[Dead Spin] How (And Why) An NBA Team Makes A $7M Profit Look Like a $28M Loss

jsmee2000 · Jul 1, 2011

This post is for those of you that enjoy finances or discussions regarding the lock out. For the TLDR ppl. f@ck off!

On the site, they also have a couple of financial statements for NJN (05 and 06).

http://deadspin.com/5816870/exclusive-how-and-why-an-nba-team-makes-a-7-million-profit-look-like-a-28-million-loss

Exclusive: How (And Why) An NBA Team Makes A $7 Million Profit Look Like A $28 Million Loss

Tommy Craggs — We've obtained audited financial data for the New Jersey Nets covering the three fiscal years from June 2003 to June 2006. Though the numbers end five years ago, you can still see the roots of the argument that will have NBA owners, come midnight, again locking out their players. You can also see how a team makes money and how it pretends not to be making any money at all.

The documents are embedded below, but here are the salient parts (click images to enlarge):

The big loss: That $27.6 million net loss looks bad, but, as you'll see, it's an illusion — a trick of accounting, one practiced by every sports franchise with the full blessing of American tax law and one we should keep in mind whenever an owner pleads poverty.

"Anyone who quotes profits of a baseball club is missing the point," Paul Beeston once said (at the time he was a Blue Jays vice president). "Under generally accepted accounting principles, I can turn a $4 million profit into a $2 million loss and I could get every national accounting firm to agree with me." If anything, he was being too modest.

The hustle: The first thing to do is toss out that $25 million loss, says Rodney Fort, a sports economist at the University of Michigan. That's not a real loss. That's house money. The Nets didn't have to write any checks for $25 million. What that $25 million represents is the amount by which Nets owners reduced their tax obligation under something called a roster depreciation allowance, or RDA.

Bear with me now. The RDA dates back to 1959, and was maybe Bill Veeck's biggest hustle in a long lifetime of hustles. Veeck argued to the IRS that professional athletes, once they've been paid for, "waste away" like livestock. Therefore a sports team's roster, like a farmer's cattle or an office copy machine or a new Volvo, is a depreciable asset.

The underlying logic is specious at best. As Fort points out, a team's roster at any given moment isn't actually depreciating. While some players are fading with age, others are developing and improving. But the Nets don't have to pay more taxes when a player becomes more valuable. And in any case, the cost of depreciation is borne by the athletes themselves, when they pass their primes and lose their personal earning power.

Nevertheless, the IRS not only agreed with Veeck but allowed any owner claiming the write-off to deduct roster expenses twice — first under "player salaries," in the case of the Nets' documents, and then under "loss on players' contracts" — and an enormous tax shelter sprang up within the balance sheets of franchises everywhere. This can't be emphasized enough: Every year, taxpayers hand the plutocrats who own sports franchises a fat pile of money for no other reason than that one of those plutocrats, many years ago, convinced the IRS that his franchise is basically a herd of cattle. Fort calls it "special-interest legislation." "It's not illegal," he says. "It's just weird."

The rules have changed over the years, but the depreciation shelter remains one of the great graces of owning a sports team. In some ways, it's gotten more fanciful. Between 1977 and 2004, owners could write off half the team's purchase price over five years, thanks to the pretend-loss of player value. One consequence, Fort notes, is that teams would change hands every five or six years, once the exemption had dried up. Now, after tax law revisions in 2004, owners can write off 100 percent of their team's purchase price, albeit over a 15-year span. What they're buying, as far as the RDA is concerned, is a set of players — the brand identity, the right to stage games and charge admission, and everything else are throw-ins. (According to Fort's analysis [pdf], the new RDA rules had the twin effect of increasing both tax payments and team values.)

It's not hard to see the benefits. Owners who've set themselves up as a partnership or a Subchapter S corporation can pass their "losses" onto their personal income tax forms. Let's assume that's what the Nets owners did, and let's put them in the 33 percent tax bracket. (The audit here covers the last year that Lewis Katz and Ray Chambers owned the team, the fiscal year ending in June 2004. In August 2004, six years after buying the Nets, they sold the franchise for $300 million to real estate developer Bruce Ratner. In 2009, Ratner sold an 80 percent share to a Rocky and Bullwinkle character named Mikhail Prokhorov for $293 million in equity.) That $27.6 million loss would mean tax savings of $9.1 million ($27.6 x .33).

