Sometimes, a topic comes along that pretty much justifies the existence of your blog. I got an early Christmas present right before Easter. Or something like that. One of major league baseball’s most important franchises was sold at a controversially high price. Baseball and business dominating the front pages??? BINGO. This is like a Jamie Moyer “fastball” down the inner half of the plate and thigh-high. All I have to do is square up the pitch…
A couple of weeks ago, word came down that the beleaguered Los Angeles Dodgers had finally been sold for approximately $2.1 billion. The price stunned the sports world in light of the fact that no baseball team had ever sold for an amount above $1 billion, let alone $2 billion. Further, the perception was that the Dodgers, a franchise that struggled for competitive respectability under Frank McCourt, might be had for a relative “song”. For one really cool morning, the Mike & Mike on ESPN Radio and Ken and Tom on Bloomberg Surveillance were talking about the same thing! The transaction occurred against the backdrop of a tidal wave of negative public opinion around McCourt, who had been perceived as a guy who bought a team he couldn’t afford with debt, and proceeded to reduce payroll to make ends meet – turning the Dodgers from a jewel of Major League Baseball into a struggling, small market team. An investigation by the Los Angeles Times indicates that reducing the team’s payroll was apparently by design. In 2011 the Dodgers applied for bankruptcy protection, which happens in baseball more often than you would think. The Orioles were bought out of bankruptcy in 1993 and the Texas Rangers in 2010. We look at an owner like that and think he should be put in the state fair dunking booth, not walk away a cash billionaire. But buying a company and squeezing more profit from it is supposedly the American way, or at least that’s what Mitt Romney should be saying on the campaign trail…
So we have a guy who buys your baseball team, is able to do so apparently because he has the right rich friends to back him, not because he has amassed this wealth himself, and then reduces the fan experience in order to pay that debt. With this deal, McCourt pockets an estimated $1.5 billion, with the balance being assumed debt and payouts to his ex-wife, Jamie (who reportedly cheated on her husband, not the other way around). So, to sum up, McCourt charmed his way into buying the Dodgers, weakened the team in the 8 years that he owned it, and then walked away with $1.5 billion. I get it – not a sympathetic figure. But if we’re honest with ourselves, the outrage has a lot more to do with envy than it does with outrage at a high price being paid for an asset. We are envious because it doesn’t look like McCourt “earned” that payout, and we are perhaps saddened because under his ownership, the Dodgers didn’t win a World Series. But, with all the vitriol, I’ll bet it would surprise you to learn that over the period of his ownership (8 seasons) , McCourt’s Dodgers were actually 645-620 with 2 90-plus -win seasons and only two seasons below .500 – he was not as bad an owner on the field as he is made out to be.
So, putting the emotions aside, let’s look at this deal. Did Magic Johnson’s group truly overpay? If they did, what are the implications?
I’m going to invoke a little valuation vocabulary here. Value itself is a squishy concept. There are many definitions of value (we call them standards of value) that are invoked, depending upon the purpose of the valuation. I think that that standard that tends to fit the layman’s definition is fair value. To make things trickier, there is no standard definition of fair value. The Financial Accounting Standards Board (FASB) has a definition for accounting purposes. The federal Revised Model Corporation Act has a definition (adopted in many states) that applies to dissenting minority shareholder disputes. And yet again, many states have a different definition for purposes of divorce. Without getting all Webster’s Dictionary on you, I’ll boil down fair value.
Fair value is the theoretical price at which a company or company interest would sell when the buyer and seller are perfectly willing and both have knowledge of all relevant facts to make an informed decision on the transaction.
By definition, fair value generally ignores considerations of distress or synergies. Fair value also generally ignores considerations of discounts for minority interest, and only sometimes considers restrictions on transfer. Fair value represents a transaction where the buyer and seller have an equal desire to own the asset and they have perfect information about the asset. In other words, fair value only happens on paper.
Now, I do a lot of transaction related work – more than most of my competitors- and by transaction work I don’t mean compliance to report a transaction or fill out a tax form, but actually helping people buy and sell companies. Buyers and sellers view fair value a little differently. Buyers view fair value as the highest price they are willing to pay without feeling like they overpaid, and sellers view fair value as the lowest price they are willing to accept without feeling like they are being ripped off. The buyer’s high point doesn’t always meet the seller’s low point and that’s when the transaction dies.
