Tuesday, June 3, 2014

Ballmer's bid for the Clippers: Investment, Trade or Expensive Toy?

Now that he has stepped down as CEO of Microsoft, Steve Ballmer has both plenty of time and moneyon his hands, and he put the latter to use last week, when he announced his intent to buy the Los Angeles Clippers, that city's second favorite NBA team, for $ 2 billion. Since that was more than three times higher than any other NBA team had sold for and matched the price tag for the most expensive sports franchise sale in US history (the sale of the Los Angeles Dodgers in 2012), the bid raised questions about whether a sports franchise can be valued, how it is priced and whether there is an ego premium embedded in this particular offer. I am not a Clippers fan, but I love sports, and these questions not only deserve answers but have broader implications for valuing entertainment and media businesses.

The value of a sports franchise
Much as we like to glorify the beauty of sports and praise it in its purest forms, it is increasingly a business. Like any business that is expected to generate profits and cash flows, it can be valued, based upon these expectations.

1. Revenues: From gate receipts to media contracts!
My favorite sports team, the New York Yankees, was sold for $460,000 in 1914. At the time, it was a struggling franchise, with $20,000 in debt, and the new owners turned it around with two big investments: the storied acquisition of Babe Ruth from the Boston Red Sox for $100,000 and the construction of Yankee stadium for $3.1 million in 1923. In 1924, the Yankees reported EBITDA of $441,640 on revenues of $1.1 million, almost all of it generated from gate receipts. Until 1946, the revenues for the Yankees (and almost every other professional team in sports) came from the revenues generated at games from ticket sales, concessions and parking, with some supplementary revenue from radio broadcasts. In 1946, the Yankees became the first team to sign a local television contract, netting them $75,000 for the season. It is fitting that the Yankees owe their current status as one of the most valuable sports franchises in the United States to an updated local television contract, which generated more than $100 million in revenues for the team in 2012.

The last two decades, in particular, have seen a shift in revenues from gate receipts to media right across sports, with the shift more pronounced in some sports than others and for some teams within each sport. In the table below, I break down total revenues in six sports - baseball (MLB), football (NFL), basketball (NBA), North American hockey (NHL), European soccer and Indian cricket (the IPL), using information from 2012:
For European soccer, I use only the top 20 firms in terms of value (according to Forbes). The IPL numbers are my best estimates, based on news stories.
Of the six sports, baseball is the most dependent on gate receipts, perhaps because it has a 162-game schedule, and the NFL is least so. The IPL and the NFL are the two sports most dependent on media rights (TV and digital broadcasting), while European soccer gets a larger slice from sponsorship than do the other sports. (The fronts and backs of player uniforms are prime sponsorship territory in Europe, making it different from US professional sports where that is not the practice. The IPL follows the European model.)

While broadcasting revenues are now a much biggest slice of the total revenue pie in every sports, the structure of revenue sharing varies across sports, with profound consequences for franchise value. The NFL and IPL have a shared revenue model where all teams get an equal share of the television broadcasting revenues of the sport, but the IPL keeps 40% of broadcasting revenues for itself (up from 20% in the first few years of the contract). Baseball, basketball and hockey all have mixed models, where the teams share equally in the national television contract revenues but are allowed to enter into and keep all or a large portion of the local contract revenues. Not surprisingly, this generates higher revenues for teams in larger media markets, with the New York Yankees generating media revenues ($158 million) in 2012-13, almost four times larger than the Seattle Mariners ($42 m), in baseball, and the Los Angeles Lakers ($150 million) drowning out the Oklahoma City Thunder ($20 million), in basketball.

2. Expenses and Operating Profits
The biggest expense associated with running a sports franchise is player expenses,   and it should come as no surprise that each of the sports has gone through turmoil (including strikes and shut downs) around controlling these expenses.
Player expenses as % of Revenues
IPL Player expenses based upon teams at salary cap of Rs 60 crores ($9 million) each
Players receive just over 50% of total revenues in the NFL and NBA, a little less in baseball and hockey and much less in soccer and cricket. Note that, with the IPL, there is little information at the franchise level, since many of the franchises are subsumed into much larger corporate organizations. 