If we're trying to arrive at some idea of how much money the Nets really made in 2004, we'll need to do a little crude math. Knock out the $25.1 million RDA — a paper loss, remember — and add the $9.1 million in tax savings. Suddenly, that $27.6 million loss becomes a $6.6 million profit.

A typical profit: In the 2003-04 season, the Nets went 47-35, won the Atlantic Division, and lost in seven games to the eventual champions — the Pistons — in the Eastern Conference semifinals. (This was the last of the Kidd-Jefferson-Martin Nets.) That playoff run brought in an extra $4.8 million in revenue, a decent haul that few owners can count on every year. So let's pretend the playoffs didn't happen. Take away that $4.8 million, and the $1.4 million in expenses, and the $27.6 million net loss is now $31 million. Run the earlier calculation again and you would have a $4.4 million profit in a non-playoff season.

The sale: Bruce Ratner's ownership group took over in fall 2004, and the Nets became a small piece of Forest City's $12 billion portfolio. This includes the Atlantic Yards land grab in Brooklyn, the future home of the Nets and the best explanation for why a buccaneering real estate developer like Ratner might buy a middling franchise like the Nets in the first place. As Neil deMause, co-author of Field of Schemes, explains: "If Ratner had gone to Brooklyn politicians and said, 'Hey, I want to build offices and residential buildings on public land,' they'd have hung up on him. But when he says, 'I'm going to bring professional sports back to Brooklyn,' suddenly here's [Brooklyn Borough President] Marty Markowitz holding press conferences and sobbing about the Dodgers. [Buying the Nets] helped him get a foot in the door with Brooklyn politicians."

This means you have to think about the Nets under Ratner as a single node on a vast network — "an element in a billionaire's wealth-generating portfolio," as Rodney Fort says. The real value of the team to Forest City will likely show up in small type on the balance sheets of another subsidiary, lying just beyond our view.

The motor plant: Operating income was down in 2005, dropping from $95.7 million to $77.4 million, and expenses rose, particularly in those line items representing what we'll loosely call the team's self-presentation: ticket sales, marketing, broadcast, etc. Fort's guess is that the Nets were "presenting the team to Brooklyn" and spending a good deal of money in the process. (The accounting also changed — among other things, we now have line items for both "loss on players' contracts" and "depreciation and amortization.") Still, that doesn't quite account for the swing from a mild profit to a seemingly large loss. "One of two things must be true," Fort says. "Either they haven't found all the values [of owning a team], or they're not losing money."

We can't know for sure, though, since we're seeing only a sliver of Forest City's portfolio. The mistake is in thinking of a sports team as a self-contained unit. Fort says a team is more like the motor plant at Ford. If you were to look at the motor division's revenue, he says, "I'd promise you it's negative." He continues: "But if you said, 'Look, Ford is losing money!' that'd be ridiculous." The motor plant is selling motors at a price that enables Ford to turn a profit when it sells completed motor vehicles. It creates value, Fort says, "every time a Ford goes out of the assembly line."

For anyone who wants to extrapolate these numbers to the rest of the league, caveats apply. These are six-year-old financials for a single team in the NBA, where market size is destiny and where, for instance, New York's books won't look anything like Milwaukee's. What's more, this is about as close a look as you'll get at the financial workings of a sports franchise, and even then the balance sheets are hopelessly opaque. But that's partly the point. In the modern era, franchises are owned by businessmen who approach their teams as one of many interconnected wealth-generating mechanisms. As in Fort's example above, the real value of one asset (the Nets) can't be known without looking at the numbers for another (the Barclays Center) and another (the rest of the Atlantic Yards development), and so on. There's nothing illegal or even wrong with that, but in such a system you can see very quickly why incentives for owners often fall irreparably out of plumb with the wishes of their fans — owners want to maximize revenue (which is their right), and fans want to win (which is their nature), and both Wayne Huizenga and the folks in the grandstand at PNC Park will tell you that these goals aren't necessarily compatible.

