Contemporary Tulip Bulbs
By Arnold Kling
Profitable sports franchises may be priced at 20 times annual cash flow, at least double the valuation of a mundane company with similar prospects. Weaker teams can sustain operating losses of $10 million a year or more, before taking into account debt service and noncash charges such as depreciation and amortization.
In my intro econ class, I use a hypothetical sports franchise as an example of an asset where the interest cost exceeds the income, with capital appreciation making up the difference. Suppose that the franchise costs $100 million, net earnings are $5 million, and the interest rate is 6 percent, so that the imputed interest cost is $6 million. The operating loss would be $1 million a year. However, as long as franchise prices are going up at, say, 2 percent per year, it’s still a profitable investment.
Why do sports franchise values keep going up? For the same reason that tulip bulb prices rose during Dutch tulip mania. Back then, the price of a rare tulip bulb depended on the price that the next rich person was willing to pay for it. And for a while the number of rich people interested in tulip bulbs was increasing.
I think that the U.S. has an increasing number of rich people interested in owning sports franchises. So, for a while at least, franchise prices can continue to increase.
Incidentally, I think that newspapers are going to be similar. They will be owned by wealthy individuals, and they will be profitable investments as long as there is another wealthy individual willing to own a newspaper franchise.