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Squeeze Play

Forget steroids. It's spending that has baseball in a bind.
Tim Reason, CFO Magazine
April 1, 2004

It's been called the biggest deal in baseball since the Boston Red Sox sold Babe Ruth to the New York Yankees in 1920. And, as fate would have it, it was the Red Sox who once again let one of the game's best players slip away when the Yankees acquired shortstop Alex Rodriguez from the Texas Rangers in February. Only weeks earlier, the Sox had abandoned efforts to bring A-Rod to Boston by restructuring his $252 million, 10-year contract.

Red Sox owner John Henry fueled the ensuing Boston-New York tabloid frenzy by grousing that "baseball doesn't have an answer for the Yankees," and calling for a salary cap. Sour grapes, shot back Yankees owner George Steinbrenner, taunting Henry for not going "the extra distance for his fans."

Here we go again. As the duel between the two richest teams over the highest-paid player demonstrates, baseball does not reward financial control. "Baseball is a funny game," muses Bob Furbush, longtime CFO of the Red Sox. "From the financial standpoint," he says, pointing to his chest, "we're here to make money. From the owners' standpoint, they're here to win the World Series. It's a dichotomy."

That's far from the only contradiction in the peculiar world of baseball finance. Thanks to the soaring cost of buying and running a baseball franchise, almost all teams have CFOs, who are generally prized more for their CPAs or MBAs than for their knowledge of ERAs or RBIs. But between bosses who hold the purse-strings and a player's union that controls the rules, those CFOs are constantly pitching out of a jam. One consolation: they can get away with reporting yearly losses—and most do—that would get them fired in any other industry.

In baseball, in fact, there is no bottom line. Even winning does not guarantee financial success. Florida Marlins senior vice president and CFO Michel Bussiere says the World Series champions "suffered an operating loss" last year—"as we did the year before." Those losses are key to Bussiere's argument that the team needs public funds to help build a new stadium (see "Build It and They Will Spend," at the end of this article). But like most of his peers, he clams up when pressed about team debt and other financial details. "This is a private partnership," he says. "I don't normally disclose numbers unless the owners desire to."

Indeed, the Yankees turned down CFO's request to interview CFO Martin Greenspun, citing a reluctance to expose that front-office function to public scrutiny. Greenspun, like his fellow CFOs, has every legal right to guard his finances from public scrutiny (only three teams are owned by publicly held corporations). But baseball's lack of transparency also fuels skepticism about the sport's perennial claims of poverty.

Major League Baseball CFO Jonathan Mariner counters that teams do share their financials with MLB, which distributes the numbers to the other teams and the players' union. Still, he admits, "one of the biggest challenges we face financially is the perception, in this fishbowl-like environment, that things aren't right."

A Game of Monopoly
Even baseball's harshest critics agree that at least a third of the teams—not just the Montreal Expos and the Minnesota Twins—are losing real money. More to the point, all of them agree that the sport's economic model is a mess. And no matter how well run their own teams are, baseball CFOs cannot escape that model.

In finance terms, baseball's 30 teams are best viewed not as competitors, but as franchises of a self-regulating monopoly conglomerate. (Baseball has long enjoyed a unique—if debatable—exemption from antitrust law.) Team CFOs report not only to their presidents and owners, but also to Mariner, who has something of a hybrid job—the former CFO of the Marlins manages both the finances of the league and the financial health of all teams. That means he can force individual franchises to comply with certain financial controls while at the same time administering the league's luxury-tax and revenue-sharing systems.

In both cases, his goal is to correct—or at least mitigate—the vast economic gulf between teams, which is increasingly reflected in the caliber of the players put on the field. With the addition of A-Rod, the Yankees payroll is estimated at about $184 million. By contrast, the Tampa Bay Devil Rays' payroll comes in at a meager $20 million. Little wonder that when a blue-ribbon commission on baseball competition issued its report in 2000, it noted that spending must be "tempered by regulations designed to ensure fairness...among clubs with unequal economic resources."