The other lesson to draw is that there are certain baked-in advantages to owning a team. You have both the relevant labor law and the tax code firmly on your side. You are making money you didn't exactly earn from the moment you sign the paperwork, and you are making more money for your other businesses — your shopping mall across the street from the arena, your legal practice, your broadcast holdings — and then, come tax time, you are allowed by law, and even encouraged, to pretend you are not making any money at all. Remember this the next time David Stern says the NBA's economic system is broken. "The bottom line about the bottom line," Fort says, "is that even if it looks like they're losing money, it doesn't mean they're losing money."
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jsmee2000 · Jul 1, 2011

http://www.atthehive.com/2010/12/7/1862259/the-hornets-financial-statements-the-hornets-have-been-unprofitable

The Hornets' Financial Statements: The Hornets have been unprofitable for a long time

In a Wikileaks-like dump, Deadspin released the Hornets' financial statements from the fiscal year ending 2009. I'll be going through these statements for the next couple of days off and on, but I can share some of my preliminary analysis with you right now. I'm happy to finally be putting my finance major to good use.

The short version of the story is that the Hornets were not profitable from 2008 to 2009, and it doesn't appear that they were particularly profitable before that. The NBA was keeping them on life support, giving them loans, letting them get cheap credit, and deferring payment of the Hornets' liabilities to the NBA. Follow me beneath the jump for some of the details.

Star-divide

A couple of quick notes:

1) The Hornets have their fiscal year end on June 30 of every year (befitting an NBA franchise), so when I say "2008," I mean the financial results of the 2007-2008 season. Deadspin only released a financial statement that has results from 2008 and 2009, so the 2009-2010 season is not included in this analysis (presumably, with the Chris Paul injury, that season went even worse for the Hornets financially).

2) I'm going to be focusing on the Hornets' cash flows, since that's where the money is. As long as the team can generate positive cash flows, they can continue operating. If they have a hard time doing that, then they won't. It's that simple.

So, on to the analysis. If you'll go to page 11 of the Deadspin dump, you'll find the Hornets' statement of operations This tells us what in the Hornets' organization is making how much money, and whether their revenue is able to cover their expenses.

In 2008, just on operations, the Hornets lost money. A lot of it, in fact - $7 Million. That's a -7% operating margin, which is terrible. In the end, they reported a Net Income of -$16 Million, which, again, looks really bad. The next year, 2009, the Hornets were able to significantly boost their Net Income to the point that it was positive - nearly $2 Million. Why is that? Well, there are two big causes for the jump. The first is a nearly $10 Million jump in home ticket revenue, and the second is a strange $4 Million "Gain on modification of relocation obligation." Without that strange $4 Million addition, the Hornets would have lost $2 Million in 2009, even with the huge spike in ticket revenue and a $3 Million cut in expenses.

Now what was the "Gain on modification of relocation obligation?" The bottom of page 25 and all of page 26 gives us the answer. The Hornets owed the NBA a $30 Million for moving from Charlotte to New Orleans. They decided to pay that over a 7-year installment plan. However, the Hornets were having such a hard time paying the fee, the NBA allowed them to push back their payment of the fee until they were more profitable. So in 2009, the Hornets were able to log a "Gain" of $4 Million, since the NBA wasn't making them pay their existing liabilities. Without that charity from the NBA, the Hornets would have lost $2 Million in 2009.

Now let's look at the Hornets' statement of cash flows. That tells us how much cash the company is currently taking in. It's the most important measure of a company's health. We see under the line "Net Cash used in operating activities" that the Hornets bled cash due to their operations in both years, even with the NBA's creative bookkeeping (creative bookkeeping, by the way, doesn't mean anything untoward was being done. It just means the NBA was doing all it could to keep the Hornets afloat).

To make sure that the Hornets could keep doing business, they had to rely on borrowing money from other people. Look at "Proceeds from related-party notes payable" under "Cash flows from financing activities." We can learn on Page 29 of the Deadspin dump under note 15 that Shinn and Chouest gave short-term loans to the Hornets to make sure that they could keep operating. In 2009, we see that those short-term loans had been paid back, and the Hornets had issued $14.5 Million of long-term debt to cover that payment back to the owners, and had drawn $8 Million from their revolvers (a standing line of credit from the NBA). These revolvers are the lines of credit that David Stern said the team had maxed out.

