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The CFO of Major League Baseball fields questions about debt, labor costs, and the steroid problem.
David M. Katz, CFO.com | US
March 26, 2009
To invoke the name of a 1949 baseball movie: it happens every spring. Well, two things actually happen, observes Jonathan Mariner, the executive vice president of finance for Major League Baseball: one glorious for the game, and the other not so hot.
Looking out at the potentially dire effects of the economic meltdown on the National Pastime, Mariner notes that his boss, Baseball Commissioner Bud Selig, likes to say that "hope and faith are what baseball is about. Every single team is a contender in March." One need only recall last year, when the lowly Tampa Bay Rays, who never had a winning season before, won the American League pennant. "And so hope springs eternal," the baseball finance chief says. And baseball sells nothing if it doesn't sell hope.
At the same time, Mariner says, every spring there's a scandal. He points especially to the fact that the scandal involving the Yankees' Alex Rodriguez 2001-2003 use of steroids emerged "somehow or other" just as players were starting to populate the fields of Florida and Arizona to start pre-season training.
Mariner feels the ongoing story of how the Bay Area Laboratory Co-operative (BALCO) and others allegedly spawned steroid use by Barry Bonds and at least 104 other players has been overblown by the press and prosecutors. He admits, however, that the financial outlook may not be as brilliant for MLB as it has been in prior years. Just as you might expect, baseball's Pollyannaish owners were late coming to the realization that there was a financial crisis afoot that could affect their optimistic predictions.
Mariner began picking apart those bright forecasts, and owners have responded with cost-cutting and special promotions. Further, he's proud that the financial discipline he started dishing out when he joined MLB in 2002 has put the game in a position to absorb some pretty heavy fiscal blows. One of his major accomplishments, he says, was to help put in place severe debt limits-an innovation that forced owners to live more within their means and slow the growth of player payrolls. Under its debt-service rule, club borrowing was curbed to ten times the amount of each club's earnings before interest, taxes, depreciation, and amortization (EBITDA).
Interviewed onstage at the CFO Rising conference in Orlando, Fla. earlier this month by Lori Calabro, the editorial director of CFO conferences, Mariner also fielded questions from members of the audience. Following is an edited version of that interview.
Coming into the season, what letter grade would you assign to baseball's finances?
I would give us today a grade of a B+ or an A-. I came to this office in the CFO role in 2002, when we as a league had lost a half billion dollars by the end of the year. Of the 30 clubs, only three had positive EBITDA by the end of 2002. We had debt that was beyond our capacity to service it. It was growing at a rate that was keeping up with the spending on player payroll. And we needed to put in place something that would change that. We resolved in the 2002 Collective Bargaining Agreement to put in place some specs, and as a result things have really turned around. Today we only have two clubs that don't have positive EBITDA. What was a half billion dollar deficit five or six years ago is now a cumulative positive EBITDA of half billion dollars for the league.
What were some of the steps you took?
I like to describe that era leading up to the 2002 Collective Bargaining Agreement as a time when we were financing player compensation and whatever growth we were realizing through debt. There was a lot of available debt, very cheaply priced. We put in place the most critical element of that CBA, a debt-service rule. The debt rule said that what used to be balance sheet, ratio-based debt would become EBITDA-based debt. It also said the debt cannot exceed more than ten times EBITDA.
Most people say, "ten times EBITDA, that's a pretty big leverage factor." But not if you consider that most clubs didn't even have positive EBITDA. We had a lot of work to do. But putting that rule in place basically forced clubs to focus on earnings and, as a result, slowed the pace of payroll growth. Payroll has still gone up every year for the most part, but the pace of growth is more in line with revenue growth.
We also put in place expanded revenue sharing. Smaller-market clubs like Pittsburgh and Kansas City are going to benefit greatly from the new revenue-sharing plan. In fact, Milwaukee went to the playoffs last year and that's an example of how it really made a difference—not only in terms of increasing the club's financial footing but also making them more competitive on the field.