How well the current regulations work is a subject of fierce debate. Many see the battle for A-Rod as unequal economic resources run amok. "There's a cadre of five to eight teams, led by the Yankees and the Red Sox, that can purchase better players than everybody else," says Colorado Rockies CFO and general counsel Harold Roth (at close to $60 million, the Rockies' 2003 payroll is around the median for all teams). "If the Yankees don't win every year, shame on them," he says.

Mariner doesn't dispute that view, but sees a silver lining in the Rangers' willingness to pick up part of A-Rod's $25 million­a-year contract. "The richest club in baseball was willing to pay only $16 million a year for the best player in baseball," he says. "So one could argue that it has established a new, and lower, cap on the price of a ballplayer."


That argument is largely theoretical, however, since baseball—unlike football—does not have a salary cap. Instead, any restraints on player salaries have to be "generated by some sort of fiscal responsibility," says the Red Sox's Furbush. And that type of cap lacks teeth, for two reasons: first, as most CFOs interviewed for this article admit, they have little control if owners decide to buy the next A-Rod. "If the owner tells the general manager he's willing to put in more money, that's his [green] light to go," says Marlins CFO Bussiere. "I wouldn't want to argue against it." More important, the player's union tends to view with suspicion any concerted effort at fiscal restraint.

For example, baseball CFOs widely attribute today's shorter contract lengths and a recent drop in player salaries to market conditions: insurers will no longer cover long-term contracts, and teams are using improved statistical methods to find and hire undervalued players. But the number of "untendered" players (younger players who become eligible for salary arbitration but are instead released by their teams) flooding the free-agent market has reportedly led the union to consider once again bringing collusion charges. (In 1990, MLB was found guilty of collusion and fined $280 million.)

Indeed, although baseball's finance chiefs work together on many issues, any explicit agreement to sit on their wallets at hiring time would be a serious violation of baseball's labor contract. The union's control extends further than outright collusion. The current collective-bargaining agreement (CBA) between the players and MLB spells out rules for just about every aspect of baseball finance and its accounting, from obvious salary-cap substitutes like luxury taxes to more-subtle "fiscal responsibility" initiatives such as team debt limits.

Behind in the Count
Fiscal controls such as debt limits are considered a labor issue because they ultimately limit spending, and baseball teams spend the bulk of their money on salaries. At the same time, it's clear that the increase in salaries over the past decade (as well as the soaring cost of buying a franchise) have contributed to a massive debt load in Major League Baseball. According to the blue-ribbon commission, aggregate team debt nearly quadrupled from $604 million in 1993 to $2.08 billion in 1999. Current estimates of combined team debt range from $3 billion to $4 billion.

Bussiere says that that debt growth is the best answer to those who are skeptical about baseball's reported losses. "Most of the teams have been driving losses and financing them through debt in the past 10 years," he says. And without some relief, says Los Angeles Dodgers CFO Cristine Hurley, "we are going to lose our ability to run our business."

Mariner says the debt issue is being attacked in two ways. First, MLB successfully bargained for a new debt-service rule in the current CBA that caps allowable debt at 10 times EBITDA by 2005. A previous rule, which required that teams maintain an asset/liability ratio of 60/40, says Mariner, proved unenforceable, in large part because the union had never agreed to it. Second, Mariner recently refinanced MLB's $1.5 billion central debt facility, converting it from a full revolver to a partial-term structure.

"One of the reasons I converted it," he explains, "is that a lot of the needs—including funding losses—were long-term needs." Each team now has access to a $50 million revolver and a $25 million term loan. The $500 million term-loan portion is securitized by national television rights and backed for the first time by institutional investors.

That structure offers even more insight into the fragile health of Major League Baseball. Because securitization reduces investor risk, Fitch Ratings gave MLB's first-time foray into the public debt markets a higher rating (A-) than MLB would have received for unsecured debt. MLB has no other publicly rated debt, but the head of Fitch's sports-rating practice, Dan Champeau, allows that the league would likely be considered an investment-grade credit. That puts MLB squarely in the BBB range. And given the level of credit enhancement typically provided by securitization, it seems safe to say that MLB, if rated, would be barely a notch above junk-bond level.

