I am writing for CBS about Steve Ballmer’s purchase of the Clippers.
- Is the $2 billion purchase price a good deal?
Here’s what I told you in the last interview:
There is a perfect storm brewing for the value of the LA Clippers to approach $1 billion.
First, if the Clippers are indeed put up for sale, there will be several bidders circling above the franchise. In an auction the winning bid is always the highest bid and not the average or most accurate bid. There is always a systematic upward bias called the winners curse. The good news is that the winner gets the Clips the bad news is that they systematically have paid too much. The amount of the bias (overbid) depends on the uncertainty about the true value of the asset and the number of bidders and the artificial scarcity of viable NBA franchises. All 3 pre-conditions are perfect for a high bid that exaggerates the sale price.
Second the true value of the Clippers is the present value of the net future cash that flows through the franchise. The future cash flow forecast is also favorable because the TV rights fees agreement with Fox Sports West for about $20 million per season expires after 2016. There will be at least 3 bidders for those rights including Fox Sports West, Time Warner and Sports Net LA (owned by the Dodgers). As a result the rights fees will systematically be overbid because they will go to the highest bidder. If the Lakers are currently getting $180 million per season the Clips will certainly get half that amount and so the net cash flow increase will be $70 million per season for the current stepchild of the Staples Center.
The values of MLB franchises are currently trading at a multiple of 4 to 5 times revenues and so the new TV deal will add about 4/5 X $70million = $280/$350 million to the value of that TV rights deal to the Clips. Based on recent comparable sales of $535 million for the Sacramento Kings and $550 million for the Milwaukee Bucks (both with terrible arena deals) the current value of the Clippers would be $600 million plus about $300 million for the present value of new TV deal.
The weakness of the Clipper valuation would be the fact that do not control the Staples Center which is owned and controlled by AEG which owns interest in the Kings and Lakers, the other two tenants of the Staples Center.
Now here are the necessary revisions to get the price to $2 billion.
Set the comparable Lakers Time Warner deal at $200 million per year for a cool $4 billion over 20 years and it could bump to $5 billion for TV money alone.
The bidding war among the three media outlets could still support that price at the max for the Clips. This would be a healthy $180 million per season over what the Clips gather now from local media.
The cash flow is almost certain so it would capitalize at 4-5 times its annual value so that would put the value of the new TV deal to the Clips owner at about $900 million at the maximum by itself.
The national TV deal is expected to come in at $50 million per clubs over and above the $30 million the clips get now. This cash flow is almost certain so the multiple would be about 5 times $20 million or $100 million.
Based on expected TV revenue alone that would put the value of the Clips at $1 billion above its recent valuation of $600 million.
Given the bidding frenzy for the Clips this would put the winners curse (also called the greater fool theory) at between $1.2 billion and $1.6 billion at the max which were reportedly two of the other bids.
In this auction the frustrated finalist in the quest to get the Kings and move them to Seattle is going to make the highest bid which systematically selects the price above $1.6 billion. This has to be the case because Ballmer also wants to blow away the competition to stop the back and forth bidding.
Ballmer (Microsoft) especially sees another potential revenue source in “new media” or electronic media. This is also driving the valuation way over $1.6 billion. New media + the auction bias + the blow them away factor could easily put the price at $2 billion, especially for someone recently shut out in the Kings to Seattle monopoly power play.
All of this suggests that the $1.2 billion bid was a touch low and the $2 billion purchase price was a touch high and the true value of the cash flowing through the Clippers is about $1.6 billion. In an auction environment where the NBA holds all of the cards (and there only 30 of them) the winning bid is the highest bid.
I would say that the $1.2 billion to $1.6 billion price tag could at the max be supported by market fundamentals and the extra $400 million blow away factor is a possible irrationally exuberant bubble. This is still risky business and risky cash flows are not worth as much as certain cash flows, but about $1.6 billion of the price is sustainable investment and the extra $400 million may be what a billionaire owner (with a Harvard degree in economics) simply wants to pay for his NBA “jones.”
- How is owning a professional sports team like running other types of businesses and how does it differ?
As we have seen the major difference is that the club is a member of a larger cartel and as a result sports clubs have a dual identity and cash flow. The NBA league cartel is what makes the individual club less risky of a risky business. This is basically how Sterling was able to bungle his way into this mega-manna from heaven.
Because the NBA only shares about a third of its revenue there is some exposure to risk and reward on the other two-thirds. So there are some local club specific risks that depend on the owner’s acumen. In this case the Clippers risk is also relatively small because they are sitting on third base in the second largest media market in the world. The Clippers did their best to even blow that under Sterling. They are the third tenant renter in the Staples Center behind the Kings and Lakers both of whom are owned by AEG who owns the Staples Center. Their local TV rights are chump change at $20 million per season. This is how an potentially valuable LA sports franchise can languish under Sterling and how its value can explode over night with the ambitious expectations of savvy ownership like Steve Ballmer.
- What are some “rookie mistakes” that new team owners typically make?
The revenue side usually takes care of itself but the soft salary cap and hard luxury tax are tough to maneuver and player roster composition has humbled even the best businessmen as NBA owners. The Brooklyn Nets new ownership for example has the league’s highest payroll at about $100 million but they will probably have to pay a luxury tax equal to that amount next season. That cuts into the positive cash flow big time and a club can squander its revenue advantage in one season.
- Can you discuss the relative profitability of NBA franchise versus other pro sports?
The relative profitability is capture in the revenue multiple used to appraise the value of a club and the multiple of 4 is on par with the NFL and slightly higher than MLB and the NHL. The salary cap delivers cost certainty and so revenues determine profit and so the higher revenue teams obviously have higher profits. Sterling actually stayed in the black by squeezing player costs rather than actualizing incredible market potential. My guess is that Ballmer will reverse the strategy.
- Is there enough fan interest in Los Angeles to support two NBA teams?
Yes the LA market is a multiple team market and the monopoly leagues have not even begun to penetrate its revenue potential. This reluctance is on purpose to enhance the value and monopoly power of the existing teams. In spite of the exact opposite seasons between the 2 NBA teams LA is probably still a Lakers town, but a consistent long run in the regular season for the Clips they can make inroads on the Lakers, Kings and Ducks. Playoffs four seasons in a row and getting into the later playoff rounds are critical. The NBA demographic is volatile and fickle and things could change relatively quickly. The core players and coach are already in place and now the proper ownership can actualize the full market potential. The name probably needs to change and the new ownership needs to distance itself from the Sterling scandal as soon as possible.