CBA Talk: Why it's so good to own a sports team

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This is part 2 on a series looking at the upcoming CBA negotiation. The first article on player salaries can be found here.

By Jared Young (@jaredeyoung)

In September a portion of the Chicago Fire was sold, valuing the team at $400 million. In a sports world where large numbers float by with regularity, another big dollar sign went largely undigested. In 2007, Forbes began to publish valuations of MLS franchises, including the Fire. The first valuation estimated the team was worth $41 million, and so the investors appear to have returned almost ten times their money since then. That’s a 21% annual rate of return, which is a remarkable number for a twelve-year period, especially one that included the great recession of our lifetime. Over that same period, the Average Pat might have seen returns in the 6% range. The Dow Jones Industrial Average (DJIA) had an annual growth rate of 6.1% from the end of 2007 to September of this year, while the S&P 500 trailed slightly at 6.0% over the same time period.

But asset values aren’t the whole investment story. There are also profits from the investments distributed along the way. In the sports world, the owners have operating incomes, and for the Fire those have been mostly negative. In the investment world there are shares of the profits paid out to investors called dividends. The DJIA has paid out roughly 2.5% per year in dividends, increasing that investment opportunity to 8.6%. Forbes estimates operating incomes for MLS franchises, but have only done so six times since their inaugural projection. If you assume their numbers represent the average over the 12 years, then the Chicago Fire investors have approximately put in another $80 million along the way, the worst figure in the league. Even accounting for those losses, the owners have returned 18.7% per year, ten percent higher than the stock market.

But the very wealthy people who can conceivably own a sports team aren’t limited to playing the public markets like most people, they also have access to alternative investments. Even comparing to those higher returning investments, sports teams look appealing. The wealthy have access to alternative investment options like angel investment funds, venture capital, hedge funds and more. Often these investments are less liquid than stocks, meaning once they put money in it’s not very easy to take it out. That’s a serious constraint in sports ownership too. But alternative investments typically have better returns than the publicly available options. According to this report, Venture Capital returns have averaged approximately 15.7% for investments made between 2007 and 2016. From 1970 to 2013 hedge funds averaged returns about 3% better than the US Stock Market. The Chicago Fire compare very well to alternative investments, and so do the majority of investments in sports.

Here’s a chart of the net returns across the major sports from 2007 to 2017, the last full season computed by Forbes for all of the sports covered.

Source: Forbes.com

International soccer clubs are represented only by those clubs that have appeared in every Forbes publication - Arsenal, Barcelona, Bayern Munich, Borussia Dortmund, Chelsea, Inter Milan, Juventus, Liverpool, Schalke 04, and Tottenham Hotspur

The fourteen MLS franchises that have been constant since 2007 lead the way across American sports, and a collection of the top club soccer teams around the world. Their value has returned 6x even when accounting for the net operating losses. The second best league has been the NBA, which gained 5x over that decade primarily due their intelligent tapping of the global market, something the NFL has failed to really do. If you were wondering why owners are lining up around the country to hand Garber and his friends $200+ million to join this league, wonder no more.

The accuracy of Forbes’ valuations         

Before we go too far with these numbers from Forbes, an informal investigation of the work they have done over the last two decades is warranted. There are the Forbes methodology detractors, and there are those that accept their valuations with some indifference, but I have not seen anyone actually attempt to validate their valuations, not even Forbes. To remedy the issue, I found 59 cases where a sports team was sold for a publicly available price and Forbes had published a valuation in the past year. The results:

Values are per million dollars

Sources: Forbes.com, many wikipedia pages and news sites

The dotted line represents the best fit line, while the solid line represents a valuation that exactly matches the purchase price. That the dotted line is higher indicates the purchase prices are higher than Forbes’ valuations. The total sale price of my sample was $36,847 billion while Forbes had previously valued the teams at $28,408 billion - a 30% market premium over the value. Some of that difference can be attributed to the fact that Forbes only values teams annually based on their previous season’s revenue, which would allow time for more growth before the purchase price was determined. But the reality is that purchase premiums over the market value of a company are typically 20% to 30%. If anything, one could argue that Forbes valuations have been a tad conservative over the years. If you take out the Los Angeles bias, the obscene $2 billion purchase price paid for both the Clippers and the Dodgers, that purchase premium drops to 22%, a relatively low number.

Not surprisingly, that conservatism is even more stark when it comes to MLS. When including D.C. United’s 2018 public valuation of $500 million, the purchase premium paid over the Forbes valuation for the two recent transactions is 90%. MLS can do no wrong it appears.

Next is a look at those premiums over time.

There doesn’t appear to be any trend until after the recession when things got exciting for sports owners. The Manchester City partial sale in 2015 and the Los Angeles deals all contributed to a five year run of very high premiums.

Forbes valuations get my thumbs up. Valuations are all about projecting future cash flows, and it’s not an easy task. Now let’s dig in to a few more observations before touching on the MLS CBA.

MLS Franchises since the last CBA

Here’s a look at average annual value growth of the fourteen individual franchises from 2007, plus six more that started prior to 2012.

Source: Forbes.com

If you are still in therapy for post-traumatic stress disorder thanks to #SaveTheCrew, you might want to avert your eyes from the chart. The Columbus Crew returns have been aligned with the average MLS franchise.