Champeau won't confirm that speculation, but the fact that MLB's securitized facility is rated lower than the National Football League's unsecured debt (A+), he concedes, suggests "a meaningful difference" in the creditworthiness of the two sports. (Football's hard salary cap and robust revenue sharing, notes Champeau, has long made it the gold standard of sports finance.) Still, he says, Mariner seems to be making good use of the stronger financial controls offered by the new CBA, which he notes is "a significant improvement from years past."

That's comforting, because individual teams are in far worse shape than MLB itself. A debt ratio of 10 times EBITDA, says Champeau, is generally indicative of below-investment-grade credit. Yet, CFOs of some 15 teams—half the league—submitted three-year plans that Mariner thought were unlikely to meet that limit by the 2005 deadline. Teams that fall short in 2005 can be forced to inject more equity into the team, be denied their share of national revenues collected by MLB, or even have the commissioner take over their financial decision-making.


Under- and Overachievers
Baseball's implied debt ratings lend some credence to the league's claims that debt is eating a larger chunk of earnings. But at the same time that teams are struggling with debt, baseball's most-notable effort to level the economic playing field—through revenue-sharing—has led some to charge that wealthy teams underreport their earnings to MLB.

Under the current revenue-sharing system, all teams place 34 percent of net local revenues into a putative pool, which is then divided among the teams. Some, like the Yankees, are net contributors, while others, like the Marlins, are net recipients. Last year's World Series winners "absolutely could not have won had they not received tens of millions of dollars in revenue sharing," says Mariner. "The Anaheim Angels could not have won [in 2002] without being a significant revenue-sharing recipient."

Andrew Zimbalist, an economist at Smith College, disagrees. In his recent book, May the Best Team Win, he argues that revenue-sharing rules have not reversed growing payroll disparities, because poor teams aren't required to spend the money on payroll. But, he says, the rules do give the richest teams the incentive to hide revenue by shifting it to affiliated companies. Indeed, he argues that team-level book or operating losses are irrelevant. "The proper question to ask is, 'Does making an investment in a Major League Baseball team pay off or not?'" he says. "It pays off in lots of ways." In other words, he suggests that the financial reporting of team CFOs is rendered irrelevant by the owners' ability to manage their larger investment portfolios.

Such accusations infuriate Mariner, who calls Zimbalist a "hack economist who's never had a job in sports." (Zimbalist's book is particularly critical of the Marlins' transfer-pricing practices in 1997, when Mariner was team CFO.) Mariner points out that under the current CBA rules, PricewaterhouseCoopers performs a separate revenue-sharing audit on every team based on "aggressive" rules defined by a committee of owners and Mariner's staff, and reviewed by the players' association. "We want to capture all baseball- related revenue," he insists, "and we will find no revenue we don't like." Moreover, he says, the notion that teams would knowingly operate "in a system where everyone else is cheating is just absurd."

But at least one finance executive echoes Zimbalist. "Ask baseball CFOs about related-party transactions and see if they don't turn pale," suggests Ray Schaetzle, former executive vice president of finance of the New Jersey Nets, which merged with the Yankees to form the YankeesNets organization. Schaetzle (now a consultant with Resources Connection Inc.) won't discuss specific details about YankeesNets, but Zimbalist's book claims that the organization helped the Yankees shield some $60 million from revenue-sharing requirements in 2002.

"When you have related-party transactions, you have a lot of opportunity to reduce costs through economies of scale—or to hide things and make the franchises look less profitable than they are," explains Schaetzle. But since the rules that PwC audits are defined by MLB itself, baseball outsiders are largely reduced to speculating about the fair-market value of broadcast rights and other contracts.

For example, when News Corp. sold the Los Angeles Dodgers to Boston real-estate mogul Frank McCourt, the team's contract for local broadcast rights was boosted from $23 million to $36 million. To Zimbalist, that $13 million difference is evidence that Fox had been underpaying its sister company. But the Dodgers' Hurley insists "there is no chance for even slightly manipulating the numbers." In fact, says Hurley—one of the few CFOs in baseball who has also been subject to Sarbanes-Oxley rules—"the criticism that everybody can report what they want and they are all making a ton of money really isn't true. The unfortunate part is that the level of losses we are showing is embarrassing."

