A Look at the Finances Behind the Miami Heat’s Success
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 he 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 his 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 could the day of reckoning the league had envisioned for the Heat soon be upon us?
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.
So the question becomes: How profitable is the Heat organization?
First, some background.
Micky Arison is a multi-billionaire.
He is the son of Ted Arison, co-founder of Carnival in 1972. He became Chairman and CEO of Carnival in 1979. He announced his intention to step down as CEO earlier today, retaining his role as Chairman, but he nonetheless remains the beneficial owner of 174 million shares of the company, currently valued at a whopping $6.0 billion!
He is the majority owner of the Miami Heat, having purchased the team from his father and two other men, Billy Cunningham and Lewis Schaffel, for $68 million in 1995, who themselves paid out $32 million in expansion fees in 1988 to bring the team to Miami.
An Overview of Heat Revenues
The team’s true revenues are not known. The Heat is a private entity, with no public disclosure requirements. Certain financial details, however, can be reasonably estimated:
The Heat generates in excess of $1.4 million in ticket sales for each of its 41 regular-season home games – with an average ticket price of $72 per game, and a sold-out seating capacity of 19,600 – of which 6% is required to be repaid to the NBA in the form of a capital contribution. The average ticket price does not include premium seats (suites, booths, court-side seats, VIP packages), so this isn’t the entire picture – but it’s close. The team charges a premium for playoff home games, of which 45% is required to be repaid to the NBA in order to cover the league’s costs to fund the Player Playoff Pool and to produce the playoffs, including expenses for travel, marketing and officiating. In all, the Heat likely generated approximately $80 million in gross gate receipts for the 54 home regular and postseason games played this past season.(1)
The Heat collects an average of $31 million per year from its share of national TV revenues. In June 2007, the NBA executed eight-year deals with ESPN/ABC and TNT covering the 2008-09 through 2015-16 seasons that promise pro basketball a total of $930 million per year, divided equally among all thirty teams.
The Heat collects approximately $20 million per season from its local television rights deal with Fox-owned Sun Sports. In March 2004, the two parties executed an eight-year deal covering the 2004-05 through 2011-12 seasons. In June 2008, the deal was extended through the 2017-18 season.
The Heat generates $2.1 million from American Airlines each year to have its name on the arena in which they play. The two parties signed a 20-year, $42 million arena naming rights deal in 1999, that comes due in 2019.
The Heat generates food and beverage revenue under an arrangement with concessionaire Levy Restaurants. According to Chris Bigelow, the president of Bigelow Companies, a consultant to stadium operators, fans tend to spend an average of $18 to $26 a person on concessions. The Heat’s arena capacity is 19,600, which would suggest concessions revenues of between $15 million and $20 million before accounting for the playoffs. It is unclear how those revenues are split between the two parties.
The Heat generates additional revenue through sponsorship deals, though it is unclear as to just how much. Each sponsorship deal is different, and contracts are confidential. They work something like this: A company signs up to partner with the team for one or multiple seasons. For example, Kia becomes “the official vehicle of the Miami Heat.” A contract spells out details: what kind of game tickets; how much access to luxury suites; what signage at the arena; how much exposure in print, broadcast, websites and social media; and even which players might visit their stores or offices. Experts say the bulk of Heat deals run between $100,000 and $500,000. Some produce less, partly because of relationships forged before LeBron James and Chris Bosh joined. And some produce more, say for a broader partnership, with more media. Major corporate sponsors include American Express, Anheuser-Busch InBev, Coca-Cola, Bacardi, Kia Motors, Papa John’s, T-Mobile, and Tsingtao beer. With the Heat now back-to-back NBA champions, the list is sure to increase in the years ahead.
The Heat generates additional revenue through merchandise sales, though it may be less than you’d think. Despite the popularity of LeBron James and Dwyane Wade jerseys, all merchandise sales are split equally among the league’s 30 teams, except for what the team sells locally. NBA revenues from merchandise sales and all other miscellaneous league-generated sources is difficult to project, but probably falls somewhere in the neighborhood of $10 million per team.
The Heat generates a additional revenues from other sources as well, including via a deal with Clear Channel Radio to make WINZ 940AM the official English radio station of the team, its locally-sourced merchandise sales and on-site parking.
Add it all up and you get approximately $180 million.(2)
An Overview of the Heat Cost Structure
An analysis of cost is a far more difficult proposition, made even more challenging by the scores of non-cash charges and intra-company arrangements professional sports franchises often incur in an effort to reduce both their tax liability and their reported profitability for when they need to negotiate with their local governments for arena/stadium funding.
