What Manfred got right and wrong about MLB team values

Last Thursday Rob Manfred had a press conference after the MLB owner meetings in Florida, and was widely ridiculed for the answer he gave to a question about whether MLB teams were good investments:

We actually hired an investment banker, a really good one actually, to look at that very issue. If you look at a purchase price of franchises, the cash that’s put in during the period of ownership, and then what they’ve sold for, historically the return on those investments is below what you’d get in the stock market, what you’d expect to to get in the stock market, with a lot more risk.

The uproar concentrated on the fact that, like all major sports teams, MLB team values have appreciated almost continuously for the last 30 years. A secondary point was why MLB wouldn’t release the report, though that wouldn’t be meaningful. Any investment banker worth his or her salt can produce whatever results you want from underlying data (to paraphrase Upton Sinclair, it is easy to get a man to understand something when his livelihood depends on it).

Now, far be it from me to carry water for Rob Manfred, given that the principle function of a modern sports commissioner is to carry the owners’ water and the heat for them. They’re very well-paid to say absurd things with a straight face. But to the extent there was an erroneously assertion in that response, it’s not what the critics have seized on. And more broadly, rather than nitpicking the minutiae, it’s the broader basis or comparison that’s more flawed.

The immediate rejoinder to Manfred’s response was that of course baseball teams have been not just good investments, but extraordinary investments. But frankly, so have public stock market returns over the long term.

Let’s consider our Toronto Blue Jays. In 1976 when expansion franchises were awarded to Toronto, and Seattle, the fee was $7-million (all figures USD). However, in addition to that, theyhad to pay $175,000 for each of the 30 players selected in the draft, for the further $5.25-million paid to the existing fees. I believe this was done for tax purposes, as at the time contractual rights could be amortized and deducted for tax purposes, and this put an explicit value on them, but regardless, the real all-in cost for a new franchise was $12.25-million.

The most recent Forbes valuation put their value at $1.675-billion last year, but let’s assume that’s continued to go up and will be $1.8-billion this year. Increasing money over 100-fold sounds over a couple generations sounds astronomical, too good to be true! Over 46 years, it works out to an annualized rate of 11.1%, and that’s indeed excellent. But since November 1976 (when the expansion draft happened), the S&P 500 has returned 11.8%.

Rogers has perhaps done slightly better. They paid $140-million for the Jays in 2000, which would work out to 12.3% annually since compared to 7.8% for the S&P 500. However, that valuation was suppressed by the prospect of near term operating losses essentially baked into the cake, so they had to inject significant further equity (and there was also a 20% retained stake that bad to be bought out at a higher price). Accordingly, it’s more accurate to put the all-in purchase north of $200-million. Still a bargain, but more like a 10% annualized return.

What about one of the more famous cases? In 1973, George Steinbrenner bought the Yankees from CBS for $10-million. Forbes put their value last year at $5.25-billion, which works out to 13.6% annualized. That does beat the market at 10.8% over the same time, but it’s not blowing it out of the water. Moreover, that was likely a particularly great deal. According to Cot’s, CBS had purchased 80% of the Yankees for 13.2-million in 1964, so they took a big bath. A $17.5-million value in 1964 to even $6-billion today works out to 10.6% per year. The market over that time? 10.4%.

Maury Brown at Forbes suggests that even the comparatively, Manfred’s claim is wrong, using the example of the most recent sales. I’m skeptical the examples cited are broadly representative—he notes the Dodgers sale by Fox was a distressed situation. The Royals and Marlins were very small market teams purchased around the same time, when small market teams were in most imperiled and disproportionately gained from revenue sharing since.

And that’s only using a very broad public market in the S&P 500. The tech heavy, faster growing Nasdaq has handsomely outpaced the S&P over pretty much any interval in the last 50 years comparable to the time one would own a baseball team. Returns in investment vehicles available to those with MLB team owner type wealth have outpaced as well. But regardless, even if Manfred was not technically correct about market returns being on par with public market returns, the point is, they’re far more similar than dissimilar.

Instead, the real whopper in Manfred’s answer that was gone largely unnoticed is the very last part, about higher risk. That is the truly fantastical part, since owning MLB teams has in fact been much, much lower risk.

To achieve that return in public markets, investors have had to stomach a lot of volatility. A short term decline of 20% in the stock feels wrenching in the moment, but it’s really hardly a historical blip. The really big pain is when you get a -40% year, or a 60% decline from peak to trough (like happened from 2007-09, or even worse in some markets during the tech crash). Or a longer lasting bear market.

By contrast, MLB team values had never experienced that kind of volatility. In the last 20 years, it’s been basically a one way ticket upward on a pretty smooth glide path, fuelled by ever higher media rights. At various points, the upward trajectory has stalled or slightly declined (if one had to liquidate their ownership), but no owner has sold for anything approaching a loss since at least the early-1990s.

It’s these superior risk-adjusted returns that have made MLB teams such a fantastic investment. You get market returns (or maybe even better than the market), but without the risk level associated with public markets. This is the part that makes Manfred’s statement bonkers.

the focus on the exact level of MLB returns versus market returns also glosses over a large, more fundamental point. To a large extent, this is comparing apples-to-oranges in the first place. Stock market values are equity values—the value of the business after debt—whereas MLB team values quoted in media are entreprise values—the total value of the business.

That probably sounds completely technical, but consider someone purchasing a house for $500,000 with a $100,000 down payment and a $400,000 mortgage. If that house is sold 10 years later for $1,000,000, then the total value has doubled, an annualized return of 7.1%. However (assuming for simplicity that the mortgage was maintained rather than paid down), the equity has increased sixfold from $100,000 to $600,000, which makes for a much higher annualized return on equity of 19.6%.

Buying a baseball team is little different. When you see a headline that so-and-so bought a team for $2-billion, they’re not actually writing a cheque for that amounts. That’s the valuation being placed on the franchise. Some of that will be equity, but a good whack of that will be debt, both existing and new debt.

There’s a few reasons for this. First, as demonstrated above, it increases financial returns, especially for a business where significant future revenue streams are locked in and effectively secure it. Second, the tax code incentives it. The interest incurred on debt can be deduced against the the operating profits f the business before calculating taxes owing, whereas equity cannot.

Related to that, it makes teams look less profitable which is very useful when it comes to negotiating collective agreements. For example, suppose the average team generates operating profit (revenue less direct expenses to generate that revenue) of $50-million and is worth $2-billion but carries $1-billion of debt funded at 4%. That’s $40-million of interest expense which reduces net profit to $10-million (80% lower!).

The difference between these measures is critical, as the way a business is financed can transform strong underlying profitability into a much more meager bottom line on paper. MLB relies on sports media not being financially sophisticated to appreciate the difference, and when they leak selected data to generate sympathy, it’ll always be these lower numbers. So in addition to maximizing returns, it also helps make the public case when it comes time to negotiate collective agreements.

Given that, comparing the increase in team values over time to stock market returns doesn’t make a whole lot of sense in the first place. The equity returns released by team owners are probably even higher, but absent a release or huge leak of team/league financial data, that’s not possible.