Deep in the Hole
As CFO went to press, baseball was more embarrassed by the growing steroid scandal than by its financial state. But the sport's finances have always been inextricably linked to its labor problems, which have far more potential to damage the game. The 1994 strike that canceled the World Series was a financial disaster for owners and players alike and devastated attendance in subsequent years.

Unless baseball's finances show at least some unilateral improvement under the current CBA, owners and players are likely to find themselves at loggerheads again in a few years. Baseball CFOs have a chance to drive that improvement by controlling debt limits, expanding revenue streams, and rationalizing salaries. But that would fail to account for the unique x-factors in baseball—especially the fact that for many owners "the bottom line is not the end game," notes Fitch's Champeau.

In fact, odd as it sounds, investors in professional sports are far less—if at all—concerned about financial payback than corporate investors. "There are psychic benefits," explains Marvin Goldklang, a limited partner in the Yankees. For Goldklang, who says he hasn't looked at a Yankees financial statement in years, the benefits include celebrating a World Series win by riding up Broadway in a ticker-tape parade. "That's a once-in-a-lifetime experience," he says. "Although in the case of the Yankees, it's been several times."


Clearly, Goldklang is simply a wealthier version of the ultimate baseball stakeholder—the fan. And that's why A-Rod deals will continue to happen. "We tell owners all the time: fans don't care if you are losing money," says Mariner. "And they shouldn't. It's not their concern.

"You have to try to operate in a fiscally responsible way," he says, "but at the end of the day, all the fans really care about is winning."

Tim Reason is a senior writer at CFO.

Build It and They Will Spend
No refrain better epitomizes baseball finance than the cry for public assistance in building new stadiums. "The timing could not have been better," says Florida Marlins CFO Michel Bussiere of the team's 2003 World Series win. By that he means the victory is likely to help convince state officials to help subsidize a new stadium. "We are revenue-challenged because of our lease structure," says Bussiere, noting that the team has limited concession, parking, and advertising revenue at its current home, Pro Player Stadium.

Instead, the Marlins want to build a baseball-only covered stadium in Miami. Ironically, a smaller stadium also will increase their gate receipts. "Scarcity of tickets is important in sports," explains Fitch Ratings's Dan Champeau, noting that football teams balance their huge stadiums by playing just eight home games—and charging much higher ticket prices. That, he says, has benefited popular, small-stadium teams—notably the Chicago Cubs and the Boston Red Sox. "Most new baseball-only stadiums have significantly fewer seats than their predecessor multipurpose stadiums. The architects are trying to get that supply-and-demand balance right."

That balance is critical because, among all sources of baseball revenue, the "gate is huge," says Red Sox CFO Bob Furbush. That's particularly true for Boston's Fenway Park, which has the highest ticket prices in baseball. Some 48 percent of Red Sox regular-season revenues come from tickets alone. Add in concessions, suites, and other game-day in-park revenue, and the figure is closer to 60 percent. Local and national media revenues, by contrast, are roughly 25 percent, with the remainder coming from miscellaneous sources like ballpark advertising and parking.

Those economics have resulted in multiple cases of baseball threatening cities with relocation or contraction unless they subsidize a new stadium. That's another critique of the sport leveled by Smith College economist and baseball gadfly Andrew Zimbalist, who says teams rarely present a believable case for financial need. But that may have to change. The Milwaukee Brewers moved into a new, covered stadium—built with the help of public funds—in March 2001. But when the club's plans to slash player payroll—one of the lowest in baseball—leaked out last year, the team's perceived failure to reciprocate the public financial commitment sparked widespread outrage.

The team (owned by the family of baseball commissioner Bud Selig) is for sale, and skepticism about its claims of financial distress ran so high that CFO Robert Quinn signed an agreement to open the team's books to auditors from Wisconsin's Legislative Audit Bureau and an independent panel of local executives. Despite strict restrictions on the level of detail negotiated by the team, both groups of auditors will make their findings public. That's an unprecedented breach of baseball's closely guarded financials, and one that could lead more cities to demand a closer look at the books before committing to replace their teams' aging stadiums. —T.R.




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