.
The reverse of this equation is that you can also use the purchase price of a business to figure out approximately how much income a business generates. For instance, if a business is purchased for 2.0 billion dollars and the cap rate is 5.0, the business probably generates about 100 million in revenue annually. When Steve Cohen purchased the New York Mets, a 5.0 cap rate would have been a good, but not outstanding, return. Using a 5.0 cap rate, the purchase price of 2.475 billion would seem to indicate that the Mets generated more than 100 million per year. However, if you believe Rob Manfred that Major League Baseball teams just broke even in 2019 and lost money in 2020, this purchase price makes absolutely no sense at all. Of course, there is always the possibility that Cohen, who made a fortune investing in hedge funds, is a bad businessman. Or that he wildly overpaid for the Mets because owning a Major League Baseball team is all about prestige, not profits. But the truth of the matter is almost surely that Cohen bought the Mets from the previous owners as an investment and he probably paid a good, but not outstanding, cap rate for it.
Assuming that the cap rate of about 5.0 is correct and Steve Cohen is actually a good businessman, the New York Mets almost surely generated somewhere around 125 million dollars of income in 2020. The Kansas City Royals would have made about 50 million a year and the New York Yankees (provided the estimated franchise values are correct) somewhere between 250-350 million dollars. Interestingly, if all these figures are correct, Steve Cohen is certainly a pretty good businessman. He purchased the Mets from the Wilpons (who, as victims of the Bernie Madoff Ponzi scheme, were not known for being all that financially astute) for basically the average purchase price of a Major League Baseball team. But the New York Mets, located in the largest media market in the country, are hardly a mid-market team. Only the mismanagement by the Wilpons had been keeping the team down. The Mets have more in common with the Yankees than the ordinary Major League club. So the question boils down to: do you believe Steve Cohen is a good businessman or that Manfred was lying about the profits of Major League baseball being zero? That would have to be strike three against Rob Manfred.
Lock Out Blues
Even more interestingly, if you try to estimate the net operating income of Major League Baseball with a currently normal cap rate of 5.0 and an average franchise price of 2 billion dollars (i.e. all 30 Major League teams together are worth a cumulative 60 billion dollars), the profits of the whole League come out to 3 billion dollars annually. In other words, the same exact amount that Rob Manfred claimed baseball lost in 2020. The most likely conclusion is that Scott Boras was correct: the Owners lost profits were 3 billion dollars in 2020. If the Owners did actually make 3.0 billion dollars of profits out of 10.7 billion dollars in revenue in 2019, Baseball has to be an incredibly lucrative business for the Owners. But, if that is true, then why in God’s name have the Owners locked out the Major League players and threatened the pig that lays golden eggs? The answer to that is simple. It is the most basic reason any billionaire becomes a billionaire: greed. As the player’s salaries have stagnated recently, the overall revenue of Major League Baseball has soared. Virtually every cent of that recent increase has gone into the Owner’s pockets.
Conclusion
There will almost certainly be more than just a bit of blood on the floor at the end of the current labor dispute. This post has argued (and concluded) that Rob Manfred was either dissembling, stretching the truth, or simply outright lying about the finances of Major League Baseball. Of course, just the simple fact that they will do almost anything rather than open their financial records to outside scrutiny, tells you all you really need to know about the finances of Major League Baseball. So this post could simply be considered superfluous. As for Manfred, it is literally his job to dissemble or lie for the Major League Baseball Owners. For the money he gets paid, I would probably dissemble or lie with a straight face too. One of constants of Major League history is that the Baseball Owners always lie about their finances. But, if you lie constantly in a negotiation, you can hardly be surprised when the other side reaches the point where they don’t believe a single word you say. My current prediction for this lockout would be: a quarter or the season [40 games] goes down in flames before the negotiations even get serious.