The Fuzzy Math of the NBA Lockout

 

The NBA lockout is a complex subject. Let's not pretend that it's easy to know exactly who's right and who's wrong. I'm by no means an expert in economics - I had one macro class back in college, almost 30 years ago, and a little real world exposure at work. (Not that I have to tell you guys, but please feel free to point out any egregious misstatements or misinterpretations of economic principles in the comments.) It's not as if the NBA is a free market at any rate, so standard economic theory doesn't really apply anyway. Every aspect of the economics of the league is manipulated, which is why we need a Collective Bargaining Agreement in the first place. I'm personally fascinated by the "Law of Unintended Consequences" aspect of the CBA - things like Keith Van Horn unretiring to be included in a trade, making $4.3M basically for taking a physical. I'm sure David Stern and Billy Hunter didn't see that coming when they put together the last CBA. I mean, let's face it, if the system were normal, you'd never have Pau Gasol traded for Kwame Brown, or Marcus Camby traded for a second round pick for that matter. So you have to be careful about making assumptions, or saying things like, "It's obvious that it should be this way" - nothing is really all that obvious, at least not to me. It is necessarily a laboratory experiment, and it's constantly being tweaked.

Even something fundamental, like how much money the league makes (or evidently loses) is open for debate. One of the basic precepts for the owners in the current dispute is that league is losing money - $300M in 2010-2011. The Player's Association disputes that number.

And let's face it, they're not really going to be able to reach an agreement on a new deal if they can't agree on this point. It would be like negotiating a price for a car, while you and the salesman were working in two different currencies. You need to have some common ground as a starting point.

It's pretty clear that the disagreement over the league's overall losses is at least partly related to the choice of accounting practices. If the players choose to look at cash flow, while the owners focus on net income, then of course there are going to be major discrepancies. What's maddening is that the league has been so tight lipped about all of this. We get leaks from both sides, so we know that each disputes the other camp's numbers. But surely both of them have, or can hire, someone whose seen an income statement before. Isn't job one just to sit down and look at the books and agree on which numbers they're going to use?

In recent days, both Tommy Craggs at Deadspin and Larry Coon at ESPN have delved into the financials of a couple of individual NBA teams and have surmised that the NBA must be including amortization of the purchase price of the franchise and depreciation of the players as assets in order to arrive at such hefty losses. Those practices, which may make sense in terms of Generally Accepted Accounting Practices (GAAP), aren't very good real world arguments for why the league needs the players to accept a hard cap or salary roll backs. Stern's position made him none to popular at SBNation.com - Tom Ziller called him a liar, while Andrew Sharp thinks he's risking the league's future. The NBA then reached out to SBNation.com with a clarification - they weren't in fact including franchise purchase amortization in their loss calculations (presumably they were copping to depreciating player salaries as assets). Which is all well and good, but the question remains and is even more urgent and confused - where exactly are these losses coming from?

We may not have access to the league's books, but we do have something. Every year, Forbes publishes valuations for each team in the NBA, including Operating Income. It's not internal team documents, but hey, this is Forbes magazine - we can assume they've done some leg work on this, right?

So what does Forbes say? First of all, the most recent data from Forbes is for the 2009-2010 season; so we wouldn't expect to match up with the league's $300M losses figure, since that was for 2010-2011. However, given the slightly improved economy as a whole this year, and increases for the league both in attendance and in TV ratings over last season, we would expect this year's losses to be less than last year's. The second thing you have to understand is that Forbes is looking at Operating Income, which they define as EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). The league is certainly looking at a number that includes at least depreciation, and is probably looking at net income, which includes all of those ancillary expenses, to arrive at such big losses.

According to Forbes, 13 out of 30 NBA franchises were profitable on an EBITDA basis in 09-10. Unfortunately, that means that 17 lost money, even at the level of EBITDA, which basically means 17 teams had a negative cash flow. The league currently maintains that 22 out of 30 teams are losing money, which seems reasonably in sync with the Forbes list if you assume that the two are looking at different bottom lines.

But here's where the data don't seem to agree. Despite the fact that there are more losers than winners on the Forbes list for 2009-2010, losses for the 17 teams in the red total $145M - and those losses are more than balanced by the profits of the top three teams alone. According to Forbes, on an EBITDA basis, all told the league cleared over $182M in operating income in 09-10 - and bear in mind that this year should have been better. That's a far cry from $500M in losses. Of course, there's that little problem of which numbers we're going to use, EBITDA or EBIT or EBITDAR or EBDIT or, you know, something boring like Net Income.

