It’s often said that the value of something is the price at which somebody is willing to acquire it. In accounting terms, however, when the price exceeds the actual value of the company’s assets, the excess is referred to as “goodwill.” Additionally, when a useful or productive asset/company is acquired, the acquiring firm is paying not just for the physical assets and/or goodwill of a firm, it is paying for the projected future earnings of the firm as well.
The Los Angeles Dodgers have announced that a group led by NBA Hall-of-Famer-turned-businessman Magic Johnson has won the bidding for the team at an approximate price of $2.15 billion. This represents the highest price paid for any Major League Baseball team ever…by almost 2.5x. Many scenarios exist in which the Dodgers become more competitive and maybe even start their own TV station like the Yankees or Mets with YES and SNY, respectively, but the economics simply to do not support a valuation of $2 billion.
The Dodgers are one of the most marketable franchises in baseball. The club has a large national fan base and a rich history dating back to its time in Brooklyn. The Dodgers logo is among the most recognized and attractive in the sport, and obviously Los Angeles is among the largest media markets in the world. With new ownership promising to bloat the team’s current $90 million payroll to put a winner on the field, surely an improved product will drive attendance, apparel sales, and national exposure.
There’s just one problem: Of those factors, only attendance at Dodger Stadium actually improves the valuation of the club.
By dramatically increasing the team’s payroll, the new ownership group is likely to push the Dodgers into luxury tax territory. In 2011, the luxury tax threshold was $178 million, which required offending teams to pay a “competitive balance” tax of 22.5% of the amount in excess of the threshold. Second time offenders must pay 30%, and third time offenders 40%. It’s easy to envision a scenario where the Dodgers sign Cole Hamels for $25 million/year and throw money at other big name free agents to build a winner. Once the barrier is crossed, every signing becomes a little bit more expensive.
Believe it or not, licensing and media rights are equally shared amongst MLB teams. This means that the Pittsburgh Pirates, who rarely make appearances on national television, account for a small percentage of overall apparel sales, and who have a much smaller fan base than, say, the New York Yankees, get the same cut of licensing media rights as the media behemoths. If the Yankees, Red Sox, and Dodgers all sell 10 jerseys apiece to fans, and no other teams sell a single piece of apparel, every team gets a 1/30 cut of the revenues. The Red Sox and Yankees, who comprise roughly 50% of all apparel sales, have been complaining about this for years. More succinctly: Big market teams, the teams that truly push the value of national media contracts and apparel revenue, are essentially subsidizing smaller market teams. This does not benefit the Dodgers.
There are two ways in which a better “product” on the field improves the Dodgers’ financial standing. While apparel, even that sold within the confines of Dodger Stadium, and national broadcasting revenues treat the Dodgers unfairly, gate receipts at Dodger Stadium go directly to the club, and there is room for improvement. The Dodgers ranked 11th last year in gross ticket receipts with almost 3 billion, but sold only 64.7% of its available seats. With almost 13 million people in the LA-Metro area, there’s no reason to believe that the Dodgers can’t push gate receipts to 4 billion and beyond.
The Dodgers also retain the right to start their own network or, at the very least, sign a lucrative local media contract. The Dodgers’ current local broadcasting contract runs out at the end of 2013 and the team took in about $55 million from Fox and KCAL in local broadcasting revenues last year. To throw the Dodgers a bone, let’s assume that that $55 million remains the same through the end of the current contract, and then the amount doubles to $110 million/season and they sign a 10-year broadcasting deal. Even at a 9% discount rate, which could be debated given the current inflationary economic environment, the net present value of their broadcasting contracts is only about $750 million.
This means that the remaining $1.25 billion in value must be bridged by the net present value of operations and the value of Dodger Stadium and its surrounding parking lots. Assuming that the value of the real estate held by the firm is $250 million, the team must produce $90 million in operating profit in perpetuity for the production value of its assets to justify a $2 billion valuation. As a point of reference, the Dodgers made only a $1.2 million profit on revenue of $230 million last year, inclusive of its media contract. Given the economics of baseball today, producing $90 million of profit in excess of a bloated local media deal is simply impossible considering the most profitable team, the Cleveland Indians, made only $30 million in total last year.
(Note: Even using the recent Angels media deal of 20 years-$3 billion as a precedent transaction, the Dodgers would still need to produce roughly $40 million in net operating profit in perpetuity for Magic to break even).
So how much of this acquisition is goodwill? It’s hard to say, and the books will obviously never be released to the public. Certainly a professional sports franchise is unlike any other asset. Owning a team, especially in a market like Los Angeles, instantly makes its owner a celebrity. Wealthy titans of industry with nothing else to spend their money on are willing to splurge on glamour assets even if it means losing money because hey, pride of ownership is real.
There is strong evidence, intrinsic reasons aside, to suggest that this was a brutal overpay that was likely influenced by the novelty of owning such a prestigious asset. A scenario exists where the Dodgers adopt a model like the YES Network, thus creating two revenue streams for one entity, but it seems that Magic and his group are not likely to see significant financial gain through the operations of the club and that we will look back on this in the future as a poor financial decision (assuming we don’t already feel that way).