25 August 2014

An Update to the MASN Situation

The situation with MASN has been in the news a lot over the past month. First of all, I would like to congratulate the Eutaw Street Report for having an article included in the court record. Camden Chat has written a comprehensive series of posts that do a good job explaining the situation. Given everything already written about the situation I questioned whether it made sense to write yet another article discussing it. However, we do have access to many of the redacted documents on the court record and I thought there’s information in those documents that hasn't been discussed that explain aspects of the situation that haven't been discussed.

To understand the situation it is necessary to start from the beginning. The Orioles were promised by MLB in 2002 that the Expos would never be moved to Washington without the Orioles consent. So, the Orioles were very concerned to learn in 2004 that there were serious discussions about the Nationals moving to Washington. After all, 30% of the Orioles' fan base, sponsorships and revenues came from Washington DC and its suburbs. An analysis by Deloitte estimated at that time that the harm this would cause the Orioles should be valued at $40-50 million annually. Presumably that number would be considerably higher in 2014 dollars. MLB recognized the damage that moving a team to Washington would cause the Orioles and therefore proposed deals that would mitigate the Orioles’ losses. Eventually, the Orioles and MLB agreed that a team could be placed in Washington if the Orioles could have the majority control of a television network that had control of both teams’ television rights.

As a result of this deal, it was agreed that the Nationals would receive $20 million in 2005 and 2006, $25 million in 2007, $26 million in 2008, $27 million in 2009, $28 million in 2010 and $29 million in 2011 in media rights fees. The Orioles received slightly less in 2005 and 2006 as the deal indicated that the Nationals and Orioles would only receive the same amounts starting in 2007. The amount that the Nationals received ranked between tenth and fifteenth in baseball during each year of the 2005 to 2011 period.

The Nationals asserted numerous times in documents that their rights should have been worth a considerably larger amount but I haven’t seen any substantial supporting evidence. Perhaps the evidence is redacted. In response to these claims, Mark Wyche (the managing director of Bortz Media Group) stated that according to his methodology the Nationals rights over this period were worth approximately $119 million or $16 million less than the Nationals actually did receive. The Nationals were paid more than a fair amount for their rights according to the Bortz methodology. It is important to consider that MASN had to fight a number of legal battles with Comcast to become viable and this could have had an impact on the media rights fees that the Nationals could expect to receive.

The contract states in paragraph 2.I that after 2011 and for each successive five year period, the Orioles, Nationals and RSN shall negotiate in good faith using the most recent information available which is capable of verification to establish fair market value of the telecast rights licensed to the RSN for the following five year period. The contract states in paragraph 2.J.3 that if the parties are unable to agree on fair market value then the rights shall be determined by the RSDC.

MASN and the Nationals were unable to come to an agreement. Using the Bortz methodology MASN determined that the Nationals rights over this five year period were worth nearly $200 million dollars or roughly $39.5 million per year. The Nationals claimed that their rights over this five year period were worth AT LEAST a total of roughly $590 million dollars or $118 million dollars/year from 2012-2016. The Yankees TV contract pays them roughly $470 million dollars from 2012-2016 in media rights fees. The Nationals were claiming that their rights were worth at least about $24 million a year more than the Yankees. The Nationals further stated that whether MASN underpriced its programming by design or mismanagement is irrelevant as is whether MASN can afford the amount. They stated that fair market value is neither negated nor constrained by MASN's economics. Most of the Nationals’ argument is redacted testimony. All I know is that the Nationals were basing their request at least in part on what MLB considered to be fair market value for the Dodgers.

Dr. Hal Singer's affidavit stated that the RSDC ruled out the Nationals' valuation explaining that the contention that they would receive a rights fee of $109 million in an arm's length transaction with MASN cannot be accepted by the Committee because MASN would not agree to a rights fee that would potentially bankrupt the network. However, the RSDC also stated that they were unwilling to exclusively use the Bortz methodology to determine media rights fees. Instead, the RSDC decided that MASN has to pay each team about $300 million over the five year period. The Nationals have claimed that since the RSDCs decision is closer to the MASN' numbers than the Nationals' numbers shows the RSDC isn't biased.

I’ve seen testimony suggesting that the RSDC determined the amount that MASN should pay based on two primary arguments. The first is that MASN has had low operating margins in the past and should be willing to accept low operating margins in the future to secure must-have rights especially given that MASN will be able to renegotiate its rates in 2016 and improve its operating margin. The second is that MASN shouldn’t expect to receive historical operating margins because of the robust demand for sports rights fees and because the Orioles and Nationals are paid the same amount per the Agreement.

Dr. Singer attacks these arguments in his affidavit. He notes that while it is true that MASN did have low operating margins in 2007 that was because they were struggling to come to agreements with all of their providers and from 2008-2011 they have had industry-standard margins. He further stated that while some RSNs have had low operating margins in order to secure must-have rights this isn’t the case for all RSNs. Likewise it is true that MASN can renegotiate their rates in 2016 but having a low operating margin will weaken MASNs bargaining position. MASN may need to go to court to receive fair rates from its cable providers. If MASN has only a limited amount of money in the bank then MASNs leverage is limited. Speaking for myself, I don’t understand why MASN being able to renegotiate its rates in 2016 should have anything to do with what MASN pays to the Nationals and Orioles from 2012-2016.

