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August 1, 2005

Lies, Damned Lies

The Manny Non-Deal

by Nate Silver

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More often than not, the trade deadline winds up being anti-climactic. Between large contracts, seven-way wild-card races and a condensed time frame, it's awfully hard to find a deal involving superstar players that is suitable to all sides. The 2005 deadline, unfortunately, has been no exception; we pundits are stuck with the scraps of Geoff Blum and Kyle Farnsworth and a whole bunch of almosts and coulda-beens.

Nevertheless, sometimes the coulda-beens are news unto themselves. Even though a deal was not consummated, it's remarkable that the Boston Red Sox, bathing in cash, coming off a championship and in the midst of a heated pennant race, were seriously contemplating trading Manny Ramirez, who remains one of the best hitters in baseball.

What's also been surprising is the lack of editorial opinion on the deal. Under ordinary circumstances, a contending team considering trading one of its best hitters, a couple of its best prospects and a heap of cash would trigger a lot of questions about the sanity of that team's general manager. In this case, nobody has suggested that Theo Epstein has lost his mind, nor has there been much discussion about whether the deal would be a good one for the Sox. Much of that, I think, is because the would-be trade is awfully tough to analyze from a traditional, on-the-field perspective. The reason the Sox might have traded Ramirez would be to get out of the remaining years of his huge contract. There isn't much debate that Ramirez, even if he ages reasonably well, isn't going to be worth what the Sox will be paying him through 2008. But in order to analyze the deal, you have to have some notion of exactly how much Ramirez's remaining contract years are likely to cost the Red Sox. That's fairly tough to do, but we're going to give it a try.

Ramirez is scheduled to make $23.2 million this year (a figure that includes the final prorated chunk of his signing bonus), $19 million in 2006, $18 million in 2007 and $20 million in 2008. His contract also includes team options for 2009 and 2010, but at such a steep price ($20 million per year) that it's safe to attribute no material economic value to them; they're not going to be picked up.

What sort of return on investment are the Red Sox likely to get for their money? Let's walk through a quick, four-step process:

  • Step 1: Determine the marginal cost of Ramirez's contract. This is straightforward. We take Ramirez's annual salary and subtract from it the major-league minimum salary of $317,000, the amount Red Sox are obligated to pay to whichever player fills Ramirez' roster slot. This produces a marginal cost of:
    
    2005   $22.88 million
    2006   $18.68 million
    2007   $17.68 million
    2008   $19.68 million
    
  • Step 2: Estimate Ramirez's on-field productivity. This would ordinarily be very tricky to do, but fortunately we have PECOTA, which uses comparable players to estimate a ballplayer's performance several years into the future. PECOTA estimated, prior to this season, that Ramirez would be worth 7.8 wins above replacement (WARP) this year, 6.4 WARP in 2006, 5.1 WARP in 2007 and 4.1 WARP in 2008.

    Ramirez losing essentially half his value in the span of four years might seem like a fairly steep decline, but it has plenty of precedent. Ramirez's top comparable is Albert Belle, who hung up his spikes after his age-33 season. Also ranking high among his comps are Sammy Sosa and Dick Allen, who lost their skills plenty fast. Certainly, there are also some more favorable names on the list--guys like Frank Robinson and Tony Perez who aged well--but considering that there's some chance of a steep decline for Ramirez (possibly triggered by injury), and a near certainty of at least some decline, PECOTA's estimate seems reasonable. In fact, it may be too generous. Ramirez is on pace to finish at about 6.9 WARP this year, a fair bit worse than the preseason forecast, but for simplicity's sake, we'll go ahead and leave his PECOTA forecast as is.

  • Step 3: Translate on-field productivity into cash. This is the trickiest part of the problem. We might have a pretty good idea of how many wins Ramirez is worth, but there hasn't been a lot of work done recently on just how much money a win is worth, in terms of increased ticket sales, media exposure, postseason sales and so forth. What's more, this number surely varies from team to team: a big-market team like the Mets that doesn't fill its stadium probably gets more cash benefit from an additional win than, say, the Padres do.

    But there is another approach to the problem, which is to determine how much teams are willing to pay for an additional win. In an analysis of last winter's free-agent market, I determined that the market price of an additional win is about $2.14 million dollars. We'll use that as our working estimate, which leads to a marginal revenue product (MRP) for Ramirez as follows:

    
    Year       WARP          MRP
    2005        7.8     $16.69MM
    2006        6.4     $13.70MM
    2007        5.1     $10.91MM
    2008        4.1      $8.77MM
    