Of course, there's another pretty glaring problem in the last paragraph - did you notice it? "[L]osses for the 17 teams in the red ... are more than balanced by the profits of the top three teams alone." The Knicks had an operating income last year of $64M, the Bulls were at $51M, and four more teams were at $25M or more. And that's the other very strange aspect of these CBA negotiation; we're acting as if there are two sides squaring off against each other, but in fact there are two very distinct types of owners on one side of the table - big market owners and small market owners - and the bigger problem (arguably the only problem) is revenue sharing, not player salaries.

The league admits that they need a new revenue sharing plan to help make small market teams viable, but they have insisted on conducting the CBA negotiation separate from the revenue sharing discussion. They seem to want to drive the best bargain they can, with the losses of the small market teams being made up by concessions from the players. Meanwhile, the profits of the big market teams get even bigger, and then whatever revenue sharing results eventually just makes the small market teams that much more secure. The league is no doubt being disingenuous on many levels in these negotiations, but the issue is most extreme as regards revenue sharing. It's patently absurd to be discussing the need for a system that allows all 30 teams to be competitive with the players, while at the same time saying "Don't worry about revenue sharing, that's an internal discussion." All other issues of competitive balance are secondary to revenue sharing. It seems self-evident that the owners are not negotiating in good faith here. I mean, we've reached the deadline for a new CBA, and they've imposed a lockout, and they've barely discussed this key issue - which they insist is theirs alone to discuss! It's not as if they haven't known this issue was out there.

Let's examine a specific example. Earlier this year the Lakers signed a new local television deal worth, depending on the estimate, between $150M and $200M per year for the next 20 to 25 years. Compare that with Sacramento's local TV deal which pays about $11M per year. Ticket revenue and local television rights are, you guessed it, two things that have absolutely no revenue sharing in today's NBA. So when the league insists that the model is badly broken, perhaps the question should be, for whom? Certainly not for Jerry Buss and Phil Anschutz, who will make about triple the salary cap in TV rights alone when their new TV deal kicks in.

Of course, there's a form of revenue sharing that may force itself upon the big market teams if they don't proactively address the problem. You may recall that the Kings came very close to becoming the Anaheim Royals in April. In the current climate, without any revenue sharing on TV and ticketing, it's no doubt more economically viable to have three or four teams in LA (and four in New York and two or more in Chicago, etc) than to have teams in Sacramento or Indianapolis or New Orleans or Milwaukee. So Buss can share his revenue with the small market teams by reaching some agreement this summer, or he can share it with the Kings er Royals starting next year, by literally sharing the market with them.

There's one other point that I keep coming back to when I think about this situation. Stern insists that the current model is untenable, that teams are losing money and that they simply must have concessions from the players in a new CBA in order to remain viable. And yet, the Golden State Warriors sold for $450M (an all time record price for an NBA franchise) last year. Are there 29 billionaires who are dissatisfied with the margins on their vanity projects? Let them sell! There's no shortage of buyers, and valuations continue to increase, even in a terrible economy. (Yes, I realize that the league was unable to find a buyer for the Hornets and had to step in, but that is due primarily to the desire to keep the team in New Orleans. If they were willing to move the team to Las Vegas or St. Louis or Anaheim they could sell the Hornets tomorrow.)

The last time there was a lockout, the start of the season was delayed until late January and the season was shortened to 52 games. As it happens, I had just returned to the United States after living overseas, so I was none too happy to have to wait an additional two and a half months to see NBA basketball again for the first time in over three years. But let's face, they're not going to lose me, nor the vast majority of the Citizens of Clips Nation. As annoying and inane as this lockout may be, we're die hards, and we're going to watch the very next Clippers game that is played, whenever that may be. But the league has the data that shows how ticket sales and TV ratings took a nose dive the last time this happened. If they suffer another work stoppage, casual fans will stop watching games in droves, disgusted by what will accurately be described as a dispute between billionaires and millionaires over a school yard game.

It was a given that there would be a lockout on July 1 - what are they losing by having a lockout on July 1? Summer League? Big deal. It's been a game of chicken to this point. They can afford to lose July and August. But if they want to allow some time for negotiating free agent contracts, and some time for some semblance of a training camp, and still get the season started on time at the beginning of November, they need to get serious by September.

Hopefully by then they can at least agree on which numbers to use.

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