How much have these ratios changed over time? With baseball, which is where we have the longest history, player expenses, as a percent of total revenues, jumped after free agency in 1974, peaked in the early 1990s and has been declining since:
MLB: Player Expenses as % of Revenues
Since this is the statistic that most fights between players and owners have fought over (and have had strikes over), it is controversial. Note that the expenses in major league baseball peaked in 1994, just before the longest strike in baseball history, and have fallen since. In 2010, the NFL shutdown was predicated on both what this statistic was (with owners and players using different base numbers) and on what it should be in the future. In the final agreement, the owners agreed to give the players 55 percent of national media revenue, 45 percent of all NFL Ventures revenue, and 40 percent of local club revenue.

There are a host of other expenses that are of less import but aggregate to take a big bite out of income. These include team expenses (associated with the logistics of transporting and accommodating the team), player development costs and stadium maintenance expenses. In many sports, the richest teams also pay luxury taxes that can add substantially to their expenses, with the amount of the tax tied to how much their player payrolls exceed league caps. Given the paucity of financial information from sports teams Forbes does a good job of estimating the EBITDA of these franchises (though it does bother me, from a semantics standpoint, that they call it operating income). In the table below, I list the EBITDA values and EBITDA margins, by sport, as well as the percentage of teams in each sport that reported negative EBITDA in the most recent time period.
Revenues and EBITDA - Most recent year
European soccer, the NFL and the NBA are the most profitable sports, with baseball bringing up the rear. Again, the absence of stand-alone information on IPL teams makes it difficult to measure how profitable these franchises are to their owners. While the IPL as a league overall looks like it generates a profit, the league takes a disproportionate share of these profits (40% of broadcasting revenues, 20% of gate receipts and worst of all, 10% of initial franchise price as an annual franchising fee!) and keeps it for itself. Since the IPL is more a political body than a business entity, the potential for mischief and corruption is huge. (The more I look at the IPL's profit sharing arrangements, the more I am struck by how greedy the BCCI has been in structuring this league and how risk the franchises are at, financially. If cricket is the goose that lays golden eggs, the IPL seems to be looking for ways to kill that goose!)

There are a host of reasons why we should be cautious about the reported earnings at all of these franchises. The first is that sports franchise accounting is an art form, with the wild card being "bad" player contracts, and the way they are written off or amortized can have profound consequences for reported profitability. The second is that most of these sports franchises are privately owned and tax considerations can lead to systematic understatement of income. The third is that critics have long argued, with some basis, that teams over state their expenses, so that they can plead poverty, either to extract larger subsidies from the cities in which they play or to put caps on player compensation, in collective bargaining agreements.

3. Risk
How much risk is there in investing in or owning a professional sports team? While you can make a laundry list of potential risks, the best way to assess these risks is not by looking at anecdotal evidence on individual teams but at the collective performance of sports franchises over their history.  The challenge that you face is that most of these teams are privately held, transactions are too infrequent for conventional risk measures and accounting earnings numbers are either unreliable or unavailable over long periods. While beta may not be the best measure  of risk when valuing sports franchises for private sale, we can use traded franchises (which are primarily European soccer teams) to get a risk profile for these investments:
Betas estimated against local indices, using 5 years of monthly data: May 2009-May 14
Based on these traded franchises, it seems reasonable to conclude that sporting teams tend to be below average risk.