  • Step 4: Deduct output from cost to determine the marginal gain or loss associated with a contract. This is mostly just a simple subtraction problem, but we'll add a couple of additional wrinkles for the sake of completeness. First, both MRP and cost need to be prorated for 2005, since most of the season has been completed, and since most of Ramirez's contract has already been paid. We'll use one-third as our multiplier, since about two-thirds of the season has been played to date. Second, since a dollar today is worth more than the same dollar tomorrow, we need to discount future years of the contract to account for the time value of money. In order to do that, we'll apply a neutral discount rate of 5% per year. That gives us the following result:
    
    Manny Ramirez     2005(ROY)*   2006     2007     2008      Total
    
    Marginal Salary     $7.63     $18.68   $17.68   $19.68    $63.67
    WARP                 2.6        6.4      5.1      4.1      18.2
    Market Value        $5.56     $13.70   $10.91    $8.77    $38.95
    Net Value          -$2.06     -$4.98   -$6.77  -$10.91   -$24.72
    Discounted @ 5%    -$2.06     -$4.75   -$6.14   -$9.42   -$22.37
    * Rest of Year
    
    We estimate that the net present value (NPV) of Ramirez's remaining contract is negative $22.37 million dollars. Put another way, if Ramirez offered to let the team buy out the rest of his contract for $22.5 million, the Sox would benefit from taking him up on his offer. Thus, it's pretty easy to see why the Sox are almost obligated to listen to offers that could reduce the financial burden associated with Ramirez, even if some of these offers might marginally reduce their chances of repeating their World Series championship.

Since a deal was never consummated, we can't know exactly what the Red Sox would have been willing to give up to get this $22.37 million liability off their books. But according to this Jayson Stark column, the Red Sox were at least reasonably close to agreeing to a deal in which they would have given up Ramirez, Hanley Ramirez, Jon Lester and $15 million in cash and received Aubrey Huff and Mike Cameron in return. Would this have been a good deal for the Sox?

We can estimate the NPV for the other player contracts in the same way that we did for Ramirez. This is straightforward in the case of the veterans, who are locked into multi-year deals of their own, but more difficult for the prospects. Let's start with Aubrey Huff:


Aubrey Huff       2005(ROY)*   2006      Total

Marginal Salary     $1.39      $7.18     $8.57
WARP                 1.9        5.2       7.1
Market Value        $4.14     $11.13    $15.27
Net Value           $0.91      $3.95     $4.86
Discounted @ 5%     $0.91      $3.76     $4.67
Huff is owed $4.5 million in 2005 and $7.5 million in 2006; after that, he can become a free agent. He hasn't quite lived up to his preseason PECOTA projection, which means that this estimate may be slightly too generous, but this still looks like a pretty cheap contract in the near-term. We estimate that the NPV associated with Huff's remaining contract is positive $4.67 million.

Mike Cameron:


Mike Cameron      2005(ROY)*   2006     2007     Total

Marginal Salary     $1.89      $7.68    $6.18   $15.75
WARP                 1.8        3.4      3.1      8.3
Market Value        $3.85      $7.28    $6.63   $17.76
Net Value           $1.96     -$0.13    $0.15    $1.98
Discounted @ 5%     $1.96     -$0.13    $0.14    $1.97
Cameron's contract includes a team option at $6.5 million in 2007; if the team does not exercise that option, he'll be owed a $500,000 buyout. PECOTA estimates that Cameron's market value in 2007 will be $6.63 million, making it worthwhile to exercise that option, so we've gone ahead and included that year of the contract. All told, his contract looks like a slight net positive for an acquirer.

The economic value of a prospect comes in his first six years of major-league service, when he'll provide value to his team either essentially free of charge (before becoming arbitration-eligible) or at a material discount below market rates (arbitration years). To my knowledge, there hasn't been a study done of just what sort of discount a team can anticipate during a player's arbitration years, but it's clear that 1) arbitration awards or settlements tend to run at least somewhat below what a player would be paid in the free market, and 2) this discount tends to decrease--he makes a larger fraction of his market value--as the player's service time increases. My educated guesstimate is that we're looking at something like this for a typical player:


MLB Year 1      $350,000 salary
MLB Year 2      $500,000 salary
MLB Year 3      40% of market salary
MLB Year 4      60% of market salary
MLB Year 5      70% of market salary
MLB Year 6      80% of market salary
Both Ramirez and Lester look like they're fairly close to major-league ready, especially for a team like the Devil Rays, so we'll assume that their first major-league seasons are in 2006, at which time their arbitration clocks start running. Each will be 22 next season, and assuming they stick in the majors, both would become free agents after their age-27 seasons in 2011.

PECOTA's five-year forecasts give us estimates of each player's value through 2009. For Ramirez, those numbers are 2.5 wins (2006), 2.8 (2007), 2.6 (2008) and 3.0 (2009). He'll be at his age 26-27 peak in the two years that follow, so we'll make a reasonable extrapolation outward and assume 3.5 wins above replacement in 2010, and 4.0 in 2011. Note, by the way, that these WARP estimates are the weighted average, accounting for both favorable and unfavorable outcomes. If Hanley Ramirez becomes a regular major-league shortstop, he'll probably be worth somewhat more than 4.0 WARP in his age-27 season, but there are some unresolved questions about Ramirez' ability. He hasn't had a great year in Portland, and we have to hedge those favorable outcomes against the substantial chance that he isn't able to establish himself, and is worth very little to his club.

