I have been a sports fan all my life, following (and playing) cricket, tennis and now baseball (especially since my sons are all big baseball fans). Since I have lived in New York now for almost 25 years, I have become a New York Yankee fan.. As some of you may know that Yankees have built a new billion dollar stadium (actually the city did...) and opening day is April 17. I was able to get on EBay and buy three tickets for the game.
I am really looking forward to that day but as the Yankees run on to the field, my thoughts will turn to debt and leverage and here is why. The Yankees have the most expensive infield in baseball history (and perhaps the highest payroll of any team in any sport):
At first base: Mark Teixeira: $22.5 million every year for the next 8 years
At second base: Robinson Cano, $7.5 million every year for the next 4 years
At short stop: Derek Jeter, $19 million every year for the next 2 years
At third base: Alex Rodriguez (injury healed and steroid free), $27.5 million a year for the next 9 years
Behind the plate: Jorge Posada, $13.5 million every year for the next 3 years
On the mound: CC Sabathia, $ 23 million every year for next 7 years
These contracts represent commmitments that have be met, no matter how well or badly the Yankees do as a team, and independently of how these stars play. In other words, they are debt commitments. Taking the present value of these commitments, using a pre-tax cost of debt of 6%, we arrive at an astounding sum of $561 million. Here are the implications:
1. Looking at the Yankee balance sheet will give us a misleading measure of how much they owe as a business Their conventional debt is a small number but adding the present value of commitments gives us a debt ratio that is much higher. (General lesson: Firms with significant fixed commitments, such as retailers and restaurants are much more highly levered than they look, based upon conventiional measures.)
2. Last year's Forbes estimate of the values of different sporting franchises put the Yankees on top of the list, with an estimated value of about $1.5 to $ 2 billion, with Manchester United just behind them. If you are wealthy enough to buy the Yankees for $ 1.5 billion, you really are paying close to $ 2.1 billion (since you are assuming the player contracts when you buy the team) (General lesson: When we use ratios like EV/EBITDA to value firms, and define EV = Debt + Equity - Cash, we should be including the present value of commitments in debt in computing enterprise value.)
3. From a corporate finance standpoint, firms that already have substantial fixed commitments for extended periods should be cautious about adding to these commitments. In other words, if the Yankees had decide to pay for their own stadium, I would have cautioned them against borrowing; I would have suggested selling a portion of the equity. (General lesson: A typical airline makes huge lease commitments to buy its planes. To add to these commitments by borrowing conventional debt seems to be asking for trouble. Yet, the typical airline still does it.. Any wonder that the sector is full of distressed companies?)
I am sure that I will be able to put all these thoughts out of my mind before the first pitch is thrown, but it adds to my contention that life is full of corporate finance lessons.