Friday, October 07, 2005

Contraction Reaction

If you haven't read it yet, take a look at the essential guide to the ownership quagmire posted at Capitol Punishment yesterday. Chris Needham breaks down what's at stake for each of the three parties (MLB, D.C. city council, and DCSEC) in the negotiations. For supplemental reading, don't miss misschatter's comprehensive breakdown of would-be Nats owners. Needham rears the ugly spectacle of contracting the Nationals.

"In the last Collective Bargaining Agreement, the Player's Association agreed to drop their objections to contraction after the '06 season. I know it's a longshot, but it IS a possibility again, especially with Florida's continued inability to get their stadium built. If MLB decides to hold on to the team through the end of next season, the likelihood skyrockets.

Why would they turn down $450 million though? Because they stand to make more money.

Short-term, they'd each have a larger share of the $2.37 billion TV contract they just signed with ESPN. Long-term, MLB could expand in a decade when Las Vegas or Portland become more viable markets. Arizona and Tampa Bay, for example, paid $130 million as an expansion fee. That's a price that's only going to go up, netting them more money down the road."

I commented that I didn't think contraction of the Nationals would happen. I feel the need to elaborate on this point.

From a purely business standpoint, the Washington Nationals are worth more to MLB alive than dead. Their $450 million sale price isn't just some made up number. It reflects the net present value of the team, that is, some higher, terminal value (the value at some fixed future date) discounted for expected cash flows. In other words, MLB expects the team to generate significant positive cash flows for the forseeable future. There's no way they'd give up this revenue.

Needham states that the owners would make more money by garnering a larger share of the ESPN contract. This larger share would amount to peanuts, only $7.9 million more per team, assuming contraction of two teams and even distribution of the contract among those teams. $7.9 million will barely buy a one year contract for a quality starting pitcher.

Needham also says that MLB will stand to gain more by contracting now and re-expanding in a decade when other viable markets emerge. I disagree for several reasons. There is no guarantee that Portland or Las Vegas will be any more desirable in a decade than they are now. Also, baseball would be losing those ever-increasing cash flows that I discussed earlier by not having a team in DC. Economics 101 tells us that a dollar today is worth more than a dollar tomorrow. MLB would be foolish to scuttle a team that is profitable today only to wait a decade to start a team that might be profitable in 2015. Finally, Needham says that MLB would gain by reaping a large expansion fee. This is true, but it's still not enough to justify contraction of a profitable team. That $130 million fee, or whatever it would be down the road, is only a one-time cash infusion. A profitable Nationals team earning cash flows (and thus revenue sharing) each year generates a continuous stream of money for the league. In other words, the Nationals are worth much more to MLB than just $450 million in 2005.

You can't say the same for clubs that persistently dwell on the lower end of the revenue scale. If MLB is losing money, they would be nuts not to contract or relocate a franchise. Others have pointed out that there is really nowhere left to go for MLB if and until Portland or Vegas prove their commercial viability. We fans often miss the big picture. We care about whether the team wins; baseball cares about whether or not it makes money. A look at Forbes' MLB team valuations shows that the "safest" teams are not always the most sucessful ones. The Yankees are operating at a $37 million loss this season while the D-Rays are netting $27 million. The Nationals are safely ensconced in the middle as the 16th most valuable franchise in baseball. But even more telling is the fact that the franchise's value has soared 114 percent from 2004. It made sense to consider contracting the loser Expos, but contracting the Nats would be fiscal suicide. And you can't collect the insurance from that...