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A View Into the Miami Heat’s Local TV Deal

“This is a hobby of passion, it’s not a business… The reality is we’re not a big market team. Where we find ourselves struggling is our local TV revenue is smaller than big markets…”

That was Heat owner Micky Arison in July of 2012, describing the difficulties of sustaining a winning basketball team while maintaining some semblance of profitability under the auspices of the new and far more restrictive Collective Bargaining Agreement.

Local rights deals for sports franchises are in the midst of a tremendous boom in the television landscape that social media sculpts, as regional sports networks (RSNs) bid up prices to secure access to one of the few remaining DVR-proof properties. And when I say “boom,” I want to do more than just evoke the idea of growth: In 2011, the Los Angeles Lakers signed the richest local television rights deal in NBA history; the 20-year contract with Time Warner Cable included the launch of two new regional sports networks – one English channel and one Spanish channel – and averages a payout to the Lakers of approximately $200 million per year, for a total value of $4 billion!

To give you an idea of just how astronomical that is: It’s roughly 10x the $20 million payout the Heat currently generates from its own longstanding TV rights deal. In fact, the average annual payout on the Lakers’ deal is more than what the Heat currently generates in total revenues!

The Heat is at a substantial disadvantage when it comes to negotiating the payout on its TV rights deals. That’s because the size of a team’s local television rights deal is directly proportional to the projected number of television households tuned into its broadcasts. The Heat, by the NBA’s own definition, is a small-market team.

It may shock you to know just how small the Heat’s designated market area (DMA) truly is. The Heat has just 1.66 million TV households in its DMA.(1) By contrast, the New York Knicks and Brooklyn Nets have 7.46 million in their shared DMA, the Lakers and Los Angeles Clippers have 5.67 million in their shared DMA, and the Chicago Bulls have 3.53 million. In fact, the Heat has a smaller TV market than even the Minnesota Timberwolves. Its DMA is good for just 17th overall, among the league’s 30 teams.

The greater Miami area may be small, but it is powerful. Despite the nightlife and weekend distractions that come with such a desirable city, an average of 6.85% of its 1.66 million TV households tuned into locally-broadcasted Heat games on Sun Sports last year. That may not sound like much, but it is. It was the third highest such percentage in the NBA last season, behind only the San Antonio Spurs and Oklahoma City Thunder. To put it in proper context, the playoff-bound Nets had just 0.77% of the TV households in its DMA tune into its broadcasts on YES Network. The Clippers on Prime Ticket averaged just 1.27%, despite being widely considered as favorites to reach the NBA Finals. The Lakers on SportsNet LA, despite the massive new TV deal, averaged just 2.15%. The Knicks, even though they were in playoff contention until the season’s final week, produced ratings on MSG of just 2.18%.

Miami_Heat_TV_Households_Primary_DMA

Despite its small market size, the Heat consistently produces above average local TV ratings.

The very high percentage of a very small number of TV households has produced some nice total viewership figures for the Heat. An average of 114,000 TV households tuned into Heat games on Sun Sports this past season.(1) That was good for third in the NBA. The Knicks and Lakers, on the strength of their massive markets and despite declining viewership percentages, averaged 163,000 and 122,000, respectively. To give a bit more context to the Heat’s total, Chicago has more than twice the number of households capable of viewing Bulls games than do the Heat, and yet an average of 9,000 more households had televisions tuned into Heat games this past season.

On the strength of similarly strong numbers, rumors began to surface in June 2012 that the Heat was negotiating the terms of an extension with Sun Sports for the carriage of its local television broadcasts.

The Heat has had a successful partnership with Fox’s regional sports network(2), formerly called Sunshine Network, that dates back two decades. Heat games were first televised on the network in the 1993-94 season.