To get a broader measure of the risk in these investments, we looked at the operating data of each sport. The consensus view seems to be that professional sports is recession proof and that neither attendance nor aggregate revenues are affected much by the economic environment. We have information on aggregate revenues at each sport going back in time and can measure how responsive these revenues have been to macroeconomic variables.
Correlation of annual revenue growth at sport with macroeconomic variables: 1990-2012
T statistics in brackets under correlations
Looking at the correlations, the statement that sports franchise revenues are unaffected by macroeconomic factors seems to be mostly true, with a few caveats. First, while the correlation between annual revenue changes and real GDP growth is low and not statistically significant in any of the three sports that I was able to get historical data for, some sports seem more recession proof than others. In particular, the NFL seems to be the most recession-resistant sport (at least during this period), with a lower correlation with real GDP growth than either MLB or the NBA. Second, some streams of revenues. within each sport, are less affected than others (television revenues are usually contracted for long periods and are immune from recessionary pressures but luxury box sales may be more sensitive to economic conditions). It stands to reason, therefore, that the European soccer clubs and IPL teams will share the recession-resistance of the NFL, since all three sports derive the bulk of their revenues from media rights. Overall, though, the risk of investing in a sports franchise is low and market indicators from the few sports teams that trade seems to back up this proposition.

There is also the question of how much debt these franchises carry. While the conventional debt load is low, at least on average, at all of the sports, that understates the true financial leverage, since many player contracts offer guaranteed money over long periods. Capitalizing these player contracts, as I did in this post for the New York Yankees in 2009, dramatically increases the financial leverage at these teams and with it, the risk. 

We may be guilty of survivor bias in our focus on the MLB, NBA, NFL and NHL, all of which have survived multiple scares during their lives. The list of professional sports leagues that have failed is long, and while the risk of failure may be small, it is not non-existent. The other risk that we are not factoring in is on the legal front, which can manifest itself in multiple ways. For instance, the growth and profitability of the MLB can be traced, at least in part, to the fact that it has been granted a special exemption from antitrust laws, and removing that exception could have disastrous effects on franchise value. With the NFL, the recent spate of publicity about head injuries and long term brain damage to players may very lead up to a class-action lawsuit with the potential to bankrupt even this most powerful of sports leagues.

Valuing the Clippers
With that long lead in, we are in position to value a sports franchise, and in keeping with the news story that initiated this article, I will try to value the Los Angeles Clippers. In doing this valuation, I will make a couple of simplifying assumptions, which you are welcome to change. Given the risk discussion in the last section, I will attach a cost of capital of 7.50% for investing in the Clippers, at about 25th percentile of all US firms. I will also assume that once I reassess the numbers for the Clippers, given my expectations  of changes (in TV contracts, revenues and costs), the cash flows will grow at roughly 2.5% a year in perpetuity. Finally, I will assume that with the NBA's protection from competition in place, the Clippers will be able to generate a 25% return on capital on their investments (which will allow them to generate the 2.5% growth with a 10% reinvestment rate).
Intrinsic Valuation of Clippers: Actual, Median, Laker-like & Best Case
In this table, I value the Clippers, first using their 2012 numbers (which I know are too low), next using the median revenues and EBITDA margin for an NBA team, then giving the the revenues and margins of their more lucrative neighbor in the city (Los Angeles Lakers), and finally with a combination (best-best) of the league's highest revenues (which belong to the Lakers), the best pre-player expense margins in the business (Knicks) and the lowest payroll of any team in the sport (the Utah Jazz). Even with this improbable mix, the value that I estimate for the Clippers is $1.61 billion, well below the $2 billion paid by Mr. Ballmer. You are welcome to download the spreadsheet, which has in it the key numbers, by team, for all NBA teams and do your own assessment.

The Pricing of Sports franchises
In keeping with the recent posts I have had about the divide between the value of an asset and its pricing, it is worth examining how sports franchises are priced. In fact, that is the reason why I did not talk about the well-publicized Forbes valuations of sports teams, even though I did use the raw data that they so helpfully provide on individual teams. The Forbes valuations are really franchise prices that they estimate based on the most recent transaction prices in each sport. You can see the latest Forbes value estimates for teams in five of the six sports in this link. They are rigorously done, but they don't pass the valuation test.

