A Look at the Finances Behind the Miami Heat’s Success
(Note: This post has been updated from last season)
Micky Arison was one of five NBA owners who voted against the current Collective Bargaining Agreement back in December of 2011. It was mostly a symbolic move – he knew the agreement would pass either way. But the point that Arison was making was clear: the harshest elements of the new contract, the more penal luxury tax system and the new revenue sharing model, were clearly aimed directly at the Miami Heat.
The lockout having ended, the season was spared and the Heat went on to win its first, and now its second, championship of the Big Three era. Heat fans have thus far been spoiled by Arison’s willingness to spend his way into ensuring the future is bright in Miami. But the day of reckoning the league had envisioned for the Heat is now upon us, and Pat Riley and crew had better be prepared.
Yes, Micky Arison is a multi-billionaire. And yes, he is sitting on a several-hundred-million-dollar unrealized gain with his investment in the Miami Heat, having purchased the team for a mere $65 million in 1995. But how much can be reasonably asked of him to spend on payroll? After all, it is a business. He has a right to turn a profit. Or at least limit the losses.
Player salaries, when combined with luxury tax obligations, can get quite expensive for a title contender such as the Heat. Revenue sharing obligations only increase that financial burden.
In this new salary cap environment, where even the most lavish of owners such as Mark Cuban of the Dallas Mavericks and James Dolan of the New York Knicks are for the first time monitoring their payroll, where legitimate championship contenders need to part ways with budding superstars, some financial responsibility is inevitable.
Player Salaries and Luxury Tax Obligations
The Heat may be two-time defending champions and the top pick to take the title again next June, but they’re paying the cost to be the best. Even with only four players making more than the league’s average salary, they paid out $83 million in salaries this past season, vaulting deep into the dreaded luxury tax territory. When adding the dollar-for-dollar tax payment, the Heat shelled out $96 million in total payroll obligations (before escrow adjustments). That’s $12 million more than the Heat has ever spent in its entire 25-year existence!
As a result of the new Collective Bargaining Agreement, the NBA will amplify its already painful luxury tax penalties by instituting a more punitive “incremental tax” that starts next season, and an even more onerous “repeater tax,” aimed at teams that have paid the tax in four out of five seasons, starting the season after.
These punitive tax consequences will affect the Heat in a way with which dynasties of the past never had to deal. The luxury tax as a concept was only started in 2002. When the Chicago Bulls outspent their nearest competitor by a whopping 30% in support of their dynasty in 1997, they didn’t need to worry about luxury tax consequences. They didn’t need to worry about luxury tax consequences when they led the league in spending the following season either. Neither did the Lakers and Celtics dynasties of decades past.
The Heat has produced three straight finals appearances, two straight titles, without ever having led the league in spending – not even close – and yet the new and more punitive tax rules threaten its continued existence as presently structured. It is, quite simply, far more difficult to build a dynasty now than it has ever been in the history of the NBA.
The Heat is in the midst of doing so, but it’s getting expensive.
Attached below is an overview of the Heat’s current payroll obligations, including luxury tax consequences, for this past season as well as the next three. Bear in mind that league rules stipulate a team must have no fewer than 13 and no more than 15 players on its regular season roster (and that future luxury tax thresholds are based on current estimates, which will be updated in the first week of July).
2013-14: For the 13 players it currently has under contract, the Heat is already facing a tax bill of $29 million and a total payroll of $115 million. That’s a $19 million increase from last season’s record total, and that’s before addressing the Chris “Birdman” Andersen situation.
2014-15: Projecting out two years into the future is an exceedingly difficult task, made even more complicated by the fact that the Heat only has 7 players currently under contract, and all of them are subject to player or team options. However, as things currently stand, this figures to be the most expensive year the Heat will ever face in the Big Three era. The team’s biggest contracts will still be on the books, and most of the ones that expire, those of Chalmers, Allen, and Battier, figure to be for key contributors whom the Heat may look to re-sign or replace. That would imply a payroll of around $140 million after incorporating the repeater tax. That’s almost double the highest ever payroll in team history prior to the Big Three era!
And that number could easily increase even more. It assumes the minimum 13-player roster. It doesn’t account for the Heat’s 2014 first round draft pick, and it doesn’t account for the potential first round draft pick received from Philadelphia in the Arnett Moultrie trade. When including these draft picks, bringing the roster to 15 players, payroll obligations could reach $155 million or more!
2015-16: Relief! The contracts of Mike Miller, Udonis Haslem and Joel Anthony all finally expire. The Heat starts the offseason with only 3 contracts on the books, at a total cost of $66 million. But the team still needs to build out a roster. And given that the 3 contracts take up the team’s entire projected cap space, options with which to do so will be limited. The team’s first round draft pick will go to Cleveland as part of the sign-and-trade that brought LeBron James to Miami.