The current deal was originally executed in March 2004, establishing the network as the exclusive regional carrier of Heat games throughout the team’s designated broadcast territory, which includes the metropolitan areas of Miami–Fort Lauderdale, West Palm Beach–Fort Pierce–Port St. Lucie, and Fort Myers–Naples. It called for an eight-year term, covering the 2004-05 through 2011-12 NBA seasons.

The rumors were pegging the value of the extension at between $80 million and $100 million per year. Although that represents less than half the amount the Lakers are getting from Time Warner Cable, it would nonetheless have been the second-richest local TV rights deal in the NBA, multiplying the Heat’s current take at least times four!

It all seemed to make perfect sense. The prior TV deal could not have been hand-picked to expire at a better time – just after the Big Three construct had secured its first ever NBA championship, in the midst of vastly increasing local television ratings, having increased from a 2.48 share in 2009-10 to a 4.94 share in 2010-11 to a 6.59 share in 2011-12.

The 6.59 share for the 2011-12 NBA season represented approximately 104,000 TV households in its primary Miami-Ft. Lauderdale DMA (and perhaps as much as 180,000 total TV households, when including the 1.3 million additional TV households within the full reach of Heat broadcasts on Sun Sports in West Palm Beach–Fort Pierce–Port St. Lucie and Fort Myers–Naples), and rising quickly.

That’s more than 40% (and potentially a lot more when including all TV households within the full reach of Sun Sports) of the 258,000 TV homes averaged by the huge-market Los Angeles Lakers at the time. Is it all that difficult, then, to envision the Heat negotiating for a deal roughly 40% of the size of that of the Lakers, supported by what at the time was presumed to be a long-term relationship with the NBA’s biggest television-watching guarantee in superstar LeBron James? Perhaps not so coincidentally, that equates to an average local TV rights payout of at least $80 million per season. The rumors, then, seemed to have some logical validity.

But rumors of such negotiations were quickly shot down by Fox. “There’s no truth to that report whatsoever,” said Chris Bellitti, Vice President of Communications for the Fox Sports Network. “We are in the middle of a long-term deal with the Heat that has several years remaining.”

The rumors were shot down because they were largely untrue – a fabrication of several critical facts, not the least of which was the remaining term of the existing deal.

What the erroneous report failed to recognize was that in 2008, just four years into the original eight year term, Fox and the Heat had executed a six-year extension to their local TV rights contract, to run through the 2017-18 NBA season.

Which begs the questions: Why would Arison sign such an extension? And why did he sign it when he did, with so many years still remaining on the existing contract?

This was a privately-negotiated transaction. It would be impossible to fully comprehend the circumstances surrounding the execution of the extension. But a couple of facts are known:

1. The extension was executed in 2008, after the Heat had just completed its worst season in team history. Which begs the following follow-up question: Why would Arison sign an extension to a contract four years prior to its expiration, at a time when his counter-party had such incredible leverage, with the Heat having produced the lowest local television viewership totals it had ever experienced under the contract?

2. At the time of the execution of the extension, the Heat were already well into their plan to rebuild for the summer of 2010. Which begs another follow-up question: If your general manager is putting all of his efforts into a massive rebuild strategy predicated on creating a title contender for the summer of 2010, wouldn’t you want to align your financial concerns with such a plan?

As it turns out, Pat Riley’s vision did come true. The Big Three era did become a reality.

Arison therefore wound up costing himself big money by signing the extension.(3) How big?

Any incremental revenues from a new local TV rights deal beyond the current $20 million would seemingly contain very little if any incremental associated cost, and thus presumably flow straight to the bottom line.

The NBA, however, imposes its own measure of cost on any new such revenues, in the form of revenue sharing.

The NBA’s current revenue-sharing 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, with no team to contribute more than 30% of its total profits(4) in excess of $5 million into the revenue-sharing pool.