Market traded sports franchises
As we noted earlier, most sports franchises are privately held and are not traded. The exceptions tend to be European soccer firms, where there are about a dozen that are traded primarily on mainland Europe. In the table below, we list the values attached by the market to these teams, both in terms of equity value and enterprise value, and relate these values to operating measures for each team:
Enterprise value, Equity Value and Multiples: Traded Sports Franchises
At the outset, it is worth noting that many of these firms are in poor financial health, with negative earnings and high debt ratios. With that concern in mind, we still computed multiples of revenues and earnings, and concluded that the median sport franchise, at least in European soccer, trades at about 2.13 times revenues and 9.31 times EBITDA. While the median PE ratio is 22.7, note that almost half the sample has negative net income.

Transaction-based pricing
While sports franchises are privately held, there are transactions that occur, albeit infrequently, where a team or a portion of a team is sold. It is difficult to compare transactions prices over time and across franchises, partly because they have to be inflation adjusted (which is easy to do) but more because the revenues and earnings potential for franchises change over time. The best way to control for this is to convert the transaction prices into multiples of levels of operating variables at the time of the transaction. In the table below, I list the current owner of each NBA franchise, the prices paid to acquire the franchise, the revenues of the franchise in the acquisition year and the resulting revenue multiple.
Revenues are from year of transaction. NA= Not available
Looking across all 30 teams, the median multiple at which a franchise has traded at historically is 3.30. It is worth nothing that the two most recent transactions, the sale of the Sacramento Kings in 2013 and the Milwaukee Bucks in 2014, were the first to occur at more than five times revenues.

While the history of franchise sales in the NBA is limited by the fact that the league has a shorter history, the history of franchise sales in major league baseball go back more than a hundred years. Using information partly from Michael Haupert's excellent treatise on the economic history of major league baseball and partly from public records, I show the change in franchise values for MLB franchises over the decades in the table below, as well as some the more recent transactions involving MLB teams, scaled to the revenues of these teams at the time of the transactions:
Franchise values from 1910-1999 from Haupert, rest from public information
It goes without saying that a long term owner of a baseball franchise has been rewarded richly for the investment, but the increase in value for much of the last three decades can be attributed to increases in revenues, rather than a surge in the multiple of revenues that buyers are willing to pay. For much of the last three decades, buyers have been willing to pay about 3 times revenues for a baseball franchise, with the sale of the Los Angeles Dodgers for $ 2 billion (more than 6 times revenues) representing the outlier.

Completing the story with the NFL, the table below lists transactions involving NFL teams, with revenues from the year of the transaction and multiples paid on each one.
NFL Franchise Trades with Revenues from year of trade
On average, NFL franchises have sold for higher multiples of revenues than either NBA or MLB franchises, trading at just over four times revenues, though the recent surge in NBA valuations may have put that league ahead right now.

Looking across the sports, there is a pattern that emerges, with NFL and NBA franchises historically being priced at the highest multiples of revenues (about four times) though the NBA's recent surge may have given it the lead. Major league baseball brings up the rear, with franchises typically selling for three times revenues, and that ranking is consistent with the profitability margins we reported in the last section; the NBA had a median EBITDA margin of 11.29%, the NFL was close behind at 10.93% and baseball had the lowest EBITDA margin at 2.71%.

Pricing the Clippers
With this information on how investors/buyers have priced franchises in hand, I tried to price the Clippers using a rudimentary combination of variables: the annual revenues of the franchise and a multiple of revenues gleaned from the historical transactions:
EV/Sales from NBA transactions in last 20 years
As with the intrinsic valuations, it is difficult to justify a $2 billion price tag on the Clippers, even with assumptions that stretch credibility. You can download this spreadsheet as well and see if you can derive your own price.