The term “fair value” resonates with most Americans. We have an innate desire to believe that the world operates in ways that are fair – that justice ultimately prevails, even though most grown-ups recognize and instruct their children routinely that life isn’t fair. We are disillusioned when the stock market is revealed to be unfair, such as in 2000. We are disillusioned that the housing market is revealed to be unfair, such as in 2008. We are outraged when Netflix has the temerity to raise their prices and feel justice when their spineless CEO rolls them back (and then Netflix was savaged by the stock market). And so it should perhaps come as no surprise that there is genuine outrage at the price paid for the Dodgers, even when nobody expressing such outrage was in any way a candidate to actually buy the Dodgers. “They paid too much” the commentators and talk show callers say.
When valuing a company, one of the things we try to do as appraisers is look at comparables. There are no publicly traded baseball teams. Luckily, there have been some sales of MLB franchises in recent years. The Cubs, Curse of the Goat and all, sold for $845 million in 2009. The Rangers sold in 2010 (out of bankruptcy) for $608 million. The Astros sold for $680 million in 2011. That price is likely discounted because MLB is making them switch to the American League in 2013 – old rivalries are going away, although they will play the Rangers more – and they will have to re-tool their team for the American League game (more emphasis on power, less on speed and position versatility). Speaking of curses, the Boston Red Sox sold in 2002 for $660 million (and through a strange wife-swap-like chain of events, precipitated the end of the Montreal Expos). In case you are wondering about the real estate, such as the parking lots and the stadium, both are usually sold with the team and I have assumed this to be the case for purposes of this analysis. I would argue that the Cubs and Red Sox have brands equally as strong as the Dodgers, while the Astros less so. Interestingly, the Cubs and Dodgers have competition in their home cities, the White Sox and Angels – please don’t make me remember what their full name is right now, respectively), so the Cubs are perhaps the most comparable, even though I think the Red Sox, with two World Series Championships since (I still tear up when I see highlights of the 2004 series with Keith Foulke underhanding Edgar Renteria’s comeback grounder to Doug Mientkiewicz.) and the renovations to Fenway, are far more valuable now than 10 years ago (and indeed were valued at $870 million by Forbes in 2010). So, it does seem the price paid for the Dodgers is far greater than a comparable sale.
How about some independent valuations? Forbes valued the Dodgers at $727 million in 2010 (though no standard of value was indicated, I assume it to be fair value-ish) and jacked that up to $1.4 billion this year. But here’s something really interesting – recall that the McCourts (Dodgers’ owners) were going through a messy divorce – think what happens if you put Jerry Springer on a $1 billion stage. When a business is up for grabs in a divorce, both spouses hire experts to develop an independent opinion of fair value (there’s that term again!) of the business is and testify on that opinion to the court. Those experts’ testimony ranged from $900 to $1.3 billion. Further, it appears that the next highest non-winning bids were approximately $1.3-$1.5 billion, so the winning group outbid the others by at least $600 million.
So, these “market” indicators show that $2.15 billion is much higher than “fair value”. How about an income approach? In 2010, the Dodgers made $33 million in EBITDA. So call it $20 million after taxes. Let’s assume 4% annual growth in EBITDA (using this as a blunt instrument proxy for cash flows) is sustainable (IBISWorld writes that sports franchise revenue, including all sports, has a long-term growth trend of over 5%). Let’s further assume a cost of capital of 7%, so the capitalization rate is 3%. Employing the Gordon Growth Model, we get a value of $693 million. Next, let’s add back the amount of cash the McCourt’s were taking out for their lavish lifestyle. Reportedly, Jamie McCourt was paid $2 MM per year and two of the McCourt’s children were paid $600,000 per year, each. Assuming reports of the McCourts’ $2 million per month lifestyle are accurate, let’s assume Mr. McCourt took out $5 million per year (I suspect it was more like $10 but have no data to support either number so I’m going conservative). That’s $8.2 million per year in pretax addbacks or $5 million after taxes. Even that only gets our value up to $866 million. Next, the Dodgers were paying $9 million to a McCourt company for parking lot rental (which had been free to the Dodgers prior to the deal). McCourt still owns an interest in the parking lots so let’s say the rent is adjusted downward by 50%, or $4.5 million, or $2.7 million after taxes. Up to $960 million.