The Heat, as a small market team, should in theory be net receivers under the plan. In theory, money should flow from teams in larger market cities to the Heat – as it does for the Florida Panthers and Miami Marlins. However, despite its limited market size, the Heat maximizes its revenue potential better than just about any team in the NBA. Though it is nowhere close to that of the leaders, the Heat still has one of the higher revenue streams in the league. Therefore, the Heat actually becomes a net payer into the revenue sharing system rather than a net receiver. So revenue sharing doesn’t help. In fact, it hurts.

In compliance with revenue sharing rules, it stands to reason that any incremental Heat revenues that may be generated by a new local television rights deal could be reduced by as much as 30%.

Using $90 million as a baseline figure for what could have been the new average local TV rights payout over a theoretical 20-year term, the Heat might have received between $60 million and $65 million in the first year of the deal, rising to between $115 million and $125 million in the deal’s final year, with a presumed 4% increase kicking in annually.

A gross payout of around $62.5 million in the first year of the deal would imply incremental revenues of $42.5 million over what the Heat was being paid in 2011-12 in its current deal. Netting out revenue sharing, that’s $30 million in incremental profits that would presumably have flown straight to the bottom line – with profits from the deal rising by more than $2 million every year until after the 2017-18 season.

Arison is a wealthy man. He doesn’t need the extra money. But, still, one can’t help but wonder:

How might that extra $30+ million in annual profits have changed the equation for the Miami Heat over the past few seasons?

Would the Heat have elected to waive Mike Miller via the amnesty provision, in a move that was, at the time, projected to save the team approximately $40 million over two years(5)?

Would they have utilized the mid-level exception it abstained from using last season?

How might these changes have convinced LeBron James to stay?

These are questions with answers that can never be known. It’s a past that can never be re-written.

The Heat now need to focus on their future, as they come to a critical negotiation period on what was once thought to become the team’s single biggest source of revenue. We are, again, four years prior to the expiration of the current local TV deal.

Arison will face a significant challenge as he attempts to negotiate a long-term deal, whether it be in the form of an extension signed as early as this season or after the expiration of the current deal four years from now, as he attempts to limit the damage from the loss of superstar player LeBron James.

James has always had a profound impact on the local television ratings of his teams.

The Heat posted the biggest local TV ratings increase of all NBA teams in James’ first year with the organization during the 2010-11 NBA season, doubling the team’s previous year’s viewership mark. The Cleveland Cavaliers, the team James left, conversely saw the biggest decrease that season, with Cavs games on Fox Sports Ohio dropping 54%.

The question for the Heat, then, is how big its viewership drop will be without LeBron, and how any such drop will impact its leverage in negotiations with local television providers.

Despite public perception to the contrary, the Heat has always produced strong viewership ratings, even in the worst of times. During the disastrous 2007-08 NBA season, when the Heat produced the worst record in the league by a large margin, the team still generated a better-than-average 2.02% rating on local television. Most years, Heat local TV viewership rates in the top ten across the league. But the Heat’s viewership always needs to be viewed within the context of its market size. Strong ratings often don’t translate to strong viewership totals for a small-market team like the Heat.

If the last season the Heat played prior to the arrival of James serves as any indication, the Heat will face a significant challenge if it desires to strike a new deal anywhere near the value it might have otherwise received. In 2009-10, despite 2.48% of TV households in its DMA tuning into its broadcasts – ninth best in the NBA – total TV household viewership was just 38,000, exactly one-third the average viewership from this past season.

The Heat may not be able to strike a similar deal to what they otherwise could have had if Arison never executed the 2008 extension, which by the end of the 2017-18 season could have had 13 years remaining on it at an average payout of approximately $100 million, but Arison should still secure himself a financial windfall in the years to come. Even without LeBron, his team’s current TV deal is still grossly undervalued by today’s standards.

Just last week, the Sacramento Kings – a small-market franchise that plays in the league’s 21st biggest designated market area and produces substantially smaller ratings than do the Heat – signed a 20-year media rights extension with NBC Sports Group worth approximately $700 million. NBC Sports Group will pay the team $25 million next year, at the start of the long-term deal that will average $35 million.