There may be more fanciful multiples that deliver a price closer to $2 billion. For instance, you could divide the transaction prices by the population of the metro area served by the team and then scale this up to reflect the larger LA media market. Thus, taking the $550 million that was paid recently for Milwaukee which has a media market one tenth the size of the LA media market, and assuming a 50:50 split of the LA market with the Lakers, you would arrive at a value of $2.75 billion for the Clippers. Go figure!

The Clippers as a play toy
We may be spinning our wheels, trying to find rational (and financial) explanations for why Steve Ballmer paid the price that he did, when the  answer may be much simpler. He has really wanted to own an NBA team, especially one in a glamorous media market. Last year, he was thwarted in his bid to buy the Sacramento Kings and this time, it looks like he is leaving nothing to chance. In effect, he is paying an premium over even the most optimistic value or price assessment for the team, to have an expensive play toy. How expensive? Given the media revenue potential of the Los Angeles market and the global growth of the NBA, I would be hard pressed to attach a value (or a price) of more than $1.2 billion for the Clippers, leaving me with an 800 million-dollar toy. While that would be well beyond the reach of even a regular billionaire, it is affordable to a man who is worth $20 billion.

Looking at the ownership lists of the six franchises, the trend towards multibillionaire owners is more pronounced in some leagues than others. Of the top 20 European soccer teams, about a third have been acquired by billionaires who either made their wealth elsewhere or inherited it. Among US professional sports leagues, the NBA leads the list, with about a quarter of the firms in the hands of wealthy toy-seekers. As a fan,  I will never be wealthy enough to be able to spend a few billions to buy my favorite team, but I don't begrudge someone who does, especially if he or she acts in a way to make my team a winner. If it troubles you to see your favorite team become a plaything, you should be far more horrified if you are a fan of an IPL team. The wealthy individuals who own IPL teams do so through publicly traded corporations that they control, thus using stockholder money in these firms to advance a personal interest. The opacity on both the governance and the financials, both at the franchise level and the league level, is troubling, making it  difficult to pass judgment on the financial well being of the league and may be contributing to self-dealing and potentially illegal activity.

I would hasten to add that while the desire to acquire glamorous assets and pay ego premiums may be clearly visible in sports franchise acquisitions, they are not restricted to them. In my post on acquisitions little over a year ago, I drew attention to the hubris hypothesis for acquisition premiums, relating them to ego and pride. If Steve Ballmer is over paying for the Clippers, he is at least over paying with his own money. When as CEO of Microsoft, he paid $8.5 billion for Skype, it was Microsoft stockholders who were put at risk from over payment.

Downloadable data/spreadsheets
Intrinsic valuation of Clippers
Pricing of Clippers
Raw data on MLB teams
Raw data on NFL teams
Raw data on NBA teams
Raw data on NHL teams
Raw data on European soccer teams
Raw data on IPL teams
Forbes pricing of sports franchises (2013)


Anonymous said...

Just out of curiosity, why no control premium added to your calculated value of 1.61 bil. if you added say, a 20% control premium, you get pretty close to the 2 bil.

Anonymous said...

Would have been good to see the valuation compared to all the MSFT ones in the past, including Skype!

You could always look at buying a US cricket franchise.......

Aswath Damodaran said...

A control premium is a concoction created by bankers to justify bad deals. If control has value, it only because you can change the way a business is run and the $1.6 billion already assumes that you make the Clippers the most successful NBA franchise in history. If you pay a premium on top of that, you are paying for nothing!

Anonymous said...

How would you have factored in the survival risk explicitly in the valuation, assuming it had not been low?

Pardeep said...

Would you be so kind as to explain why EV/Sales is the preferred valuation metric for sports teams? It would be much appreciated.

Aswath Damodaran said...

If you have survival risk, you should just multiply the value that you get by the chance that the team will not make it. In new sports leagues, this can wipe out a large chunk of value. As for why I focus on sales, any accounting earnings based number from a sports team is suspect, partly because of how teams account for bad player contracts and partly because these earnings numbers are often used as bargaining chips when team owners negotiate with players.

Jeff and Emily Schrock said...

