Do Sports Franchises Make Money?
By Arnold Kling
Take the Sonics. The team may have lost $60 million while Mr. Schultz owned it. But he bought it for $200 million in 2001 and sold it for $350 million five years later. So he ended up making something like $90 million (taxed at the favorable capital gains tax rate, no less) on top of the fame, prestige and free tickets he got while he was owner.
If the Cubs do, indeed, sell for $1 billion, Tribune will have earned an annual return of almost 15 percent since it bought the team for around $20 million in 1981. Given the company’s recent problems, it’s probably the best investment it ever made.
In the past, I have used sports franchises to illustrate the formula that the profitability of buying is equal to the rental rate plus appreciation minus interest cost.
For baseball teams, the rental rate minus the interest cost is negative, so that they are cash-flow negative. But, as in the fruit-tree example that I used illustrates, a capital asset can be cash-flow negative and still profitable.
I wonder if the hotel business is similar. And does anybody know why hotel chains swap properties so often? (I mean in the sense that a hotel will re-open under the name of a different chain.) I assume that there’s a tax issue lurking somewhere under the mattress, so to speak.
UPDATE:Mark Steckbeck emails me with some questions:
First, if a baseball team has a negative cash flow and its profitability hinges on appreciation…aren’t MLB teams a classic example of a bubble?
I don’t think so, but I may be wrong. But look at it this way: suppose that the cash flow before interest expense is $100 K, but with $120 K interest expense the cash flow is negative. If the cash flow before interest expense increases at x percent per year (this could be pure inflation), then the value of the asset (the franchise) has to go up at x percent per year also, even with no bubble.
Second, better opportunities make professional sports participation less desirable for both athletes and fans. In terms of athletes, greater employment opportunities increase the opportunity costs for higher skilled individuals, increasing the number of lesser skilled (read: less functional, lower culture, etc.) individuals to fill the ranks of professional sports teams. If a high school athlete has a 1:100k chance of becoming aprofessional athlete and earning, say, $2.2 million, that works out to an expected income of $22 annually. Hardly a prospect for which someone with the intelligence to become an accountant or lawyer or economist will spend much time pursuing.
Sports have always been the province of those with low opportunity cost. They have always been rarely pursued by people with other talents. I would say that, if anything, since the 1960’s the earnings of top athletes have gone up, so you might see more lawyer-accountant types in sports now than 50 years ago.
Finally, he says:
But it’s also the case that alternative entertainment venues reduce the demand for tickets to professional sports events and participation in organized youth sports…It seems to me that professional sports franchises are becoming a riskier investment, especially baseball.
As we move toward a long tail environment, the business model for professional sports will have to evolve. My guess is that, looking at entertainment as a whole, the market share of pro baseball, pro football, and pro basketball is probably in for steady decline. The trick is to survive as niche businesses. My sense is that they are adapting, for example, by trying to create a “total entertainment experience,” with the luxury boxes, the loud music, and the expensive concessions. I personally liked baseball a lot more when it was just plain baseball, but fans like me aren’t what pays the bills.