Revenue Sharing Obligations
Revenue sharing obligations will further increase the Heat’s financial burden.
The league’s revenue sharing plan works in parallel with the luxury tax as a means to address franchise economic disparity. It is designed to help redistribute money from higher-revenue teams (generally in big markets) to lower-revenue teams (generally in small markets).
The basic idea behind the plan is that all thirty teams contribute an equal percentage of their total revenues into a common pool (minus certain expenses such as arena expenses), then receive an allocation equal to a 1/30 share of the pool. Small market teams with lower revenues will therefore contribute less than they receive, and will be net beneficiaries under the plan. Large market teams will contribute more than they receive, and will be net payers under the plan.
The Heat is considered, by the NBA’s definition, to be a small market team. It has just 1.58 million TV households in its designated market area, which makes it impossible to compete with the likes of a New York City (7.4 million) or L.A. (5.6 million). In fact, the Heat ranks just 17th in overall market size among the league’s 30 teams. The mean and median market size for all NBA cities is 2.35 million and 1.77 million, respectively.
Such market size differences make it exceedingly difficult for the Heat to produce the local revenue streams required to remain competitive without losing huge sums of money.
Despite nightly sellouts, the Heat is only seventh or eighth in gate revenues annually. The Heat makes nothing for the sellouts it produces on the road, even though it produces higher road attendance than any other team in the league.
Despite the second highest local TV ratings in the league, the Heat’s local television deal dwarfs those of teams in bigger markets. The Knicks and Lakers make between $75 and $150 million for their annual television rights, but the Heat number is closer to $20 million. The Heat’s current contract runs two more seasons.
Despite the popularity of LeBron James and Dwyane Wade jerseys, Arison doesn’t get incremental revenue from their sales, except what the team sells locally. He also doesn’t make more on the national television deal because the Heat were on so frequently. Merchandise and national TV revenues are split equally among the league’s 30 teams.
The Heat’s payrolls are up, but that can’t be fully offset by increased revenues due to the limitations of its market.
Therefore, in theory, money should flow from teams in larger market cities to the Heat — as it does for the Panthers and Marlins. However, despite its limited revenue potential, fueled by the success of the Big Three, the Heat maximizes its revenue potential better than just about any team in the league. Despite its small market size, and though it’s nowhere close to that of the leaders, the Heat still has one of the higher revenue streams in the league. Of course, it costs Arison a great deal of money to acquire such a lofty revenue stream; the Heat has the second highest payroll in the league. But that doesn’t matter much. Because the Heat’s revenues are so high, even though they’re spending more to achieve it, they actually become a net payer into the revenue sharing system rather than a net receiver. So revenue sharing doesn’t help. In fact, it hurts.
Given that neither the Heat’s financial statements nor the exact revenue sharing calculations are a matter of public record, it is impossible to know just how much the Heat is required to pay into the plan. The net amount for each season will almost certainly be limited to 30% of all team-generated profits in excess of $5 million, wherein the calculation of revenues is a reasonable depiction of the Heat’s true revenues as reduced by approximately 20% to reflect its small market size, and the calculation of expenses is, by and large, based on a league-average (and excluding such costs as depreciation, amortization, interest and taxes). Such a calculation causes a distorted view of the Heat’s true profitability, resulting in a substantial revenue sharing obligation despite a purported wildly negative actual cash flow.
While the Heat’s 2013-14 revenue sharing obligation is unknown, and has yet to be determined, at current revenue levels it should presumably be less than $10 million. The Marlins and Panthers, for comparison, both reportedly receive more than $10 million in annual revenue sharing distributions.
As you can see, total player costs — when coupled with luxury tax obligations and revenue sharing requirements — figure to be substantial for the Heat into the foreseeable future.
Further complicating the matter, the Heat must now maneuver in a world where new player signings are limited, trades are limited by onerous trade rules, and trade assets are scarce.
New Player Signings are Limited
For the remainder of the Big Three era, the Heat will have only three mechanisms with which to sign free agents. The first is the Taxpayer Mid-Level exception – which starts at $3.2 million next season and rises by 3% every year thereafter. The Heat can utilize the exception in every season, which allows for contract lengths of up to three years. The second is the minimum salary exception. The third is Bird rights. The Heat will be able to retain its own free agents using their Bird rights, but most will have crossed into their late 30s by the time their contracts are up.