SteveB probably didn't look at these types of analyses. He wanted an NBA team, he can afford it and you only live once.

That said, you didn't take tax into consideration. Assuming he's still long MSFT (which he is) and there is a tremendous amount of unrealized capital gain (which there is), he could potentially borrow $2 billion, get a $400 mil per year interest expense and use this to reduce his MSFT capital gain liability. This is the type of analysis billionaires do.

Aswath Damodaran said...

No. This is how billionaires who want to become mere millionaires think. There is a simple rule in finance. Don't do something stupid to justify doing something smart. Borrowing money to save taxes may be a smart move for Ballmer (though capital gains are realized only when you sell the stock and interest expenses occur continuously) but Ballmer can borrow $2 billion or $ 4 billion right now and not buy the Clippers. Instead, he could put the money in a global index fund or the stocks of his choice and save himself the $800 million he is overpaying for the Clippers.
As for your first comment, that is exactly my point, that he is buying the Clippers as a toy. But he is doing so, inspire of the numbers, not because he does not know what they look like.

jda 835 said...

Jacksonville Jaguars were sold in 2012. Wayne Weaver sold the Jaguars to Shadid Khan for about $760 million. Sale closed in Jan. 2012

Steve Gupta said...

Great post. I love analysis like this and was surprised at the level of correlation between the various valuation methods.

I often ponder, what value of toys I can afford relative to my net worth. Unfortunately my current (and retirement) cost of living is a higher % of my net worth than Mr. Ballmer's.

Aswath Damodaran said...

Jda 835,
Thank you. Fixed the table to include Jacksonville sale in 2012.

Califogia said...

EBITDA multiples tend to be the industry norm in valuing established firms. When looking at the the various valuation estimates for the Clippers, the EBITDA multiples trended between 10x (2012 valuation) to 13x (Ballmer's valuation). Major determining factors for your EBITDA multiple tend to be your revenues (larger revenues command higher multiples) & your EBITDA margins (better margins command higher multiples). This team is in LA (huge market) & stands to renegotiate the local TV deal (no revenue sharing) at the end of 2015-2016 season & the overall NBA also will be renegotiating in 2 years time for national TV. There stands to be a significant increase in top line revenue growth given the Clippers overall popularity/starpower, while not impacting your overall cost structure to operate a franchise, thereby improving your EBITDA margins as well.

What I would say is Ballmer overpaid for what the value is today, but with two huge negotiations in the near future, I think he could stand to get full value (if not more) in less than 2 years time. There are risks to getting it there, but Ballmer is aware and will be sure to be VERY involved in both processes I'm certain.


The two seem like a good fit.

Anonymous said...

Hi great post Prof Damodaran.

Wondering if you could enlighten me on a slight confusion over DCF valuation. When we calculate the equity value, the net debt that is deducted/added to the enterprise value, should we be using the T+0 amount or T+1 amount, if we are calculating a 1 year forward target price?

Thanks a lot!

Aswath Damodaran said...

You need to subtract out just today's number.

Anonymous said...

@Prof Damodaran, thanks so much!


Stas Nurko said...

Image 2 reflects 1 month revenue, which you mentioned as 1.1 billion. 20% as Uber's revenue is 220 million each month!! not yearly!! Considering your suppose of 300 million it should be 300*12 months= 3.6 billion Uber's revenue instead of 300 million. I put this number into your spreadsheet, left all another variables unchanged and got 10.3 billion company's value which is significantly closer to 17 billion, but anyway I agree that not enough.

John Leontop said...

You show clearly that all Microsoft shareholders should be glad Mr. Ballmer was pushed out (many thanks to ValueAct???), so that he can now concentrate on wasting his purely private money instead of shareholders´funds on totally overvalued acquisitions such as e.g. Skype; it could be quite a case for a psychologist to find out how such an outstanding brain (a perfect score of 800 on the mathematical section of the SAT according to Wikipedia) could go so astray

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