The last thing we put in place was a luxury tax, which created what I call a speed bump. We don't have a salary cap like football, basketball, and hockey; you can spend over the threshold that is set each year under the collective bargaining agreement. But if you spend over that amount, you will pay a surcharge, or surtax, on the amount that you exceed it. When we put the plan in place in 2002 we thought there would be as many as six clubs that would surpass that threshold and would have to pay the luxury tax. It turns out that only one club has consistently passed that threshold. I'm not going to say which one it is.
What headwinds is Major League Baseball facing, and how have you factored them into your budgeting plan?
We face the same headwinds most companies face. I will honestly say that some of our clubs are just now starting to realize that there truly are headwinds. Every year since we put in the new CBA in 2002, we require every club in December to submit to us a three-year projection of their performance. So in December of last year, we had clubs give us a 2009 projection, one for 2010, and one for 2011. We asked them to include with that not just a P&L, but a balance sheet and a statement of cash flow.
\Before that, it was easy for clubs to say, "Next year I'm going to cut payroll and increase attendance." Which all sounds great, except if, with your higher payroll, you don't play well and attract people. And more importantly, how are you going to finance it? And that's where the balance sheet and the P&L and the cash-flow statement came into play.
For this particular season, we also asked clubs for the first time to not just give us those three-year projections, but also a stress test rather than just giving us a one-shot, '09 projection. We control in our office a significant portion of their next revenues from national TV contracts. But just based on their revenues from ticket sales, their local TV contracts, and their sponsorships, we asked them to tell us what would happen if they dropped 10 percent, and tell us again what would happen if they dropped 20 percent.
A lot of clubs in December and November said they didn't think that they'd feel the impact of the economic crisis. We gave it some follow-up and the clubs are in fact starting to see some real resistance of people stepping up and writing that check.
You kind of forced them to give you these numbers. What kind of pushback did you get, and why did you think that there might be a discrepancy between what you thought was going to happen and what the clubs thought?
\We have quarterly owners meetings. And usually in the November meeting and again in the January meeting I will present to the owners the compilations of the teams' forecasts. In the final results they submitted in December, the 30 clubs told us that they thought that together that although they would be down maybe 5 percent in attendance, revenue would actually be up as much as 3 to 5 percent up for 2009.
Some of what they said was fine, because some clubs have pretty substantial TV contracts, and those are usually long-term deals that are contractually obligated and produce fairly stable revenue streams.
But we looked at every single club's base case, its 10-percent-down case, and its 20-percent-down case. And then we said at the meeting, about selected clubs: OK, this one's lying; OK that one's lying. There's no way they could get these numbers. I presented our own projections to ownership. I thought at the time we would be down at least 5 percent revenue, and I think the indicators tell us that it's going to be a tough summer for us.
As CFO, obviously the stress-testing and the increased financial reporting information is a new process for you. What have you learned through this process?
People look at my business and they think, gee, it must be pretty special. One of the things that you learn is that the business principles still apply. You know, there's nothing unique about what we go through. Just to give you some perspective: 2005, 2006, and 2007 were three consecutive years of record attendance for us. And in 2008, we were just off about 1 or 2 percent off of 2007. And so you look at that trend —four straight years of almost record growth— and you think gee, this is recession-proof.
The laws of gravity work for everybody, though. If you can't control your player costs, you're going to lose money. Teams lost money in the 1930s and so I think we're going to see that trend again.
You said some of the things are very predictable as far as your revenue streams. What gives you comfort as far as predicting what's going to happen?
A good part of my business truly is somewhat predictable. At the league level, we generate revenues for the teams from three primary sources. One is our national TV contracts. We've got deals with Fox, with ESPN, with Turner that generate a substantial amount of revenue for clubs. Plus we have national sponsorship deals that we provide that assure revenues to all the clubs. And third, we have licensing revenue. If you see anyone wearing a Yankees cap, a Red Sox cap, or any cap or jersey, all those marks are licensed through our office in New York City. It's divided equally 30 ways, so there's an equal share in all revenue among all the teams.
