The Nationals Lost Money Because of the RSDC Decision

Summary: While the RSDC decision allows the Nationals to receive more money in media rights fees than MASN's request, it also causes the Nationals to lose money due to lower equity stake distributions and loss of equity value. The amount that the Nationals lose due to lower equity stake distributions and loss of equity value is larger than the amount they gain in total media rights fees. Therefore this decision causes them to lose money.

Warning! Gory Mathematical and Financial Details Ahead! It’s hard to sufficiently explain how valuations work without using jargon that can be difficult to understand. 

The latest documents from the MASN case shed light on confidential conversations about a possible sale of MASN. These discussions ultimately weren’t fruitful but the parties created numerous pro forma documents discussing potential terms for a sale. These documents include figures that make it possible to determine the equity value of MASN and therefore discuss the total difference in value between MASN and the RSDC's proposals from 2012-2016.

There are two factors that are necessary to determine the equity value of an enterprise. The first is the “exit multiple.” The second factor is the “discount rate.” Let's start with the "exit multiple." Basically, an RSN is valued based on its profits. An RSN that earns $100 million in profits is more valuable than one that earns $10 million. But one wouldn't agree to sell their business for one year's worth of profits by itself. So, the “exit multiple” is used to determine how much more than profits a business should be worth. The "exit multiple" multiplied by profits determines the future value of an RSN.  This also means that if MASN earns less in profit, then it's worth less as an enterprise.

The “discount rate” is used to determine the rate of return necessary for one to invest in a business. This takes into account rates of return for other investments as well as possible risk. Think of it this way. I can invest money in treasuries and be highly certain that they won't default. If I were to buy a 30-year bond for Sears, it is considerably less likely that they won't default. Therefore, I may want to use a discount rate of 2% when buying a treasury bond while using a discount rate of 20% when buying a bond from Sears. I need to receive a higher rate of return from Sears than from U.S. treasuries because an investment in Sears is so much riskier.

These pro forma documents indicate that a fair exit multiple is 15 and a fair discount rate is between 9-11% for a network owned by a media company. They argue that a fair “exit multiple” for MASN under current conditions is between 12 and 15 while a fair discount rate is between 11-13%. The people who drafted these documents believe that the RSDC decision reduces the certainty of future MASN cash flows as well as the viability of MASN as a profitable RSN. In other words, they believe that it is reasonable to claim that a fair “exit multiple” is 15 while a fair discount rate is about 11%. However, they also believe that MASN's value should be discounted due to the RSDC being unwilling to allow MASN to earn a reasonable profit. If the RSDC is going to force MASN to pay unreasonable rights fees, then any buyer is going to refuse to pay full price (even if they were allowed to pay fair rights fees).

By multiplying the last year of free cash flow by the exit multiple listed above one can determine the terminal value of MASN at the end of 2016. Once that is known, it is possible to determine the present value (present value is 2012 and not 2014 because 2012 is when the deal started) of MASN by means of discounting expected income streams using the discount rate while also using the discount rate to determine the present equity value of MASN. 

There have been enough documents that it is possible to determine MASN's revenues, expenses, media rights fees, profits, and equity distribution according to both MASN and the RSDC. This pro forma document created by Allen & Co. has helpful information.

I've also created a document and spreadsheet that discuss in more detail what results I use for MASN's and the RSDC's proposals based on what is in the actual reports. 

According to MASN's proposal, MASN is predicted to earn a profit of roughly $67.7 million in 2016 and therefore has a terminal value in 2016 of $1.01 billion.  With a discount rate of 11% over a five-year period, the present value of terminal value is $603 million of which 83% will belong to the Orioles and 17% will belong to the Nationals. Determining the present value of media rights fees and equity distribution can be accomplished by discounting 11% per year from the amount of each received. For example, the Orioles and Nationals are expected to earn $42M in media rights fees in 2015. That amount is equal to $42M/1.11^3 or roughly $30.7M in 2012 dollars. In order to determine future value, one would increase the amount received by 11% until 2016. So, the $42M that each team receives in media rights fees in 2015 is worth $46.66 million in 2016. The chart below shows how much revenue each team earns from media rights fees and equity distributions using both present and future value using MASN's proposal.

According to the RSDC's proposal, MASN is expected to earn a profit of roughly $24 million in 2016 and therefore has a terminal value in 2016 of $360 million. The present value of its terminal value is $213.5 million. The chart below shows how much revenue each team earns from media rights fees and equity distributions using both present and future value.

This chart shows how much the Nationals and Orioles will earn using present and future value from each of these proposals. I use gross rights fees rather than net rights fees to determine total value because the Nationals currently would be eligible for revenue sharing if they weren’t ineligible due to being in a top 15 market. As a result, they won’t be paying revenue sharing tax on all of the money that they receive in rights fees and therefore using gross rights fees allows for a more accurate comparison.

Both the Orioles and the Nationals will receive increased rights fees from this deal but both will suffer significant losses in equity distributions and equity value. While the Orioles would suffer significantly larger losses if the RSDC decision is upheld, this would also result in the Nationals losing anywhere from $25-50 million dollars over the five-year period.

It is worth noting that a significant amount of the value that the Nationals will lose is from their loss of equity. The Nationals or Orioles will not be able to take advantage of any of this money unless they sell MASN to an outside buyer or if the owners of the Nationals or Orioles sell their team. It is also possible for both parties to agree to a media rights deal that could significantly increase the value of MASN right before selling it to an outside party and therefore increasing the value of MASN. However, pro forma documents written by Allen & Co. show that potential buyers consider the RSDC decision to be a detriment to MASN's value and therefore would reduce the amount that they’re willing to offer. Simply put, potential buyers aren't stupid.

