But actual profits have never even approached anything where a DCF would justify such a jump in valuation. And certainly future profits won’t justify it either, if teams keep spending like this.

The modus operandi is to spend 50-65% of your revenue, and be one of the 30 collectors of an MLB team (or one of the 120 collectors of a major sports team).

You also try to leverage that into cable deals (MSG, YES, NESN, TBS, WGN, etc). But mostly, you are buying a Picasso, or as Phil said, a vintage car.

If you can squeeze the players, like the NFL, you get the bonus of also turning profits, and thereby increasing you valuation (i.e., MLB would be 2x revenue, while NFL would be 4x revenue, or whathaveyou).

I will grant that owners do care about more than just profits, but I just don’t buy these other motivations as large determinants of their behavior.

I’m not arguing that owners don’t care about profits *at all,* just that there is another factor involved too, the utility of pure ownership.

I think of it like owning a vintage car. There are two sources of return from the car — the utility gained by driving it, and the increase in market value. If you don’t count both, it looks irrational to buy the car — it appreciates at 3% (say), while a CD earns 5%. But if it’s worth the 2% to you to be able to drive it and elicit stares and fame and pride, it may be worth it.

And the fact that the owner of the car is willing to accept a lower return (or even a negative return) doesn’t mean that he wouldn’t prefer a positive one — by lobbying the government for vintage car subsidies and the like. I guess at the margin, the owner-for-fun is as eager for an extra dollar as the owner-for-profit. It’s just that the owner-for-fun is willing to pay a certain amount for the experience of ownership, an amount that may (Steinbrenner) or may not (Harold Ballard) be tied to the success of the team.

You may be right that pride of ownership may not be a large determinant of owners’ behavior … but there should be *some* financial cost to pride of ownership, simply because of supply and demand. There are many more people who would prefer to own a team than a business of equal risk profile, just for the fun and fame.

And, also, why else would sports teams have such small operating profits compared to their market value? Perhaps owners look into the future and see an explosion of revenue coupled with a lowering of union demands?

I’m not sure what you mean about not being able to use money to proxy utility … if a team has EBITDA of 6% of market enterprise value, and equally risky investments are available at 10%, can we not estimate the owner’s private utility of ownership at 4% of market value per year?

Some owners don’t just want to be owners – they want to be *winning* owners. The supply of winning teams is limited, by definition, and so the price gets bid up.

I think you have to think of a franchise not 100% as a firm, but partly as a firm and partly as a consumer good (consumed by the owner). $2 million might be the marginal value of a win *to the fans*. But if the marginal value *to the owner* is (say) $3 million, he’ll wind up willing to pay $5 million per win.

It seems to me that the value of the player to a team is his MRP plus the consumer surplus reaped by the owner. This would explain high salaries without having to assume that owners are irrational.

Heck, we do it in the corporate world. We actually spend on things we don’t need, just so that we can justify that we need that level of budget next year. You’d think we’d be able bank the surplus, but no!

Anyone who plays rotisserie baseball (keeper league) knows the phenomenon- it’s called draft inflation.

Each team has a set budget to spend- and each teams spends that budget. In real baseball, I get the impression that most teams decide to spend $X and then spend approximately $X- no matter whether the value available is worth more or less than $X.

In Roto you can pretty much figure out what a player’s “value” is (well his past value anyway- if you really knew his future value you’d never lose). Some players- “keepers” are signed at something less than their real value. Every dollar “saved” is an extra dollar to spend on someone else.

To oversimplify- if you have 10 $20 players, and 5 are saved at an average of $10, the remaining 5 FAs are going to be signed for an average of $25-30. (It’s not linear- $10 players may go for $11-12, $20 players for $25, $30 players for $40)
In Rotisserrie this spending is rational.

Of course in most Roto leagues you can cut the guy after the year rather than being forced to keep him multiple years at $30.

I think this mechanism may be in play a bit, and would justify overpaying for the top talent in the short term- I think a misapplication of this principle may lead to overpaying for mediocrity (ie: Matthews, Pierre)- which is generally a bad move even in draft inflated roto leagues.

Unless that asset is a collectible, in which case, it’s subject completely to supply and demand.

Sports teams seem to be valued like a dot.com, without any hope of getting those 40% margins. They are much more like a consulting firm, with razor thin margins, and a workforce that is the product or service.

JC, Guy made a great point here, of which I followup: http://www.insidethebook.com/ee/index.php/site/comments/wins_and_payroll/#15

I’d be interested to hear what your model would be like.

Your last point is exactly what is probably happening, that the owner is collecting his Picasso, and he’ll pay whatever it takes to make sure he owns it.

There are only 30 MLB teams, and only 8 make the playoffs, and an owner will pay what it takes to win, if he thinks he’s close. Pirates, Royals, etc won’t do that.