To summarize: The Hornets were losing significant amounts of money as a team. To cover their losses, they were borrowing from anybody they could get money from – their owners, issuing long-term debt, and credit from the NBA. Finally, this year, the Hornets finally ran out of places they could get money from to cover their losses, and the NBA had to take over.
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TheRealist137 · Jul 1, 2011

This is why I chose finance over accounting as my major. Accounting is all illusions, the rules are arbitrary and I hate learning about some rules that a bunch of people made up. Finance is about "real" money and what a business can do with it, accounting is "fake" money designed to satisfy GAAP made by some random people.

Damion Laverne · Jul 1, 2011

Damn! I chose accounting as my major. But there is some BS in there, including "loss on players' contracts". Players are not real estate.

Air Langhi · Jul 1, 2011

RDA is the most awesome thing ever. I heard about that a long time ago and I realized pro sports is a very profitable business.

Fyreball · Jul 1, 2011

Damion Laverne said: ↑

Damn! I chose accounting as my major. But there is some BS in there, including "loss on players' contracts". Players are not real estate.
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That's the point of the article. It's pointing out how RDA allows owners to CLAIM players as depreciating entities when in fact, they are not. It's how somebody like David Stern can, with a straight face, say that the league as a whole is losing money.

MiddleMan · Jul 1, 2011

Damion Laverne said: ↑

Damn! I chose accounting as my major. But there is some BS in there, including "loss on players' contracts". Players are not real estate.
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They are Assets.

geeimsobored · Jul 1, 2011

MiddleMan said: ↑

They are Assets.
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emjohn · Jul 1, 2011

Stern will never admit it, but moving the Hornets to NO was a colossal mistake, and not letting them stay in OKC (for Katrina PR reasons) was just about as bad.

No one in the league will say it, but Stern absolutely condoned the OKC group coming in and moving the Sonics. Seattle was doing terribly because of the way the Key Arena contract cut them out of so much local revenue.

And the number of teams that were borrowing alarming amounts of cash from the NBA would surprise folks.

DonkeyMagic · Jul 1, 2011

TheRealist137 said: ↑

This is why I chose finance over accounting as my major. Accounting is all illusions, the rules are arbitrary and I hate learning about some rules that a bunch of people made up. Finance is about "real" money and what a business can do with it, accounting is "fake" money designed to satisfy GAAP made by some random people.
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financials are based on those rules though, no matter how silly or wrong they are. If you are going to be a great financier...you better know the accounting behind the numbers you're working with in finance.

Think of it like this....you can claim that finance is "playing the game" and accounting is keeping the score. Well, how do you know you've won if you don't understand how to keep the score?

TheRealist137 · Jul 1, 2011

DonkeyMagic said: ↑

financials are based on those rules though, no matter how silly or wrong they are. If you are going to be a great financier...you better know the accounting behind the numbers you're working with in finance.

Think of it like this....you can claim that finance is "playing the game" and accounting is keeping the score. Well, how do you know you've won if you don't understand how to keep the score?
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While that might be true, it's still boring as heck.

MemphisX · Jul 1, 2011

However, the Hornets losses are self inflicted wounds due to the owner killing a great market with great financial support. Even then it took a natural disaster of historical proportions to make them operate on such a poor level in one of the smallest NBA markets.

If you want to continue thinking the NBA is losing money when revenue, viewership and attendance are at record levels ... Be my guest.

Cohete Rojo · Jul 1, 2011

TheRealist137 said: ↑

This is why I chose finance over accounting as my major. Accounting is all illusions, the rules are arbitrary and I hate learning about some rules that a bunch of people made up. Finance is about "real" money and what a business can do with it, accounting is "fake" money designed to satisfy GAAP made by some random people.
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This is why I chose George Carlin over finance. Finance is all bull****.:grin:

In all seriousness: bread and games.

rrj_gamz · Jul 1, 2011

MiddleMan said: ↑

They are Assets.
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Agreed...IMHO, they are a revenue producing assest...If that asset "breaks", or fails to perform, the owners are still obligated to pay. You are able to depreciate assets...the fact that it's non-cash is irrelevent regarding an item on income statements...Cash flow is totally different but that's a different discussion...as is return on investment...

It's not a hustle...Depreciating assets is a GAAP. period...

melvimbe · Jul 1, 2011

rrj_gamz said: ↑

Agreed...IMHO, they are a revenue producing assest...If that asset "breaks", or fails to perform, the owners are still obligated to pay. You are able to depreciate assets...the fact that it's non-cash is irrelevent regarding an item on income statements...Cash flow is totally different but that's a different discussion...as is return on investment...