Buoyed by relatively new soccer specific stadiums, D.C. United and San Jose Earthquakes lead the pace in terms of value growth for their owners. The sale of a portion of D.C. United definitely contributed to the high growth of that franchise as well. The Colorado Rapids and Montreal Impact are the laggards of the league from 2012 to 2017, at 11% and 10% respectively. The DJIA plus dividend rate averaged 14% over that same period. Sports teams won’t always beat the market during the good times, but Colorado and Montreal can rest on the fact that they’ll likely perform better during the next recession.

Sports teams during recessions

Forbes has been publishing valuations since 1997, across two steep recessions, and the below chart shows that leagues as a whole do quite well across times when other markets have been faltering.

Source: Forbes.com

The NBA’s recent surge comes across more clearly when looked at over two decades. It went from the fourth best league in terms of value growth to the top league over the most recent seven year period. That MLS has topped that growth is impressive, and it’s clear there is plenty more runway for the league when looking at revenue growth.

Revenue growth and operating profits

This analysis has focused on annual growth rates so far, as that’s the standard method of measuring investment success. Let’s now turn to revenues and profits at a league level to look to examine how owners might consider higher expenses from a CBA negotiation. Here is a look at the key ratios from the 2017 seasons across sports.

Source: Forbes.com

These ratios reflect the market value placed on the observed revenues and incomes from the seasons starting in 2017.

It appears as though Forbes uses a value to revenue ratio to determine their valuations, as MLB’s value to income ratio is extremely high and MLS doesn’t have a positive one. These ratios are very healthy. According to this survey from the Stern School of Business the average value to sales ratio is 1.77 with only a handful of industries like Software and Biotechnology that reach the average sports league. Using that metric, the NBA is in the power position again with a value to revenue ratio of 7.0. MLS is next, however, with a value to revenue ratio of 6.8. This is despite a negative operating margin that is estimated at -8%.

Source: Forbes.com

Based on incomes and revenues from the seasons starting in 2017

The expectation, of course, is that MLS will achieve similar profitability to the other leagues, which averaged 18% of revenues in 2017. In the meantime, they are the beneficiaries of strong growth. MLS grew revenues 390% over the last decade while NBA great run was driven off more modest revenue growth of 124%.

MLS is earning their strong valuations on the back of revenue growth, and the expectation is that they’ll eventually turn their -8% operating margin to 15-20%. The issue as we turn to this CBA is how many more losses will the league want to pile up in the short term knowing that their overall returns will still be strong enough to overcome them?

MLS owners and the CBA

We’ve established that owning a sports team is at the very least on par with, and likely better than, the alternative investment options available to people with lots of money to invest. We’ve also established that sports investments perform exceptionally well during recessions. We’ve shown that the value of MLS franchises as a whole have grown at a faster rate than any other sports league since 2007. That’s partly due to their smaller size, but there have been plenty of small leagues that have gone the other direction. The bottom line is, it’s good to be a sports owner from a financial perspective, even if the money is illiquid, and even if there are some additional investments made along the way. While this is a meta-analysis using Forbes’ work to put sports investments in context, you can bet that these savvy financial owners are keenly aware of these dynamics. See also: the line to get in forming outside Don Garber’s door.

The owners appear to have a precious asset, but they are losing money operating the league. Let’s try to add more context as we close in on a big CBA negotiation. Here are a few things we know.

  • According to the player union salary releases the league is spending nearly $300 million on players in 2019, not including net transfer fees.

  • Following the last CBA negotiation the player compensation immediately increased 20%

  • According to Forbes, the franchises collectively lost $63 million in 2017

If for the 2020 season the salaries increase 20% like last time, it’s another $60 million in costs per year, and regardless of who pays the salaries, the single-entity or the owners, it will still impact the overall value of their shares. There would also be offsetting revenue from such an increase, as there would presumably be better tickets revenues because of the increased quality of the league, as well as improved sponsorship revenue. And as we’ve seen historically the value growth of the asset has more than compensated the owners and the league for their operating losses. And now back to the question: how many more short term losses can the league afford while knowing they’ll get compensated further down the line?

Let’s look at two ways to can try to frame the cost of the short term sacrifice in wages. First, we can simulate what would have happened in the last decade. Going back to the Chicago Fire example, we’ve established annual gross asset value growth of 21%. Net of operating losses the return shrank to 18.7%. If average wages were 20% higher over that time frame and all of those losses went straight to the bottom line, then the returns would have been 18.3%. Such a sharp increase in wages would have had almost no impact in the big picture. We are really evaluating the impact of an exceptional increase, one that could really offer a step change in the quality of talent attracted to the league.

Through a different lens, Forbes increased the total value of MLS teams from $4.458 billion in 2016 to $5.529 billion in 2017, an increase of $1.071 billion, or 24% year-over-year growth. A removal of $60 million, or even $120 million, due to higher wages would still give the ownership growth of 23% and 22%, respectively. Phenomenal. It’s also worth noting that Forbes is very likely already considering some wage growth in the valuation.

Even though the league might currently be losing money the growth of the owners projected team values is more than compensating them for those losses, and very sharp increases in player wages would do little to alter that story. The owners might pull their pockets inside out showing us how much their spending on the league, but someday they’ll be cashing out and stuffing those pockets full.

Note: Forbes recently released their valuations for the 2018 season. The total value of the 24 teams included is $7.5 billion, nearly a $2 billion increase in value from 2017 or 36%. That increase was larger than the cumulative increase between the 2007 and 2012 seasons.