At the team level you do find some differences in revenue generation. Teams have local TV contracts. Markets like Boston, New York, and Chicago have a much higher source of local revenues, so it creates some revenue disparity. But the revenue is contractually obligated, typically for 10-plus years. So even in times like this, it's a fairly stable source of revenue — one that you can count on for clubs to pay their bills. They have gate receipts that start with season tickets. While season-ticket renewals tend to run in the mid-80 percent range overall, it's probably lagging a bit this year. Clubs have to be very flexible this year in allowing extended payment plans and other innovations. Renewals tend to come out in the late fall and early winter. And so you can use that as a gauge for how things are going to be going.
The schedule will dictate an awful lot of how a team might perform. If you are a team in the National League and you've got the American League East coming to your town, if you've got the Yankees and Red Sox coming, you can count on those dates even if they're weekday dates. You can also count on moving tickets that weekend, and package them with other dates.
So there are some pretty good metrics we use to forecast our revenue that we can count on. The sponsorship revenue is probably one the softest places. As I was going through the club reports for December and discounting or rejecting some on the bases of their 10-percent-down cases, I saw that one club in particular was projecting that their sponsorship dollars would be the same in 2009 as it was 2008. And I looked at the market and I thought there's absolutely no way in this economy, in this market that you're going to be able to keep those sponsorship dollars. And it was true.
In reaction to the economic downturn, some potential sponsors are pulling back on luxury boxes and some very big underwriters for major league baseball, like Bank of America, are under pressure to pull back because they're taking government funds. How do you account for that or even anticipate something like that?
One of our corporate sponsors is Chevrolet [a General Motors brand]. General Motors has already told us that to the extent that they are able to, they would like to retain their sponsorship deal with Major League baseball. Why is that? Because, at the end of the day they have to sell cars — and to sell cars you have to advertise, you have to eke out a market.
But it's also interesting that, for the first time, there are people now saying to companies, to clubs: "There is this outrage involved. Even though we can afford to renew our suite, even though we can afford to get those seats right behind home plate and a few rows back, optically we're having a tough time renewing this year. We're telling our employees we want to cut back. We're telling our clients and other customers that things are tough, and I just can't be seen sitting in those seats or in my suite."
So that's a new dimension that we're facing that I think will have an impact on sponsorship sales beyond what we've seen in the past.
Now that you have all of this information about the clubs' financial health, what are your biggest worries?
In the process that I described, we monitor our clubs' financial health. We do not dig down into the ownerships' financial health. And in this environment, there could well be an owner or two who could have their own personal financial crisis outside of the baseball team. The advantage for us is that [owners are] a very, very select club. To the extent that an owner had a personal financial crisis that caused his club to go into bankruptcy or to consider bankruptcy, the club is protected in two ways. Number one is our debt limits. One of the things that we focused on in enforcing our debt rules is that we limit the amount that a club can borrow with the club as collateral.
Technically, an owner can pledge his shares in the ownership of the club but he cannot pledge club assets. So the club itself is never subjected to being collapsed as part of a foreclosure process.
Secondly, if an owner has a problem financially and needs to sell the club —or worse, ends up in bankruptcy — the courts have recognized that ownership cannot change except by the express, exclusive, and reasonable permission of baseball.
Structurally, every single one of the 30 clubs has one person who we call the "controlled interest" person. The controlled interest person is that one person that baseball looks to for all decisions regarding the club. It is without regard to the financial or ownership stake that that person has. In order to be designated controlled person for the club, baseball must approve that person. And the only way to change it is if baseball says it can change.