Arison, for example, negotiated a favorable arena funding deal with Miami-Dade county in 1997. Under the terms of the 30-year deal, the Heat agreed to privately finance the $213 million construction cost for AmericanAirlines arena, which opened on December 31, 1999. In return, the Heat pays no rent to play in the arena, an oceanfront venue that the county bought from the city of Miami for $38 million; instead, the team actually receives $6.4 million in annual operating subsidies.
While the arrangement includes the yearly subsidy, it also calls for Miami-Dade to collect 40% of all yearly arena profits above $14 million. But the team has never once paid a profit-sharing payment to the county. That’s partly because the Heat deducts lots of non-cash charges. Over a past five years, the team has claimed depreciation expenses – a method of allocating the cost of a fixed asset over its useful life – of $55 million. It can be argued that depreciation expenses shouldn’t be factored into the calculation at all, because they don’t reflect an actual outflow of cash, because they presumably relate to fixed assets for which the team initially agreed to pay, and because the subsidy was specifically intended to maintain and replace such fixed assets as they age. In 2012, arena profits hit $16.4 million – net of $47.8 million in operating expenses, including $12 million of depreciation – according to records filed with the county. If not for past losses, the arena would have paid Miami-Dade almost $1 million. But the deal also allows the Heat to deduct arena losses from prior years before it pays the county. The Heat will reportedly make its first ever payment to the county this year.(3)
Backed by the team’s recent success and before it recognizes and is thus required to provide details to the county of the massive new revenue streams that lie ahead in the near future, the Heat is currently looking to extend the deal for another 10 years, and is reportedly asking the county to increase its subsidy to nearly $17 million per year over the extended term. County officials have questioned the apparent self-serving nature of the timing of the Heat’s request for an extension (the current deal still has another 15 years remaining on it), and have slammed the Heat’s proposal as too generous to the Heat and too costly for the county.
What we don’t know is how much it truly costs for Arison to operate his basketball team. Among the many costs involved beyond player compensation and corresponding luxury tax payments are gross revenue charges such as excise, sales, and admissions taxes as well as payments to the league based on the sale of tickets; sales and marketing expenses such as TV, print and other advertising; general and administrative expenses such as arena operating and maintenance costs (net of any financial arrangements with the county), costs associated with concessionaire Levy Restaurants, and payroll expenses for front office employees; salary obligations to, among others, general manager Pat Riley, CEO Nick Arison, head coach Erik Spoelstra, and all of the team’s assistant coaches; and overhead costs allocated by the NBA to support its operating needs, marketing, and global expansion efforts.
Forbes data over the past several seasons approximates these operating costs for the Heat at roughly $65 million per year. This figure may or may not be correct. It may or may not be close to correct. It surely changes from year to year. There is no way to get a more definitive estimate. It is the best data we have.
Revenue Sharing Obligations
Revenue sharing obligations increase the team’s financial burden.
The NBA’s new revenue-sharing plan was years in development and today represents a staggering shift in league policy as the league redistributes wealth among its teams.
It was fueled by a plea from eight small-market teams in 2007 and grew into one of the league’s most contentious issues, running parallel with the league’s Collective-Bargaining Agreement negotiations during the lockout in 2011.
The high revenues generated by the big-market teams increases league-wide revenues, which increases the salary cap, which increases the amount all teams (including low-revenue, small-market teams) are forced to spend on player salaries — leading to an unsustainable system.
It used to be that revenue-sharing in the NBA was largely a theoretical concept. It didn’t really exist. Monies were only distributed from certain teams to certain others on the basis of luxury tax payments. Higher spending teams, those whose payrolls exceeded the tax threshold, were made to pay luxury taxes that were then distributed to teams whose payrolls did not exceed the tax.
The league’s revenue-sharing plan now works in parallel with the luxury tax concept as a one-two punch to address franchise economic disparity. It is designed to help redistribute money from high-revenue teams (generally in big markets) to needier teams (generally in small markets).
Under the old plan teams received much less than under the new plan, with the highest individual receipts averaging $5 million. With the new plan, a stunning $180 million is projected to be redistributed in 2013-14, moving money through a complex formula that shifts some of the financial wealth of big-market NBA teams to the league’s less wealthy teams, the neediest of which are projected to receive in excess of $20 million each.
While the system does not completely close the financial gap between high and low-revenue teams, it is by far the most progressive form of revenue distribution in the league’s history. By the 2013-14 NBA season, all 30 teams are projected to be profitable under this system if they meet reasonable revenue and expense standards.
