Baseball Deep In Debt (Part 1: The Scope of the Problem)

It gets worse. Baseball teams are often owned by other business entities, and these owner businesses also carry debt. The Texas Rangers’ bankruptcy was not caused by Texas Rangers’ debt, but by the debt owed by the Rangers’ parent company. It can be a difficult matter to consider what debt to assign to a baseball team that is owned by another business. For example, consider that the Toronto Blue Jays are owned by Rogers Communications, a company with more long-term debt than is owed by all thirty baseball teams combined.  Should we factor in any Rogers Communications corporate debt in determining how much the Jays team should be allowed to borrow?

Still other teams are responsible to repay “off balance sheet” forms of financing – these are obligations that are not treated as “debt” by the accountants, but look a lot like debt to the rest of us.  For example, the Yankees spend over $60 million annually to repay the bonds used to finance the new Yankee Stadium, but these bonds are not counted as “debt” owed by the Yankees. The Mets have a similar obligation to repay off-balance sheet debt incurred to build Citi Field.

The question of debt is a complicated one. It’s surprisingly difficult to calculate debt and to determine how much debt is too much.  When it comes to baseball, the question of debt becomes more complicated, because baseball teams (being private businesses) are not required to disclose their financial affairs to people like us.

It’s my job here to discuss these difficult topics, and to make them as understandable as I can.  Let’s give it a shot.

To discuss baseball’s debt, we need numbers to work with. Per usual, I’ll rely on the numbers published by Forbes in their annual Business of Baseball report. These numbers are estimates – baseball doesn’t share its financial data with Forbes.  So please keep in mind that the conclusions I’m reaching in this piece are only as good as the numbers I’ve pulled from Forbes. (You can read here how Forbes gets its baseball information.)

Forbes only attempts to report the debt owed by each baseball team directly – it does not disclose the debt owed by companies affiliated with baseball teams, nor does it touch the issue of off-balance sheet obligations. But the reported debt is supposed to include “stadium debt” regardless of who owes that debt, thoughForbes is not always consistent in what it considers to be stadium debt.  For example, the bonds used to finance the new Yankee Stadium were included as Yankees indebtedness in prior year’s Forbes reports, but not in this year’s Forbes reports.

The amount of debt for each baseball team as reported in the latest Forbes report is set forth below:

You might not have guessed, but the biggest team debt in baseball is owed not by the Mets or Dodgers, but by the Chicago Cubs. The Cubs took on this debt as part of the sale of the team out of the bankruptcy of the Tribune Company to the Ricketts Family. We will focus on this more in a later post, but the sale of baseball teams like the Cubs, Dodgers — even the Red Sox — has created much of the debt we see in the above chart.

The debt/value percentage in the above chart shows, simply enough, the percentage by which the value of each team is reduced by team debt.  So a team like the Rangers is not really worth the $561 million shown in the chart, but something closer to $191 million (the value shown minus the team debt).

Also notice the right-most column, showing the increased amount of team debt since 2005. Since 2005, the bulk of new team debt has been incurred by four teams: the Cubs, Rangers, Mets and Nationals. The remaining 26 teams have actually reduced their cumulative debt since 2005.

I want to reiterate, the numbers shown in the chart above do not include off-balance sheet obligations.  So before you read too much into the very low debt/value ratio shown for the Yankees, please keep in mind that the 2010 Forbes report showed the Yankees debt/value ratio at 89%.  The Yankees either have a lot of debt or a little bit of debt, depending on how your view those Stadium bonds.

But enough of the raw numbers.  Let’s jump to the more interesting question: which teams have too much debt?  The writers at Forbes appear to believe that any team with a debt/value ratio above 50% has cause for concern.  If this is true, then we need to be worried about a bunch of teams in addition to the Mets and Dodgers. The Rangers, Cardinals, Nationals and Tigers all flunk the 50% test, and the Padres just barely pass muster under this test. (The Cubs are a special case, as I’ll discuss below.)