So even if that person loses ownership status through his own partnership struggles, baseball can keep that person as the control person that it recognizes. If a club owner is in trouble and reaches bankruptcy, the only way ownership can change is through the baseball commission. We can control an awful lot of what happens in our franchises through both the debt monitoring and making sure that any transfer is done for the best interests of the league and the club.
What are the bright spots? What are you seeing out there that is creative and gives you hope that there will be an upside?
What Commissioner [Bud] Selig always talks about during this time of the year, in spring training, is that hope and faith are what baseball is about. Every single team is a contender in March. Some people think that there's no way my team is going to win. But then there comes a Tampa Bay — Tampa Bay had never had a winning season before last year. And so hope springs eternal.
On a business level, our clubs have already shown signs of being very innovative this year in light of what we might be facing. In San Diego they've got a really unique promotion. It's called the "5 for $5 promotion." You can come to a Padres game and at certain concession stands you can buy a hot dog, a soda, peanuts, popcorn, and cookie a game program and a fifth item — all for $5 total. Five items for $5. And if you want to substitute a beer for the soda, it's an additional $5.
That's the kind of promotion about which I say, by gosh, that might get more people to the ballpark. You always think, if I take my family it will cost an arm and a leg when I get there.
As a reflection of the economy, might we be seeing lower player salaries?
Clubs are much more nervous about how they're spending their money. I spoke to one of our owners the other day who was trying to get a bank loan done, and the bank was being particularly tough about some of the collateral. Banks are guarding their balance sheets now. When they make a loan they've got to have a reserve against it, and their equity on the balance sheet is so important. It's something that they've got to protect. Our clubs are taking the same approach to this.
Do you see the steroids problem as a risk to the reputation of the game?
My view of steroids, and I think it's shared by a lot of my colleagues in our office, is that it is a fascination on the part of the media but not a true reflection of what's happening in our game. We think we have the toughest steroid testing of all sports. If a player tests positively the first time he's examined, it's a 50-game suspension. Two positives, it's a 100-game suspension. The third positive, you're out of the game. It's essentially a life-time ban.
For some perspective, the debate surrounds something that took place in 2003. Drug testing had been an on-going debate between labor and management for some time. We were finally able to prevail upon the union to accept testing. Under the collective bargaining agreement, you cannot implement it unilaterally — you have to bargain for it. Finally, in 2002, we were able to get an agreement in place to test for performance-enhancing drugs.
The agreement was that in 2003, in order to address the union's position that "there is no problem in baseball," we said that we would do survey testing in 2003. If more than 3 percent of all random, non-punitive tests came out positive, we would begin in 2004 to implement true testing with penalties attached. Since 2004, we've ramped up the penalties.
It turns out, separately, that the prosecutor in the BALCO case was looking for evidence against some of the defendants, one of whom was Barry Bonds. Bonds had testified under oath in front of the Grand Jury that he had not taken performance-enhancing drugs. In looking for evidence against Bonds, they found out about these survey tests in 2003 because the union did not destroy the samples, which was their right and their obligation to do.
The prosecutor in that case found 104 positive tests [as part of the 2003 non-punitive survey] as part of his attempt to prosecute the Bonds case and leaked the names to the media. We went to court with the union to protect the names being disclosed because we had agreed to that under their anonymous testing plan.
So everything was under cover for literally six years. Recently, somehow or other, A-Rod's name got leaked as one of the positive tests in 2003. That is the source of all the stories about A-Rod today, the fact that someone in the prosecutor's office leaked his name to the media and all this discussion is about something that happened six years ago.
From '05 to last year we've had increasingly positive attendance. We think the fans believe that our game is clean today. I'll also say that every single year the stories come out at spring training. You know, this information about the testing has been around for six years.
Which team do you root for?
I have two simple rules. I always root for the home team, no matter where I am. Number two, during the playoffs, I always root for the team that's behind in games won. If it's down 2 to 1, I want to root for the team that's won one game. If it's 3 to 2, whoever is down 2 games, I root for that team. Why? Because we make a lot of money in seven games.