Dr. Singer notes that rights fees only increase as affiliate fees increase. In the absence of being able to raise affiliate fees (at least until 2016), it is unclear why rights fees should increase significantly. Given that the Nationals and Orioles share the same market, MASN would maintain its same markets if having the media rights for a second team resulted in a 42% increase in affiliate fees. He notes that MASN enjoyed a near doubling of affiliate rates upon the addition of Orioles’ rights in 2007 and that therefore MASN has received historical operating margins.  

The RSDC further tried to support its claim by looking at the media rights fees for four comparable markets. The Rangers were one of the four comparable markets and another comparable extended their contract in 2013. The Rangers extension doesn’t begin until 2015. The RSDC discounted the values of a contract extension beginning from 2015 backwards to 2012 while the Orioles used the prior contract for 2012 to 2014 and the new contract for 2015 to 2016. I would suspect that Orioles argument is more accurate as illustrated by the media contract that the Phillies signed and Comcast Philadelphia’s subsequent actions to significantly raise carriage fees in 2014 despite not having to pay increased media rights fees until 2016.  

The Orioles made their offer based on the Bortz methodology as well as promises made to them by MLB when they agreed that majority control of a media network would be acceptable compensation. The eighteenth report of the RSDC discusses how the Bortz methodology was applied for NESN in 2003. This document was written by the RSDC in January 2005 and states the following:

“In brief, the so-called “Bortz analysis” avoids the examination of “comparable” arm’s-length contracts and instead collects estimated or actual revenue and expense data from the related broadcasting entity, assumes a market-driven operating margin that should satisfy the broadcasting entity and then calculates back to a rights fee that should be available to the club.” It further states that since no two markets are truly comparable a better approach is using the Bortz analysis and that even if a market analysis were appropriate, the RSDC finds selection of “comparable” markets to be an inadequate and unpersuasive basis for determining an arm’s length rights fee. In the past, Bortz has used an assumed 20% operating margin for cable and an assumed 30% operating margin for over-the-air broadcasts. In the case of NESN, the RSDC recommended that an operating margin of 21.9% be used.

In case that wasn’t clear I’ll explain the methodology.

Part I: Determine total revenue.
Part II: Determine total expenses other than rights fees.
Part IIIa: Subtract expenses from revenue. This number is called disposable revenue.
Part IIIb: Determine “Bortz” Operating Margin. This percentage is determined by the RSDC and has never before been less than 20%.
Part IIIC: Multiply Disposable Revenue by Bortz Operating Margin. This is the amount of RSN Profit.
Part IIID: Subtract Disposable Revenue by RSN Profit. This is the net rights fee per contract.

The Bortz Methodology determines how much money a team should be able to keep as profit and requires the rest to be used for the rights fee. Mark Wyche notes that the Bortz methodology has been used in nineteen other cases but not in this case. In those other nineteen cases, the Bortz operating margin was no less than 20%. In this case it was 8%. Mark Wyche doesn’t understand the logic of this.

In addition the Orioles received promises from MLB. When MASN was first created an investment bank called Allen and Co was hired by MLB to analyze RSN market economics and options. MLB and Allen and Company presented a number of pro formas that showed EBITDA in the mid-30% range and that this was “industry-norm” and sufficient to provide “free cash flow” to fund Orioles’ compensation while providing both clubs with “attractive rights fees”. One of the main reasons why the Orioles agreed that control of MASN would be acceptable compensation for the Nationals moving to Washington is because they understood that if the network was successful they would receive a significant amount of profit.

I’ve seen nothing explaining why the Nationals believe they should receive $590 million over 5 years. I’ve seen one document potentially explaining their reasoning but most of the testimony was redacted.  

One of the arguments between MASN and MLB comes down to this. MASN believes that it was understood that an acceptable operating margin for MASN would be between 20 to 30%. That was the reason why the Orioles agreed to the creation of MASN as compensation for the damage caused by the Nationals moving into town. If MLB can force MASN to accept an operating margin of 8% then this will cause the Orioles to suffer hundreds of millions of dollars if not more than a billion dollars. This limits MLBs’ options to convince Peter Angelos to drop litigation.

MLB believes that MASN should be forced to pay an amount comparable to what other similar markets are receiving despite the fact that MASN is unable to renegotiate its rates until after 2016. They believe that other RSNs have accepted low rates for a period of time to receive must-have rights and there’s no reason why MASN shouldn’t do the same.

So far, the judge involved has granted and extended an injunction preventing MLB from forcing MASN from paying roughly $20 million to the Nationals and preventing the Nationals from pulling their games from MASN. He questioned whether the MLB panel was impartial and whether the Nationals’ threat should be considered blackmail and possible extortion as well as stating that his court was the proper forum for these concerns. We’ll just have to wait and see whether the judge ultimately agrees that MLBs proposed rates are unfair and should be vacated.


Paul said...

Great read, and a great article. I really resent the MLB and the Nats for these actions. The Orioles and MASN were generous in allowing a competing entity in their own back yard and now they want to change the agreements.

Matt Perez said...

Thanks Paul. I'm glad you enjoyed it.