The reason why the Nationals are willing to accept a deal where they lose money is because they believe they can receive higher rights fees in a situation where their media rights are not controlled by MASN. They believe that they can either force MASN to demand higher carriage fees (which will allow MASN to pay the Nationals a larger media rights fee while remaining profitable) or force MASN to sell the Nationals their rights. If the RSDC does decide that Bortz should be used, then MASN will likely be profitable for the foreseeable future and it could be a long time until the Nationals regain control of their media rights.

In the meantime, the value of the Nationals equity stake in MASN has decreased due to the RSDC's decision. At least from 2012-2016, the Nationals would receive more value for their rights if MASN had won rather than the RSDC.

Team-Controlled Players Have Seen a Pay Cut

I understand that sometimes when I write sabermetric posts that they can be hard to follow. What I'm going to try to do in the future is write a paragraph or two discussing the relevant points at the start of the article.  I'm hoping that doing this will make them easier to follow and make clear what I think are some of the most important points to note.

Abstract: In this post, I intend to show that both the cost of a free agent and team-controlled win (defined as a player with fewer than six years of service time) have increased from 1996 to 2013. The cost of a free agent win is increasing more than 3.9% annually more than a prospect win from 2004 to 2013. This indicates that team-controlled players are being underpaid compared to free agents. It also means that any attempt to determine a discount value for keeping prospects in the minors needs to consider that the value of a prospect win increases over time by 3.9%.

A few months ago, Lew Pollis wrote an article discussing the historical cost of a win in free agency from 1996 to 2013. He determined how much money teams spent on free agents in a given year (regardless of whether they were signed that year or not), used Fangraphs WAR to determine their production, and then divided the two. It is possible to use his method to do the same thing with team-controlled players and see whether their value has changed over that 17-year time frame. This makes it possible to determine whether a team-controlled win has increased in value compared to a free agent win and therefore if prospects are becoming more valuable over time.

The amount of money spent on payrolls has increased significantly from 1996 to 2013. Teams spent $984 million on payroll in 1996 and $3.138 billion on payroll in 2013. Team-controlled players (players with less than six years of service time) earned $357 million in 1996 and $1.323 billion in 2013. Extended players (players with more than six years of service time but did not sign in free agency) earned $420 million in 1996 and just $504 million in 2013 while free agents (players that have more than six years of service time and were signed in free agency) earned $207 million in 1996 and $1.31 billion in 2013. The chart below shows how much money free agents, team-controlled players, and extended players earned from 1996-2013.

The amount of production that each group produces partly explains this trend. Free agents have produced roughly 200 WAR per season from 1996 to 2013. However, extended players produced 324 wins in 1996 but only 110 in 2013 while team-controlled players produced only 478 wins in 1996 but 703 wins in 2013. The chart below shows the number of wins produced by each group annually from 1996 to 2013.

The cost of a win for each group of players has increased over the sample but the cost of a free agent and extended player win is increasing at a considerably larger rate than the cost of a team-controlled player win. The cost of a free agent win has increased from $1.04 million in 1996 to $7.03 million in 2013. The cost of an extended player win increased from $1.3 million in 1996 to $4.55 million in 2013. The cost of a team-controlled player win increased from $750,000 in 1996 to $1.88 million in 2013. The chart below shows how this changed over time.

Not only is the actual amount for a free agent win considerably more than the cost of a team-controlled player win but the annual rate of increase for a free agent win is more than twice that of a team-controlled player win. Over the entire sample, the value of a future team-controlled win increases by 5.6% (1.11/1.05) each year while for the past 10 years it has increased by 3.9% each year. Either way, this indicates that teams would save on player costs by keeping their prospects in the minors for extra time.

It appears that team-controlled players earning under a million dollars and those earning over a million dollars are seeing their cost per win increase at a similar rate. From 2005 to 2013, team-controlled players in each of these categories saw an annual increase of roughly 4%. I used 2005 to 2013 because players earning under $1 million were remarkably ineffective in 2004 while those earning over $1 million were remarkably effective. 2004 appears to be a clear outlier and therefore shouldn’t be used as a baseline.  This chart shows the change over time.

In addition, prospects do not appear to be receiving significantly higher signing bonuses.  According to the Associated Press, teams spent $150 million on the draft in 2004 and $208 million in 2013, meaning that signing bonuses have increased by only 4.3% per year over that period. This is similar to the increase in salaries for team-controlled players during that time period and therefore doesn’t indicate that teams are paying more in signing bonuses while paying less in salaries.

This indicates that both the minimum salary is too low and that team-controlled players don’t receive large enough salary increases in arbitration. In order to keep pace with free agent salaries they should be earning $3.4 million per win instead of $2.2 million per win and therefore their salaries should be roughly 50% higher. This raise in salary should come partially via an increase in the minimum salary and partially via an increase in arbitration.

Over the 17-year period, it is clear that team-controlled players are becoming considerably more valuable compared to free agents. The amount of money that it takes to purchase a win in free agency is growing at a considerably faster rate than the amount it takes to purchase a win with a team-controlled player -- team-controlled players produce nearly 70% of wins while free agents only produce 20%.

This is probably good for the game because it allows for greater parity. As it becomes more and more expensive to get value in the free agent market, then large market teams get less benefit for having a higher payroll. But it also means that prospects and other team-controlled players receive unfair compensation for their efforts.