The announcement that Steve Ballmer is willing to pay $2 billion for the LA Clippers, traditionally one of the less glamorous franchises in the NBA has led to a lot of discussion about whether this is a “reasonable” price to pay. My eye was caught by two articles – one by Andy Zimbalist arguing that purely as an investment the price is too high- Ballmer is just paying to mix with the stars, and another by Patrick Rishe arguing that if Ballmer wanted to sell his investment in 20 years, he’d get more back for it than he paid.
This is an interesting topic for those who follow football/soccer, since clubs regularly change hands and the value of clubs is often discussed. Forbes values the 20 biggest football clubs and currently places a value of $3.4 billion on Real Madrid, the highest value of any of the sports teams they value. Manchester United is one of the few sports teams with actively traded stock, and the market value of the club presently is $2.8 billion.
Classically there are three ways to value an asset
- Cost
- Income
- Market value
A cost based measure might be appropriate if you were thinking of starting a rival team as an alternative to buying an existing franchise. Suppose, for example, there were promotion and relegation in basketball, and you could start a team at the lowest level and then develop it to the point where it could compete in the NBA. To do this you would have the cost of the arena, the wages you paid the players, and expenses for running and marketing the team. You’d have to take into account that getting promoted would take a few years, but then you could arrive at a total cost. This might then dictate how much you would bid to buy the Clippers – you wouldn’t pay more (having taken into account your impatience) – so that would be a reasonable price. But of course, there’s no promotion and relegation in the NBA, so it’s not a very relevant consideration.
An income based measure would look at the profits that the club generates. For a profit maximizer the value of the club should equal the present value of future profits (if you’re not familiar with what this means, it’s just the way you take into account that money you receive in the future has a value today (present value) that is lower – it’s not difficult to calculate). Andy says that this method would place a value on the team of only $300 million. Income is likely to rise in the future (more broadcast income, etc) so it might be two or three times this amount, but Andy reckons that any reasonable valuation on this method will leave you well short of $2 billion.
So finally there’s the market method- what is someone willing to pay. Many people will have already said that the Clippers are worth $2bn cos Ballmer is willing to pay $2bn. That’s all well and good, but we still want to ask what the foundation is for this valuation if it is not cost or income.
Could Ballmer rationalize the acquisition as an investment? History suggests he could. Sterling paid $12.5 million in 1981, which implies a 16.6% annual return over 33 years. By comparison, the value of the Dow Jones Industrial Average of leading US stock prices rose from 933 in 1981 to 16,737 in 2014, giving an average annual return of only 9.1%. In both cases the total return was higher because investments pay dividends- and probably Sterling was able to take bigger dividends out of the Clippers than he would have received from Dow stocks.
If the Clippers continued to appreciate in value at that rate he could sell them for $44 billion in 20 years’ time. Is that a reasonable trajectory for the value of the franchise?
Well, first, the NBA is the world’s leading basketball league with all the best players. Rival leagues have seldom successfully challenged the dominance of an incumbent, so this should still be the case in 20 years.
Second, the Clippers are very unlikely to be pushed out the league- their place is secure precisely because there is no promotion and relegation. They are also protected from competition by the rule that gives them territorial exclusivity.
Third, basketball is likely to grow in popularity as a sport in the next 20 years.
Now, it may be that the growth in value in the next 20 years will be slower than the value in growth over the last 30 years. But even a more modest 10% annual appreciation would raise the value nearly seven fold in 20 years. Of course, there’s inflation, but then there are also dividends…no one can accurately forecast the future, but if my three premises above hold, then it’s reasonable to think that the Clippers will be one of the better performing assets in his portfolio over 20 years.
But that still leaves a puzzle. Income is the usual basis for the valuation of assets, so why are individuals prepared to pay so much for these assets when the income justification is so shaky? I think there are two ways to think of this.
One way is to say that the asset value reflects the level of interest in basketball, and even if that value has not yet been turned into income, one day it will be. In much the same way, many internet companies failed to make profits for years but carried a significant market value- eventually the survivors started to generate large profits and paid off (think Amazon). Of course, the added benefit with the NBA is that, unlike internet start-ups, losers do not go to the wall, they get rewarded with a first round draft pick.
The second is to focus on the nature of these franchises as cultural assets. They are like oil paintings by the old masters – ownership conveys status – there is a limited supply of these assets and as wealth increases there are more and more people want to own them. According to Forbes there are about 1600 people worldwide with assets more than $1 billion. Not all of them would want to own the Clippers, but maybe 1% would – 16 potential bidders- plus syndicate bidders- that’s a lot of potential competition. So if Ballmer wanted to win, he needed to blow the competition out of the water. And in 20 years, unless the global economy implodes, there will probably be even more competition. This seems like a classic example of positional goods, hinted at by Veblen and more fully articulated by Fred Hirsch.
Football clubs seem very similar, but there are important differences. There is only one NBA, but there are four European leagues that can credibly compete for the title of best league (EPL, La Liga, BL, Serie A), potential competition from countries such as Brazil, France, Argentina. Competition might emerge in China, the Gulf, and maybe a breakaway Superleague in Europe. Real Madrid and Manchester United, for example, would appear in every conceivable configuration of dominant clubs in the future, but once you get beyond the top ten or so teams in the world, participation at the highest level seems much more tenuous. Promotion and relegation means that failure is punished and not rewarded, making it much hard for an owner to take out a dividend.
As a result I think that outside of the top few clubs in football, there is limited market value simply in ownership of clubs- they don’t work so well as positional goods.
Hi Stefan, I found this post very interesting and particularly the last couple of paragraphs when the focus was again on football clubs. I recently wrote a piece about the ongoing Aston Villa sales process http://www.punditarena.com/football/english-football/rodonovan/anyone-want-aston-villa-football-club/ that I see as a bit of a litmus test for where we are in valuing middle tier football clubs that have a far less certain future trajectory in comparison to the super clubs you mention such as United and Real. Would love to know your thoughts?