Now, let’s say that the buyer group expects greater profits going forward. Attendance was at a relative low, and a big deal is about to be signed with FOX, and there’s talk of creating a regional sports network around the Dodgers like NESN for the Red Sox and YES around the Yankees. The Dodgers generated $247 MM in total revenue in 2010 and the deal that MLB turned down for the Dodgers was $3 billion (including $345 up front). The Angels down the street just signed a similar deal, so clearly the TV deal is market-ish value. Let’s say that FOX has no hard feelings and the Dodgers could get that deal back. It was for 17 years. Add $345 in cash right now and our value is up to $1.305 billion. TV revenue for the remaining 17 years is $156 million, per year. That’s $100 MM per year greater than what they are currently getting ($55 million). After taxes, that’s another $60 MM to the bottom line! With an
$87.7 million adjusted/projected EBITDA, that’s a value of $3.04 billion.
If you don’t agree with some of my assumptions, put them in a spreadsheet. Heck, I’ll send you mine. There’s an awful lot of leeway just to get the value down to $2.15 billion. But, good little valuation analyst that I am, I did do some sensitivity analysis. This model in particular is very sensitive to growth. a 3% growth rate (which was the average for MLB in the last 5 years, even through a murderous recession) gets the value down to $2.3 billion. A 2% growth rate gets the value down to $1.8 billion. Still, to get down to the supposed fair value according to the divorce experts, you have to assume growth of 0% forever. I’m not really open to entertaining the argument that baseball will have zero growth in the long term. Adding percentage points to the cost of capital works the same way. If the cost of capital is 9%, the value gets down to $1.8 billion.
Note: I haven’t even discussed Internet revenue or stadium naming rights. Before you gag over the latter, the (new) Boston Garden is now called the TD Garden. If the arena that succeeds the house that Russell, Bird, Orr, Bourque, Bucyk, Havlicek, Cowens and Pierce played in can be sold out to corporate naming, so can Dodger Stadium. Bet on it. Figure that’s another $15 million in annual revenue, easily.
It’s important to note that this sale was also effectively a distressed sale. Frank McCourt clearly didn’t want to sell the team if he didn’t have to – but the divorce made that a foregone conclusion. The Dodgers themselves were being run into the ground (remember EBITDA is before interest on debt), to the point where the Dodgers were having trouble making payroll and in April 2011 MLB Commissioner Bud Selig invoked the “Best Interest of Baseball” clause to appoint Tom Schieffer as the Trustee (basically a receiver) for the Dodgers. The Dodgers were in bankruptcy. Basically, the Dodgers couldn’t necessarily hold out indefinitely for the highest bid, which is why they performed a blind auction. They had a gun to their heads and a loan shark waiting around the corner with a crowbar. The Dodgers’ weak bargaining position means that in all likelihood they could have easily held out and gotten more than $2.15 billion. I think the distress scenario is the reason more bids were not over $2 billion. Some buyers low-balled hoping to get a distressed asset and take advantage of a distressed owner on the cheap. One group decided not to low-ball and instead we rake them over the coals for actually paying up.
But, you ask, what about all those other baseball deals where the teams were sold so low? How can that be? The answer is that the market and industry have changed, even since 2009. The Texas Rangers signed a landmark TV deal worth $80 million a year. This in a state where another game tends to dominate the landscape. Oh and by the way, the Rangers themselves were bought out of bankruptcy after Tom Hicks ran them into the ground, driven largely by the Alex Rodriguez deal. Once TV deals in larger markets such as Chicago, New York and Boston re-set, we will routinely see $2 billion+ franchise valuations. and I haven’t even discussed the goodwill inherent in the Dodgers brand.
The Dodgers sale illustrates a few lessons. First, the market approach, while worthwhile, is limited. It is backward looking – particularly when relying on market transactions.
In this case, using prior franchise sales as comparables without adjustments fails to consider the changing landscape of TV deals (which is where most of the value is).
Second, it illustrates the danger of relying on emotions when engaging in or analyzing a transaction. I think a lot of people wanted the Dodgers to sell low so McCourt would be poor, which was just not going to happen.
Third, sometimes the unlikable guy wins. That’s life.
Fourth, if you want the highest price for your business, create an auction. It’s a pain in the neck and it is both disruptive to your business and emotionally challenging, but that’s how you max out your sales value when you have one asset to sell.
Finally, it illustrates the importance of homework. All these guys who are blasting the deal aren’t running the numbers. It’s OK for sports guys to do that. I don’t listen to Colin Cowherd for stock picks. (I do think he’s the smartest guy with a national radio talk show.) But if you’re a finance guy, be prepared. If I can run these numbers from home on my two-bit blog, you can have your Ivy League interns run them.
My thanks to Lana Stafford for assisting me with the research for this blog.