The plan is rooted in a philosophy of including locally generated dollars from the big-market, high-revenue teams to be spread among the low-revenue teams. The core of the plan calls for all teams to contribute an equal percentage, roughly 50%, of their total annual revenues, minus certain expenses such as arena operating costs, into a revenue sharing pool. Each team then receives an allocation equal to a 1/30 share of the pool. Smaller market teams with lower revenues will typically contribute less than they receive, and will be net beneficiaries under the plan. Large market teams will typically contribute more than they receive, and will be net payers under the plan.
There are limits built into the new plan to protect high-revenue teams, such as the New York Knicks, Brooklyn Nets, Los Angeles Lakers and Chicago Bulls, with no team to contribute more than 30% of its total profits in excess of $5 million into the revenue-sharing pool.
There are also limits built into the plan to protect against low-revenue teams from collecting too much, such as the Memphis Grizzlies, Indiana Pacers, Charlotte Hornets and Milwaukee Bucks, with no team to receive revenue-sharing distributions would increase a team’s profitability to more than $10 million.
The plan makes teams responsible for meeting revenue benchmarks, based on the size of the market in which they play (defined as the number of TV households in its team’s designated market area). Revenue benchmarks range from 65% (New Orleans) to 160% (New York and Brooklyn) of the league average revenues. Any team that falls short of its benchmark is credited with excess revenues it didn’t actually collect for the purposes of the calculation — in other words, teams are penalized for underperforming, by being made to appear more profitable than they truly are, and thus requiring them to contribute more to the pool.
Expense caps are also put in place to ensure that teams don’t attempt to maneuver around the system by spending their way out of a revenue sharing obligation.
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.
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.
While the Heat’s 2013-14 revenue sharing obligation has yet to be determined, at current revenue levels it should presumably approximate $10 million. The Marlins and Panthers, for comparison, both reportedly receive more than $10 million in annual revenue sharing distributions.
An Overview of the Heat Profit Structure
Perhaps the best way to evaluate the Heat’s true profitability is to estimate its EBITDA – that is, earnings before interest, taxes, depreciation and amortization.
When we look at a business, we want to know about the dollars coming in compared with the dollars going out. Ideally, we want to isolate the numbers that are closest to showing us the firm’s pure business efficiency.
EBITDA is commonly used as a proxy for a company’s true cash flows from operations in the finance world. This is particularly true in the basketball world, where most NBA teams are private entities with pass-through tax structures that often manipulate their expenses to reduce their owners’ personal tax liabilities, and where such teams often choose not to optimize their capital structures, leveraging debt not as a funding source for operations but rather as a cheap source of capital to deflect the equity requirement for investing activities such as the original purchase of the team and/or the arena in which it plays or to pursue other ventures.
Perhaps the best way to evaluate the Heat’s EBITDA is prior to the incurerance of costs related to player compensation, due to the wildly variable nature of player contracts. We can then utilize the resulting profitability metric to back into a player salary level that allows the team to support its revenue base, turn a profit (after accounting for both player salaries and related luxury tax consequences), and produce a championship-caliber team.
The Heat currently generates revenues of approximately $180 million. Such revenues result in revenue-sharing obligations of approximately $10 million. The best approximation we have for true and direct operating costs is $65 million. Total it all up and you come to the conclusion that the Heat can spend roughly $105 million on player salaries and related luxury tax consequences, net of any funds returned from the league’s escrow fund, and still break even.
As a frame of reference, the Heat spent approximately $90 million on net player salary and luxury tax expenses this past season. If the team chooses to amnesty Mike Miller this summer, which it likely will do, it figures to spend roughly $105 million next season – maybe a little more, maybe a little less.
For Arison, rolling in the riches from the team, itself, does not appear to be a priority. It is something to break even with or, in a tax maneuver, lose a little on. It is a means to have some fun, to pump up his competitive juices as he strays further and further from the battle lines in his own particular business (from which he just stepped down as CEO), and leave him in good civic standing.
“This is a hobby of passion,” Arison said last year, “it’s not a business.”
A Look Into the Future
Owning the Heat may not be a primary source of scratch for Arison now, but it soon will be.
The league’s current national TV rights deal, which pays out roughly $31 million per year, expires after the 2015-16 NBA season, and recent deal precedents suggest the league could expect to generate at least $2 billion per year next time around, which would more than double the Heat’s average take, to $67 million, for the better part of a decade.