Baseball’s rules (about to change) look at acceptable debt in a different way. Rather than comparing debt to value, baseball’s rules compare debt to earnings, or more precisely, a measure of earnings called EBITDA.  EBITDA is short for “earnings before interest, taxes, depreciation and amortization.”  EBITDA is frequently used by financial types (particularly bankers) to measure profitability, and in particular the ability of a company to pay back its debt.  Luckily for us, the Forbes reports ALSO use EBITDA to measure profitability, so we have Forbes numbers we can use to estimate each team’s EBITDA.

As I said, banks love this EBITDA stuff. In a past life, I used to document and negotiate bank loans, so I saw a lot of bank documents that tried to limit borrower debt based on the borrower’s EBITDA. The banks would do this by assigning a multiplier to the borrower’s EBITDA: the borrower could not have debt exceeding 2 times EBITDA, or 4 times EBITDA, or 5 times EBITDA. Put a slightly different way (and in rough terms), the bank was saying that it expected the borrower to be profitable enough to repay its debts in 2 years, or 4 years, or 5.

The baseball EBITDA debt test is this: each team gets a debt exception of $44 million. A team’s debt above $44 million cannot exceed 10 times the team’s average EBITDA for the preceding two years.  However, if a team has a new ballpark (one built during the last 10 years), then the test is relaxed: a team with a new ballpark cannot have team debt (above the $44 million exception) that exceeds 15 times the team’s average EBITDA for the preceding two years.

I can say from my experience that I’ve never seen an EBITDA multiplier as high as 10, or 15.  Granted, EBITDA multipliers are industry-specific: some businesses need to borrow frequently, others do not.  One EBITDA size does not fit all. I never worked on bank loans to sport teams, and I assume that high EBITDA multipliers are normal for sports loans.  Nevertheless, from my experience the baseball EBITDA test looks like it should be an easy test to pass.

Below you can find my chart showing (based on the Forbes estimates) the teams that passed and the teams that did not:

From the above chart, five teams have borrowed money in excess of what baseball allows: the Mets, Dodgers, Rangers, Tigers and Diamondbacks. (The Tigers are something of a special case: they flunk the test because they have negative EBITDA. However, the Tigers would need earnings in excess of those of the Cardinals in order to be in compliance with baseball’s rules.) There are three other teams on the brink of flunking the EBITDA test: the Red Sox (who would have flunked if they’d made just $300,000 less in EBITDA), Cardinals and Phillies.  The Cards and Phils would have flunked the test if they’d built their stadiums a few years earlier.

I’ve highlighted the Nationals because their ability to pass the EBITDA test requires them to continue to earn EBITDA above the league average.

You may wonder why I haven’t branded the Cubs as a EBITDA offender.  True enough, the Cubs debt is more than twice what the MLB rules allow.  But the MLB rules do not consider the Cubs’ debt to be debt!  The Cubs’ lender is the Ricketts family, the Ricketts family is also the team owner, and MLB rules provide an exception where the lender is the owner. But the Cubs’ debt is still debt, no matter what baseball might think.  The Cubs still have to pay interest on the debt (3% per annum, a nice interest rate if you can get it), and the debt still has to be repaid (or if possible, forgiven or converted into equity). Of course, if the Cubs have trouble paying what it owes on this debt, we can hope that their lender will be reasonable.

So let’s count ’em up: by our 50% debt to value test, the Mets, Dodgers, Rangers, Cardinals, Nationals, Tigers and perhaps the Padres may be carrying too much debt. If we look at baseball’s EBITDA test, we have further confirmation that the Mets, Dodgers, Tigers and Rangers are all too deep in debt, we have additional cause for concern about the Cardinals, and we have to worry about the D-Backs and perhaps the Nationals. That’s 9 teams in all.

In other words, if you think that baseball’s debt crisis is all about the Mets and Dodgers, think again.

I want to end this discussion with a note of rationality: remember, we’re working here from estimated numbers.  We know we’re not looking at the complete picture.  I stressed above, some teams may have debt that we can’t see in the Forbes’ numbers.  Other teams may have assets that don’t show up in these charts. For example: the Red Sox own a big piece of the NESN regional sports network — that network may also owe money, but its value makes it silly for us to worry about the financial health of the Red Sox.  The same may be true for other teams on this list.  If I’ve mentioned your favorite team in this discussion, don’t be too concerned: we cannot reach conclusions about the financial health of any particular team without a hard look at the team.