Applying Ramirez's PECOTA forecast and the assumptions about his salary from above, we come up with the following estimate of his value:


Hanley Ramirez      2006     2007     2008      2009     2010     2011     Total

Marginal Salary     $0.03    $0.18    $2.23    $3.85    $5.24     $6.85   $18.38
WARP                 2.5      2.8      2.6      3.0      3.5       4.0     18.4
Market Value        $5.35    $5.99    $5.56    $6.42    $7.49     $8.56   $39.38
Net Value           $1.77    $1.94    $1.11    $0.86    $0.75     $0.57    $7.00
Discounted @ 5%     $1.69    $1.76    $0.96    $0.70    $0.59     $0.43    $6.12
We figure the NPV of Hanley Ramirez's contract (more properly, the NPV of the right to sign him to cheap contracts) to be $6.12 million. Intuitively, that seems pretty reasonable for a B or B+ hitting prospect.

Lester is the player involved in this conversation whose season has deviated most substantially from PECOTA's expectations. He's taken to Double-A very well. I'm going to go ahead and append an additional 0.5 wins/year to his forecast; I think PECOTA will do something similar when we run his new projection this winter. That said, any pitching prospect has substantial risk associated with him until he's demonstrated the ability to stay healthy for multiple major-league seasons, and pitchers don't experience the same predictable improvement in the age 23-26 range that offensive players do, so we shouldn't fudge upward too much. We'll estimate that Lester is worth 2.0 wins/year in 2010 and 2011, the years that aren't covered by his PECOTA forecast.


Jon Lester          2006     2007     2008      2009     2010     2011     Total

Marginal Salary     $0.03    $0.18    $1.11     $2.05    $3.00    $3.42    $9.80
WARP                 1.6      1.8      1.3       1.6      2.0      2.0     10.3
Market Value        $3.42    $3.85    $2.78     $3.42    $4.28    $4.28   $22.04
Net Value           $1.13    $1.22    $0.56     $0.46    $0.43    $0.29    $4.08
Discounted @ 5%     $1.08    $1.11    $0.48     $0.38    $0.34    $0.21    $3.59
We arrive at a NPV of $3.59 million for Lester.

We can evaluate the entire trade from the Red Sox's perspective by adding up the estimated NPVs of the players involved in the discussions, and subtracting out the reported $15 million ransom that the Red Sox would pay to the Mets:


Manny Ramirez     +$22.37MM
Aubrey Huff       +$ 4.67MM
Mike Cameron      +$ 1.97MM
Hanley Ramirez    -$ 6.12MM
Jon Lester        -$ 3.59MM
Cash              -$15.00MM
---------------------------
Net Value         +$ 4.29MM
The Red Sox gain about $22 million from shedding Ramirez's contract, and an additional $7 million or so from picking up Huff and Cameron at reasonable prices. In order to accomplish this, they must part with about $10 million worth of prospects and $15 million in cash. All told, the Stark version of the deal looks like it would have been a slight net positive for Boston, to the tune of about $4 million. That said, $4 million is not a large margin of error in the modern baseball economy, and you can make some other, reasonable kinds of assumptions that push the deal to about break-even, or just below it.

It's no wonder, in other words, that the Red Sox were pushed just about to the brink with the proposed transaction. Theo Epstein may have been getting some value here, but only a little bit, especially considering some intangible factors like a potential public backlash against trading a superstar, or the additional marginal value associated with wins for a team that is in the midst of a tight pennant race. Remove Lester from the equation, or add a decent prospect or two coming in return--the Red Sox were reportedly trying to do both of these things--and the case for the deal becomes much clearer.

No matter how you slice it, the deal looks like a terrible one for the Mets. They'd reportedly have been giving up Lastings Milledge--probably worth between $7-$8 million under this methodology--in addition to getting a raw deal on the valuation of Ramirez's contract.

Frankly, I find it refreshing to go through a process like this on a deal that the Red Sox seemed to regard as fairly close to break-even, and come to the conclusion that the trade would, in fact, have been just about break-even for the Red Sox's bottom line. The names and numbers involved in the reports you've seen about the almost-trade are not pulled out of thin air--the Red Sox almost certainly have gone through a process exactly like this, and that's why they were willing to offer exactly what they were. It might seem cut-throat or Machiavellian to evaluate a deal in this fashion, but that's the perspective that a championship-caliber front office needs to apply.

Nate Silver is an author of Baseball Prospectus. 
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