Trade Rules are More Restrictive
Starting in 2013-14, the Heat will no longer be allowed to acquire free agents pursuant to sign-and-trade agreements. So forget about acquiring another team’s free agent in trade. It’s not possible. And while the new rules don’t prevent the Heat from sending out its own free agents as part of a sign-and-trade in return for a player on another team who is already under contract, they provide less incentive for the signed player to agree. Players can no longer make more money in a sign-and-trade than they could by simply signing with that team directly. In other words, the concept that the Heat employed with LeBron James and Chris Bosh in order to give them the extra guaranteed season is no longer possible.
Trade Assets are Limited
The Heat has a wonderful collection of complementary pieces surrounding its Big Three core, but almost none would be considered a valuable trade asset. Most are on the downside of their careers and fit so well in Miami primarily because of LeBron James, a luxury no other team in the league has. Most of the rest are too valuable to trade. Norris Cole is likely to be the team’s only player that serves as a true trade asset.
First round draft picks will be difficult to trade. Picks can only be traded up to seven years into the future. The Heat has already traded away a bunch. The only ones remaining are its own picks in 2014, 2016-2019 and the conditional first rounder received from the Sixers in the Arnett Moultrie trade. But teams are also restricted from trading away all of their future first round picks in consecutive seasons. Therefore, the Heat can’t trade away a first round pick of its own, unconditionally, until 2017 at the earliest. The Heat can trade away a pick prior to then, but only on condition that it receives the Philly first rounder, which may not happen. The Philly pick can be traded at any time.
Second round draft picks hold little value. The chances of a player chosen in the bottom few picks in the draft ever making it into the NBA are slim. Such picks are valued accordingly in trade.
Cash can be included as part of a trade package. Even that, however, is limited. The total cash compensation that can be sent out across all trades for the entire 2013-14 season is $3.2 million. This limit cannot be netted against cash received. There are two separate but equal limits, one for the cash a team pays as part of trades each season, and the other for the cash a team receives as part of trades each season.
Change Is Inevitable
Will Arison be willing to spend into the $100+ million range to keep his team together?
Will he be willing to continue spending $25 million, $50 million, perhaps even $100 million more than his fellow owners to sustain a championship-caliber ball club, despite the limitations of the South Florida market? Would it be fair for us to ask him to, if it meant that he’d be losing as much as $100 million every year in doing so?
However much he may be willing to spend, some change is inevitable.
All Players With Options Should Return
The Heat holds a team option on Mario Chalmers while Ray Allen, James Jones and Rashard Lewis have player options. All should be returning for next season.
Mike Miller Should Be Amnestied
As valuable a player as he may be, as respected a teammate as he may be, as nice a person as he may be, Mike Miller is simply not worth between $27 and $50 million over the next two seasons to an owner who needs to think about saving money, nor is he worth the $11 to $25 million it would cost for the Heat to forgo amnestying him in favor of Joel Anthony. This is the ugly truth of the new Collective Bargaining Agreement.
A trade would be best, and such conversations have likely already begun, but is very unlikely.
Miller should be amnestied.
If he is claimed on amnesty waivers, the Heat will realize savings equal to the amount of the highest bid. The minimum possible bid for Miller for the final two seasons of his contract is $2.8 million. That, however, is unlikely. More likely is that he clears waivers. Once he does, there will be several teams vying for his services as a potential minimum salary free agent addition. That will allow the Heat to set-off $305K of their $6.2 million in salary obligations to Miller for next season.
Chris Andersen Should Be Offered A Minimum Salary Contract
The Birdman was a wonderful addition for the Heat this season. A perfect complement. The missing piece at a position of need. But he’s also a 35-year-old, low-minute, high-energy reserve. How should the Heat value such a player? How much can they afford to pay?
Basic math provides the answer: he should be offered a one-year minimum salary contract, with an undocumented and marginally-illegal second year promise.
Should he accept, he would be sacrificing a grand total of $892K over the MLE contract many are calling for — becoming the ninth Heat player to make such a sacrifice.
Joel Anthony Should Be Shopped
Joel is a useful player and a valuable contributor. But, let’s face it, if not for a Heat team emotionally attached to its hardest worker, his place in this league would be tenuous at best. Joel hit the free agent market in the summer of 2010, and no outside team showed any interest. He was worth, at the very most, the minimum salary contract he had opted out of. That’s exactly what the Heat should have offered. Instead, Riley chose to offer him a ludicrous five-year, $18.25 million contract!
Joel’s modest $3.8 million salary for next season will cost at least $10 million when considering the tax. In 2014-15, it will cost at least $14 million or more to retain him. That’s two years and $25 million for an aging bench warmer. Wow!
Riley should look to trade Joel without taking back any salary in return. It won’t be easy.
Give him away in return for nothing? There’s no team in the league that would be interested.
Give away a package of second round picks as an enticement for someone to take him? Nope.