Unfortunately, if your favorite team is the Mets or Dodgers, others have already looked hard at your team, and they didn’t like what they saw.  For those two teams, financially speaking, things will get worse before they get better.

This is about as much discussion on baseball debt as I can manage for the moment. But there is much more to discuss.  We’ve left the most interesting questions for another post, namely: how did baseball end up with all this debt?  And who is responsible for this mess?  Stay tuned.

26 thoughts on “Baseball Deep In Debt (Part 1: The Scope of the Problem)

  1. Great job! A very thorough and informative piece, but if I might, a few followups:

    The Mets and Dodgers are encountering two very unique situations (Madoff and messy divorce, respectively), so I am not sure they really fit in with the overall theme of team indebtedness. Also, it worth pointing out that Zimbalist said the “owners”, not the “teams, “are teetering on the brink”. That’s not really semantics because it acknowledges that personal issues are a big part of each team’s financial distress.

    A second point is baseball teams carried 39% debt/value in 2005 (using Forbes estimates of $9,960mn and $3,880mn), so that figure has actually been coming down. Nonetheless, there are a handful of teams that are in uncomfortable debt territory, but I don’t think it’s at the stage of a crisis. More accurately, it’s a situation in need of a slight adjustment.

  2. i have no problem with any amount of debt as long as there are ample cash inflows. cash actually talked about it in the offseason. if a team is taking on more debt than they should, then there's a problem. without context, debt will always have a negative connotation but creditors need to examine who's borrowing their money and assess the risk. naturally, the teams should use some discretion when borrowing, as well.

  3. Sabrina, the CBA is paper. It's only as good as the will of the Commissioner's Office to enforce the paper requirements.

    In the case of McCourt, he bought the Dodgers primarily with money borrowed by the Dodgers. On day 1 of McCourt's ownership, the Dodgers were deep in debt, probably deeper than the rules allow.

  4. Magnificent, Larry. I love the tidbit about the Ricketts loaning the money to themselves. When the lender and the borrower are the same, I believe in my high school civics class they called that a "conflict of interest." But conflicts of interest don't really exist in anymore, do they? Or, maybe more accurately, we now call conflict of interest the predominant business model.

  5. First off, the Yankees have other revenue streams besides ticket sales, so even if the first $60 million from stadium revenue was promised to pay the PILOTs, it wouldn’t cover hundred of millions of dollars worth of other revenue (hence, a future lender wouldn’t be as concerned as if the Yankees were carrying real debt). Having said that, I am not so sure that the PILOTs are secured by anything other than the underlying collateral itself. Does the prospectus specifically mention otherwise? I don’t think it’s a point of law (said with all due respect to your former profession).

  6. Good article, but when things seem the most complicated one needs to reduce things back to the simplist form…A+L=E, D/E, DSR, ROE, etc.

    These PILOT's are overhead…taxes that can't exceed property value is very fair and linear. I would think that an educated loan officer would prefer these to the typical scenerio. The tax liens always get the favorable position even in bankrupcy as the new owner pays those off to aquire the asset. Being overhead it is a liability for the period, but not long-term debt.

    The issue are the few high-fliers that put their lifestyle desires into the company creating a burden that affects operations. The Mets, Dodgers, D-backs are poorly runned teams in every sense of the word. The Twins, Marlins, Pirates, & Royals are exceptionally well runned (for their shareholders) but screw their fans (& fellow MLB owners). The NYY, Phillies, Tigers, BoSox & (new) Rangers do it right on both sides of the model (business & consumer). The rest fall somewhere in-between.

  7. You say that the Cards and Phillies would have failed the test if they built their stadiums a few years earlier, but if that were the case they would not be allowed to write off depreciation costs of their parks. Right?

  8. I have a limited understanding of it, but basically depreciation means that businesses can write down the value of new plants and equipment ( such as a new ballpark or the major renovations at Fenway) over a set period of time until it is "fully" depreciated . In baseball the depreciation period appears to be 15 years. It is one of the major benefits of a new ballpark as a tax write-off, but would have a negative effect on EBITDA.

  9. Actually, it would not. Apparently I have a VERY limited understanding of EBITDA. Good thing I'm not an accountant.