The Heat’s local TV rights deal, which pays out roughly $20 million per year, expires after the 2017-18 NBA season. The current deal was extended three years prior to its expiration in June 2008 – at a questionable time for the Heat to be negotiating such things, with the team coming off an NBA-worst record of 15-67 – and therefore represents a tremendous bargain by today’s standards. Rumors began to surface in June 2012 that the Heat were pre-negotiating the terms of an extension with Fox, even though the existing deal at the time had six more seasons to run. The rumors were pegging the value of the long-term deal at between $80 million and $100 million per year. But the rumors of such negotiations were quickly shot down by Fox. Given the explosion in recent television rights contracts, by the time the Heat’s current deal expires, that range could nonetheless seem reasonable.
The Heat’s arena naming rights deal with American Airlines comes due in 2019. It pays out an average of $2.1 million per year. That’s a tremendous bargain. American Airlines’ other sponsored arena, American Airlines Center, where the Dallas Mavericks play basketball and the Dallas Stars play hockey, yields about $6.5 million a year in naming-rights revenue from a 30-year, $195 million deal signed in 2000. Stadium-naming rights have become more trendy in recent years, and they reached a fever pitch in 2006 when Citigroup agreed to pay $20 million a year to christen the New York Mets’ new baseball home Citi Field when it opened in 2009. Barclays Bank set an NBA record last year by signing a $10 million-per-year deal to put its name on the New York arena that is home to Brooklyn’s professional basketball and hockey teams. The Heat will surely look to increase its take at the end of the decade.
By the end of the decade, after each of these deals is renegotiated, and layering in additional areas of growth, it is not all that difficult to envision that the Heat’s annual revenues could reach or exceed $300 million!
What does this mean for the Heat?
Massively rising profits, for one. But it means much more than that. It means a correspondingly massive rise in valuation as well.
Ten NBA properties have changed hands over the past three years: the Charlotte Bobcats were sold to Michael Jordan; the New Jersey Nets were sold to Mikhail Prokhorov; the Washington Wizards were sold to Ted Leonsis; the New Orleans Hornets were bought out by the NBA; the Golden State Warriors were sold to Joe Lacob and Peter Guber; the Detroit Pistons were sold to Tom Gores; the Philadelphia 76ers were sold to Josh Harris, David Blitzer, Adam Aron and several others; the New Orleans Hornets were sold to Tom Benson; the Memphis Grizzlies were sold to Robert Pera; and the Sacramento Kings were sold to Vivek Ranadive.
The average transaction value in those 10 deals was greater than 3x revenues (based on Forbes revenue estimates). And transaction values have been steadily rising over that timeframe. The most recent transaction, the Kings’ sale to Ranadive at an all-time record purchase price of $534 million, which was completed just last month, carried a multiple of 4.5x revenues.
More attractive assets naturally attract premium valuations. If we conservatively assume a would-be premium asset like the Miami Heat would be valued in a hypothetical sale at around 4x revenues, a substantial discount to the Kings ‘sale metric, we could be looking at a valuation for the Miami Heat of around $1.2 billion!
That’s “billion,” with a “b!”
Not bad for an owner who paid just $68 million to purchase his team in 1995!
(1) This is perhaps the revenue item that varies most widely based upon the team’s success. According to Forbes estimates, the Heat generated just $41 million in gate receipts in the season prior to the arrival of LeBron James.
(2) Forbes data estimates Heat revenues for the 2011-12 NBA season at $150 million, which feels rather low as a projection for this past season and beyond, particularly when considering that the season was substantially shortened by the lockout as well as the rising ticket prices in the LeBron James era.
(3) The fact that the Heat avoided a payment in 2012 despite reporting an operating profit of $16.4 million suggests that the arena was cumulatively unprofitable through that year. The fact that the Heat will make a payment in 2013 suggests that the arena will turn cumulatively profitable this year. The two, taken together, suggest that the arena may have been significantly unprofitable for the first several years of the deal, but has turned significantly profitable over the last several years, on the strength of four trips to the NBA Finals for the Heat over the past eight years. That, in turn, would suggest that the $55 million in depreciation charges over the past five years alone may have cost the county as much as $22 million – and maybe as much as $66 million thus far if depreciation averaged roughly $11 million over the past 15 years, and maybe as much as another $66 million if depreciation averages roughly $11 million over the next 15 years. The county, therefore, could be out as much as $132 million over the course of the 30-year deal because of these non-cash charges alone. This may have as much to do with not-so-financially-sophisticated county officials negotiating the terms of an arena lease as it does anything else.