Give away a first round pick or two as an enticement for someone to take him? Perhaps. But do you really want to start trading away picks that extend beyond the Big Three era?
Next year’s draft is strong. The bottom of the East is getting weaker. The Heat receives Philly’s first round pick next season if the Sixers finish in the top eight. They were ninth this year. They, at the very least, return their entire core. Milwaukee, Boston and Atlanta all finished just ahead, and all figure to get somewhat to substantially weaker next season. The pick could become quite valuable, perhaps somewhere in the mid-to-high teens. Could it serve as just enough inducement, along with cash considerations, for a cap-friendly team to take on Joel Anthony? Could Norris Cole be utilized as an inducement in such trade conversations?
A Wait-and-See Approach Should be Taken to the Mid-Level Exception
There are certainly areas of need for the Heat, help at the center position chief among them. There are certainly free agents that could potentially fill the void. But with the Heat a two-time defending NBA champion and prohibitive favorite for next season, will Arison be willing to spend what it takes to entice them?
Utilization of the MLE would require that Anthony or Miller be traded and the other amnestied. If both happen, the Heat could utilize its Mid-Level exception and still remain below $100 million in total payroll.
Between One and Three New Minimum-Salaried Players Should Be Added
If all goes according to plan, the Heat should have as few as one and as many as three open roster spots below the 15-player limit, which will be serviced by new minimum-salaried players. There are definitive needs to be filled with those players.
It also needs to adjust to how it approaches signing such minimum-salaried players. Riley has traditionally favored two-year deals with a player option on the second, as Rashard Lewis received this past season. The inclusion of the second year, however, has significant salary cap ramifications.
When a player has been in the NBA for three or more seasons, and is playing under a one-year minimum salary contract, the league reimburses the team for part of his salary — any amount above the minimum salary level for a two-year veteran. For example, in 2013-14 the minimum salary for a two-year veteran is $884,293, so for a veteran of at least ten years, with a minimum salary of $1,399,507, the league would reimburse the team $515,214. Only the two-year minimum salary is included in the computation of team salary and luxury tax, not the player’s full salary. They do this so teams won’t shy away from signing older veterans simply because they are more expensive than younger veterans.
While that ~$500K per season probably doesn’t sound like much, it is significantly more than you might realize. The incremental difference, when incorporating the tax, is at least $3.4 million, and potentially much more, over the next two years. For every such player signed.
That’s right! Signing a player to a two-year minimum salary deal would cost at least $3.4 million more than signing the very same player to two consecutive one-year deals. Even though the player himself makes equivalent money.
So… No more second-year player options on minimum salary contracts. They’re too damn expensive!
All manner of options await the Heat as they work through the challenges of possibly winning another title before having to make some significant sacrifices. The possibilities feel just about endless.
Attached below is an overview of what the Heat’s payroll obligations could be for next season if the above rules are strictly adhered to. It does not account for any potential future signings, re-signings, or trades (other than as described above):
2013-14: The Heat roster remains largely as it was this past season, save for the departures of the amnestied Mike Miller, the traded Joel Anthony, and the inconsequential Juwan Howard and Jarvis Varnado, as well as the additions of a full Mid-Level Exception player and a minimum salary player. Dalembert at the MLE? Oden at the minimum? Would that not conclude a perfect summer?
Plus, the Heat would still have room beneath the emotionally significant $100 million threshold for total payroll obligations. It could thus utilize the summer to scour the available universe of potential youngsters and aim to find another Danny Green. Or it could remain idle and have the flexibility to make in-season additions as the need arises.
2014-15: The Heat would be positioned as perfectly as possible for the harshest year it will face in the Big Three era. No new guaranteed contracts will have been added. Two big contracts, that of Mike Miller and Joel Anthony, will have been subtracted. The Heat will have maximum flexibility heading into the oh-so-expensive 2014-15 offseason.
2015-16: Nothing’s changed.
What It All Means
Pat Riley has constructed a roster that will be expensive to keep together. But, with shrewd salary cap management and a bare minimum of mistakes, it has the potential to be far less expensive than most realize.
The Big Three of James, Wade and Bosh will be under contract for each of the next three seasons. They are the playmakers. They are the heart and soul of the team.
The philosophy that head coach Erik Spoelstra has rightfully adopted requires that they be surrounded by nothing more than a bunch of one-dimensional shooters with a knack for spacing the floor and, perhaps, one or two with the capacity to defend at a high level. Ray Allen. Mike Miller. James Jones. Shane Battier. Rashard Lewis. Perfect additions all. But, on a relative basis, not all that expensive to keep or replace.
That’s enough to win. That’s enough to produce a potential dynasty.
And if the Heat were to be able to identify a difference-making center, it’d be enough to earn consideration for best team of all-time.