Wednesday, March 11, 2009

The Yankee infield and debt...

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.


Jaimin said...

Just a thought on similar lines.

Would you account for the salaries for the entire organisation when you acquire a firm? Especially in industries which are driven by human capital like financial services and IT.

If not entire company, may be top management?

Aswath Damodaran said...

There is an argument for some management contracts, but most of us don't have this kind of power in the organizations we work in. (It is true that I have tenure but that guarantees me a job but not a salary).

DWP said...

Dr. Damodaran:

Your point's very well made. This type of financial commitment certainly smells like debt. However, what about the asset side of the balance sheet? Should you present value A. Rod's services?

In similar fashion, if you're comparing the performance of two restaurant chains - one that owns the real estate and one that has operating leases - does "booking" the present value of the leases as debt lead you to recording a similar amount as a fixed asset?

Trust - Me said...

I would imagine the value placed on the Yankees would suppose to incorporate future cash flows from all sources, of which A Rod's contribution would be included.

DWP said...

Without question, the present value of A. Rod's services (and the rest of the outfield) are incorporated into the value placed on the Yankees. My questions are more geared toward modifying the asset side of the balance sheet in order to make two businesses more comparable. It's not necessary to capitalize A. Rod's services to make the Yankees' balance sheet comparable to the Mets because no professional baseball team (to my knowledge) records such an asset. However, there are many times that one tries to compare Company A to Company B and finds that A owns its real estate while B leases it. Many comparisons, such as ROA, are skewed by this structural difference.

Aswath Damodaran said...

Balance sheets have to balance. If you do capitalize these contracts, you are in effect putting on your superstars on your balance sheet as assets... Scary thought!

Anonymous said...

I guess my thought is it would be impossible to attribute cash flows to a certain player. I think it would be a case that the whole is greater than the sum of the parts.

We could attribute only a few things such as sports apparel with the players name tied to it.

Ticket revenue and other revenue sources that require the whole team would be impossible to break out individual players contribution.

Could a team of joe's off the street still bring in a crowd at Yankee Stadium... probably a bit, so not all revenue can even be attributed to just the players.

Would trying to figure out the NPV of a player be an exercise in futility?

It would be interesting to see how well the market (Major League) does in assessing how much players are actually worth(NPV of incremental cash flows).

shravan dharmaraj said...

Hello professor..this article of urs has set my thoughts rolling on IPL too..Companies (listed ones) have made high profile player acquisitions (eg..UB and Reliance groups)and these too represent debt committments for an extended maybe we must factor in this 10 year sort of contracts while valuing them..thats a nice reminder:)

Andrew said...

"Balance sheets have to balance. If you do capitalize these contracts, you are in effect putting on your superstars on your balance sheet as assets... Scary thought!"

I have a uni assignment on this very topic... the topic is should Chris Judd (Australian Rules Football) be recorded on the balance sheet?

with companies recording biological assets such as sheep, plants, trees etc etc what is the difference?

Does A Rod not provide future economic benefit? surely his value can be measured? and impaired if need be?