It's not a hustle...Depreciating assets is a GAAP. period...
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How can you depreciate an asset that you don't own? These are not slaves, they're employees. It's like Apple claiming a loss because Steve Job's health is failing. Or perhaps claiming a loss in depreciation for a car your leasing. Nonsense.

And yes, I understand that that's GAAP, and regardless of whether it's considered an acceptable practice to the gov't and possible investors, I would not expect the players to accept that junk.

Regardless of that, I do believe that many teams are in financial trouble. Why else would we see so many teams make trades for financial reasons? Why do we see such a wide variance in payroll between the haves and the have nots?

If I were the players, I would negotiate to remedy the situation where players have contracts way above their value. Perhaps that's a rookie scale change, perhaps raising the minimum age, maybe a hard cap. Don't know. At the same time, I would want to have some say in some of the NBA's expenditures. Player's don't have a say in funding the WNBA and other expenditures that don't support the core business, and they should if it's going to factor into negotiations of their salary.

As has been said many times, looks like the two groups are far apart, it's going to take some time for concessions to come through, and for both sides to recognize the other's issues. Unfortunately, it looks like the owner's can wait it out longer then the players.

RunninRaven · Jul 1, 2011

rrj_gamz said: ↑

Agreed...IMHO, they are a revenue producing assest...If that asset "breaks", or fails to perform, the owners are still obligated to pay. You are able to depreciate assets...the fact that it's non-cash is irrelevent regarding an item on income statements...Cash flow is totally different but that's a different discussion...as is return on investment...

It's not a hustle...Depreciating assets is a GAAP. period...
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Yeah, but like the article stated, if a drafted rookie is playing above his value because he improves over the course of his first contract, does that players value "increase" on the books and the team has to pay more taxes as a result? No, they don't. The NBA owners are having their cake and eating it too. If you want to claim players are depreciable assets, shouldn't also allow that they can appreciate as well?

PS. I'm not a finance or accounting person, so I might just being talking out my ass here. Just sounds logical to me.

DwangBoy · Jul 1, 2011

TheRealist137 said: ↑

This is why I chose finance over accounting as my major. Accounting is all illusions, the rules are arbitrary and I hate learning about some rules that a bunch of people made up. Finance is about "real" money and what a business can do with it, accounting is "fake" money designed to satisfy GAAP made by some random people.
Click to expand...

I guess you never learned about the 'Statement of Cash Flow'..

DonkeyMagic · Jul 1, 2011

TheRealist137 said: ↑

While that might be true, it's still boring as heck.
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True.

Icehouse · Jul 1, 2011

TheRealist137 said: ↑

This is why I chose finance over accounting as my major. Accounting is all illusions, the rules are arbitrary and I hate learning about some rules that a bunch of people made up. Finance is about "real" money and what a business can do with it, accounting is "fake" money designed to satisfy GAAP made by some random people.
Click to expand...

This accountant thinks it's funny to hear a finance guy say they deal in real $$ and not illusions, especially considering some of the things that led to our current recession.

OHMSS · Jul 1, 2011

In Europe the contracts of all players are in net terms and the teams have to pay the taxes. In the US, the sports teams can just list GROSS as a "salary" even though the player never gets that and the team never pays that.

It is a fairy tale imagination the way "salary" works in the USA. People say, "I make $50,000 a year" in the US, when they don't make that. Employers say, "I pay so and so $100,000 a year" when they do not.

It is fake and imaginary and always has been. That's why the salaries are NET in other places. The US tax system is incredibly corrupt and ludicrous.

As has been pointed out many times, not a single NBA player earns what the NBA claims they do. They earn way less than that. The "budgets" of the NBA teams are inflated and basically completely made up. In other countries, such shenanigans are not allowed by the governments. But in the US, the rich seem to get away with anything these days.

In Italy for example, the government handles the books of the sports clubs. Just compare that to how out of line the US tax laws are for the super rich billionaire sports team owners. It's pretty ridiculous and pathetic, when the working people struggle so much.

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[Dead Spin] How (And Why) An NBA Team Makes A $7M Profit Look Like a $28M Loss

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