From: jpalmer@uwovax.uwo.ca (The Econoclast)
Subject: Re: Why Owners Buy Teams
Organization: University of Western Ont, London
Date: Tue, 22 Dec 1992 13:55:50 GMT

	I'm sure Ted and Sparky will have their own comments on this material,
but I'd like to rejoin the fray.

In article <21DEC199222572800@pavo.concordia.ca>, v_siede@pavo.concordia.ca (kaldis, bill) writes:
>      I have been following the thread between Ted Frank and King Banian 
> with a great deal of interest and would like to throw in my two cents.  
...
> The general consensus 
> (except for King Banian) seems to be that the profits are a great deal 
> higher ( I believe someone even guessed at $750 million).

	Actually, I'd gotten the impression from one of Ted's posts
that many owners buy into baseball for reasons other than investment.
Some get jollies from being rich-kid groupies; some get a
feeling of power and prestige; some get big subsidies from local
govts. To the extent that these non-pecuniary and/or non-profit
and/or govt benefits affect the bid price for a franchise, the actual rate of
return (in terms of operating profitability) on the franchise price 
will be less than it would for other businesses of equal risk.

>      I would like to approach the problem from a different angle.  Let's 
> look at what has happened to the selling prices of baseball teams over
> time.  Over a long period of time, the free market prices of baseball 
> franchises should reflect the underlying economics of ownership.  I.e., 

... [data deleted]

>       In effect, we can view these figures as being equivalent to a 
> business whose stock trades 4-12 times a decade in a relatively illiquid 
> market.  The indicated compound growth rate is 6.3% - let's round it to 6%.
> As I indicated earlier, growing market prices should reflect the growth of 
> the underlying profits.  Thus, over the long-term we would expect a 
> baseball team's profits to grow at 6%.  Clearly over the short-term, the 
> earnings will bob around some - but the long-term trend is up.

	I am very skeptical about extrapolating from past franchise
prices into the future. Clearly the most important determinant of the
franchise prices has been the aggregate level of prices. And I have
little confidence in any prediction that the aggregate level of prices
will continue to rise at 6%/yr ad infinitum.

>       I think we all agree that baseball qualifies as an economic franchise 
> in that it is relatively free from competition and can price its product 
> aggressively.  

	This phrase is puzzling. Does aggressive pricing mean
predatory pricing [which rarely exists anywhere, if ever, and seems
inexplicable in MLB] or does it just mean profit-maximizing pricing?

>Since there is no inventory and little physical assets 
> involved with ownership, all the profits are distributable to the owners.  

Hmmm. What about the inventory of human capital that is committed to
each team and which appreciates with on-the-job training and
depreciates with time?

[...]

>       Therefore, we can view ownership of a baseball team as being 
> equivalent to owning a perpetual annuity set to grow at 6% a year.  

	Not likely.

>If we 
> apply a discount rate of 10% to determine the present value of the earnings 
> stream, one could calculate that it would be appropriate to pay a 
> multiplier of 25 times after-tax earnings. (This after-tax multiplier of 25 
> translates to a multiplier on pre-tax earnings of 16).

I see. A nominal rate of interest of 10% and an expected rate of
inflation of 6%. A real rate of interest of about 4%. That's probably not far
off the mark. --- for LOW-RISK ASSETS!!

>       So now we have two major pieces to the puzzle - the value of 
> franchises in the open market (I'd say about $100 million on average) and 
> the multiplier on earnings appropriate to a business displaying the 
> powerhouse economics of an unregulated monopoly.  The calculation gives us 
> an average pre-tax operating profit of $6.25 million per team or 
> approximately $160 million for major league baseball.

	But in many industries, the risk-adjusted rate of return would
have to be much higher than 4%. Some work I did three centuries ago
[Bell Jl, 1972] indicated that in periods of low rates of inflation, 
major firms in competitive industries earned about 10% on their 
investments, and firms with market power earned even more, not 
counting whatever profits were buried as expenses. And MLB is 
pretty damned risky these days.

	If, in fact, your profit estimates are correct, one possible
explanation is that owners are bidding too much for teams relative 
to other options of equal risk. Another possibility is that they are
hiding their profits. They should be getting real rates of return 
of AT LEAST 10%, and probably more. If they aren't, I'd be really
skeptical of either the numbers or the motives.

-- 
  Regards,

  John Palmer    London, Ontario       Voice: (519) 661-3533     FAX: 661-3666
  reply to jpalmer@uwovax.uwo.ca       The Economics Institute for Journalists
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