The Imbalance Sheet: Revenue Sharing

The subjects of revenue sharing and fixing the alleged performance
disparity between "large-market" and "small-market"
teams won’t go away. This despite the stellar performance of the Chicago
White Sox, Seattle Mariners and Oakland A’s, teams once firmly entrenched
in the "small-market" camp. Indeed, to listen to WEEI (the great
sports-talk radio station in Boston), one would come to believe that Boston
had suddenly dumped a half a million people into the Charles, because it,
too, is now a small market in desperate need of shared revenue.

Here’s a dirty little secret, wrapped up for Messrs. Steinbrenner and
Angelos: revenue sharing is nothing but a euphemism for the other 28 teams
coming after your money. Kind of like calling it "friendly fire"
instead of "military f&^$-up".

For all the calls for revenue sharing, no one has given much thought to
whether it’s legal, feasible or likely to achieve the desired goals. Some
in the media have thrown gasoline on the fire burning in
"small-market" fan bases, and the movement continues to take on
life of its own in the face of considerable logic.

First of all, is revenue sharing legal in either a judicial or an
organizational sense? It sounds really wonderful to talk about Winning Big
Stein’s Money, but there’s a significant question whether MLB can or should
do so.

When investors purchase a major-league club, they do what’s called due
diligence. They get to see the books–the ones the teams won’t open to the
public, for fear we’d see the gigantic piles of smelly old money that even
the Royals and Pirates have stacked up in their accounting offices–and
determine how much the business is really worth.

For example, say that you were looking at buying a small manufacturing
business that generated $100 million in revenues and $10 million in cash
flows (those are profits, for the purposes of this discussion) every year,
with no growth or decline expected. At a discount (interest) rate of 7%,
that business is worth about $10MM/.07 = $143 million. So if you buy the
business for $130 million, you’ve gotten a pretty good deal.

Now say that a year after you buy the company, the National Association of
Big Honking Manufacturers comes along and says that it’s going to take 1%
of your revenue every year to support smaller manufacturers in related
industries. That 1%, or $1 million, comes out of your revenues each year,
but since your costs don’t change to reflect it, it also falls straight
through to your bottom line. Now the business only generates $9MM in cash
flow each year, so it’s only worth $9MM/.07 = $128.6MM. And your
$130-million investment is suddenly a loser.

What’s worse, if you try to grow the business to recoup your investment,
the association will take another penny of every extra dollar of revenues
you earn, thus penalizing you for your success.

Let’s return to baseball. Plenty of owners have recently bought teams at
substantial prices, and they’ll suddenly see their teams’ values drop if a
revenue-sharing program goes into place. Do you think they’ll take that
lying down? When the government does it, it’s an illegal taking of
property. When baseball does it, prepare for the mother of all lawsuits.

In fact, any revenue-sharing program put into place will need to garner the
support of a supermajority–probably 3/4, or 23 owners–and thus will end
up taking money from no more than seven teams. That won’t result in enough
cash to make any sort of a difference in payroll disparities.

Next week, I’ll tackle some of the reasons "large-market" teams
are expected to go along willingly with this sort of larceny.

Keith Law can be reached at klaw@baseballprospectus.com.