The Money Leagues (Part 2): Accounting for Sports

Is your team really losing money?

"Every year in the building we've lost money aside from last year.." Micky Arison, owner, Miami Heat.

Like the owners of a majority of professional sports teams, Arison made his money in industry, and then bought a sports franchise. The best words to describe a team owner are "business mogul." Many outsiders believe that these men bought teams to serve as toys, just something to have fun with (lets focus on NHL, NBA, NFL, MLB...not international soccer and not Manchester City). This is something that certain team owners, like Arison, would want you to believe. "This is a hobby of passion, it's not a business," Arison said. It is not uncommon for owners to claim that their team loses money in certain years (or in Arison's case, nearly every year). Would sucessful businessmen really pay hundreds of millions of dollars for an "unprofitable" franchise?

First, I'd like to start with saying, that yes, some teams do lose money (see Charlotte and Memphis, NBA). What exactly does profit mean? If by profit you mean only the yearly reported revenues minus expenses, many teams could report being unprofitable. What about the value of the team itself, and the future sale price of the team?

With the exception of a few years during the financial crisis, team values increased like clockwork. The crisis certainly impacted the sale price of franchises. The recession even ended Mark Cuban's lust for purchasing the Chicago Cubs (Cuban's two paragraph quote is a must read). That was 2009/2010, today is July 16, 2012, and the LA Dodgers are worth $2 billion.

$2 billion? That's crazy, you say. Well yes, it is crazy, supposedly $500 million extra crazy. Do you want to know what else is crazy? In 2004, the Dodgers sold for $371 million. An appreciation of $1.6 billion, in 8 years. You do the IRR.

Yes, I know, McCourt didn't get to realize that IRR. A nasty divorce, and subsequent team bankruptcy, got in the way (he should have readUncle Eddie's thoughts on marriage). The Dodgers are not the only team that has appreciated significantly in value. Let's look at two other MLB teams...

• The Cincinnati Reds were purchased, in 2005, for $270 million. Forbe's values them at $424 million. They also have a great stadium, a devoted fan base, and one of the largest radio markets in the MLB.
• The New York Mets, were purchased in 2003, at a valuation of $391 million. Forbe's values the Mets at $719 million. If the Dodgers are worth $2 billion, the Mets and other teams might be worth significantly more.

The values Forbes attributes to teams is significantly less than their actual value; the price they could be sold for.

But what does all that have to do with your team losing money?

Quite a lot, actually. Team owners value their money, and they approach their investment in a team as they would any other investment (you did read Mark Cuban's quote about buying a sports franchise, right?). Why would they throw away money at a team that can't produce profit? Like Micky Arison claims to do (the Heat are the NBA's 6th most valuable team). As mentioned above, it is all about the sale price of the franchise itself.

*Note* The discussion below takes information primarily from notes taken from a university course, "Sports Economics." I apologize for the lack of direct sources (if you like textbooks, search Sports Economics by Rodney Fort on Amazon).

Why report a net loss for the team? For one, teams are generally owned by a single or small group of investors. When the team reports a loss, the owner can avoid making tax payments on that teams "profit" (and in certain cases, can reduce personal net income by the teams "loss"). Claiming that the team is losing money also serves as a bargaining tool during stadium development (more on this next week).

How do teams that "should" be profitable report net losses?

There are dozens of teams, and dozens of stadiums. Is a team's stadium considered a part of the team? Sometimes, yes. Often, no. Stadium's are often "owned" by a different organization than the business the franchise is owned by. When this happens, stadium revenues can be manipulated to under report revenues the team actually earned. This is also commonplace with parking lots. Parking lots, some which cost $50-$100+ to use, are often owned by seperate entities. These revenues, which should be considered part of the team's, can be attributed to an entirely seperate business. If you see a team with a strong fan base, a competitive record, and "losses" of a few million dollars, I'd check the books. Chances are, there is money hiding somewhere.

Team's also have a nifty little depreciation tactic they can use. Since 2004, the IRS has allowed 100% of the purchase price of a team to be attributed to a roster depreciation allowance (RDA). Previously, the RDA was allowed to count for 50% of the purchase price, and was depreciated over 5 years. Now, the RDA can be 100% of the purchase price, depreciated over 15 years. What does this mean? The Cubs were purchased for $845 million in 2009. That can be depreciated as $56 million a year over 15 years. Reported profits in 2008 were ~$45 million. The depreciation charge exceeds the profits, sheltering the organization from taxes (see the "look here" link below).

The real profit a team delivers to an owner also depends on what else that owner owns. For instance, several team owners own local media and broadcasting businesses. How can you account for money their sports franchise earns the media outlet? What about the box seats the owners have access to? Why do team owners invite politicians and other business people to join them for the game?

In next weeks post, I will talk about a major source of team revenues, the stadium. You will learn how a stadium impacts a team's revenue and about recent trends in stadium design.

*If you would like to see a more detailed analysis of the value of an individual team, in this case, the Chicago Cubs, look here. The author breaks down the team's value by revenue streams (which will be demonstrated throughout this series of blog posts).

*Please don't post about the Charlotte Bobcats losing $25 million a year. They are probably losing money, no matter what kind of accounting they use.