The remaining life of the Kings deal will average more than $40 million per season when the Heat’s deal comes due after the 2017-18 season. The Heat will surely look to do better than that. Last season, the Kings on CSN California averaged just 26,000 homes per telecast. Even in its historically awful 2007-08 season, the Heat averaged far more viewers than that. This past season, the Heat averaged 114,000.

So, to summarize, the Heat will surely look to get significantly north of $40 million per year in any new local TV rights deal to take effect after the 2017-18 NBA season, but probably nowhere near the $100 million it otherwise might have had. The question now is where in that range the team will actually fall. The good news for the Heat is that several other properties will come up for bid during the interim few years – including the Golden State Warriors after the 2014-15 season, the Los Angeles Clippers and Cleveland Cavaliers after the 2015-16 season, and the Dallas Mavericks concurrent with the Heat after the 2017-18 season – and that will help to push prices higher.

In the wake of James’ departure, Riley has reconstructed the team, centered around All-Star forward/center Chris Bosh, into what figures to be at the very least a playoff contender for the next two seasons, as the organization bides its time for the critical free agent summer of 2016.

The promise of things to come for the summer of 2016, then, has a similar feel to what we were all experiencing in the years leading up to the summer of 2010. Only this time around, it could mean far more than just success on the court. It could form the basis for the negotiation of a new local television rights deal to follow.

For Riley, Arison and the Heat, the pressure is on.

Notes:
(1) The NBA determines a team’s market size based on the number of television households in its primary DMA. The Miami Heat’s primary DMA is Miami-Ft. Lauderdale, which currently has 1.663 million TV households. However, Heat games on Sun Sports are broadcast throughout the team’s designated broadcast territory, which also includes the metropolitan areas of West Palm Beach-Fort Pierce-Port St. Lucie, which has 810K TV households, and Fort Myers-Naples, which has 518K TV households. Heat games are therefore broadcast to a total of 2.99 million TV households.

(2) Sun Sports is a regional sports network that is operated as an affiliate of Fox Sports Networks, and serves the state of Florida. The channel is owned by Fox Cable Networks, a unit of the Fox Entertainment Group division of 21st Century Fox. 21st Century Fox is one of two companies created from the 2013 split of News Corporation (as founded by Rupert Murdoch in 1979); 21st Century Fox retained the previous News Corporation’s broadcasting and film assets and serves as its legal successor, while its publishing assets were spun off to form News Corp at the same time.

(3) When Micky Arison was uttering the words that formed the basis for the quote at the top of this post in July of 2012, he was speaking something of a half-truth. Yes, the Heat’s small market size does limit the size of any new local TV rights deal. At the same time, however, he was speaking while knowing that, as of that very moment, he could have been negotiating a new local TV rights deal, possibly worth in the neighborhood of $80 million to $100 million per year, had he not elected to sign the six-year extension in 2008. Therefore, it could be argued that his inability to secure a larger local TV rights deal was as much a result of his own judgement as it is the size of the Heat’s local market.

(4) To protect teams from backing their way into an elevated revenue-sharing payment, the definitions of both “revenues” and “expenses” for the purposes of the calculations are both strictly defined. The plan makes teams responsible for meeting revenue benchmarks, based on the DMA of the market in which they play. 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. On the other hand, in order to avoid a team spending its way out of a revenue-sharing obligation (i.e., spending excessively in order to decrease profitability, and thus cause a smaller contribution to the pool), expenses are tabulated by expensive category, each of which is limited in cases where it exceeds the league average by a large enough amount. If a team’s expense in any category is too high, then, for the purposes of the calculation, it is adjusted back down to the threshold amount, making it appear more profitable than it truly is, and thus requiring it to contribute more to the pool.

(5) The decision to amnesty Mike Miller was projected to save approximately $40 million over two years. As things have worked out, with the Heat no longer a taxpaying team for the 2014-15 season, it will have actually saved a total of about $13 million.

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