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A History of Tax Sheltering For Sports Team Ownership

November 24th, 2014 No comments

It all traces back to a September 1934 court ruling that settled a battle between the Pittsburgh Pirates and the IRS.

In those days, MLB contracts had a one-year term with a standard renewal option (called a “reverse clause”). The reverse clause gave the player’s team the right to renew the contract each year upon expiration at a salary to be negotiated between the parties. If they were unable to agree on a salary, the team could, within certain limitations, fix the player’s salary. Although the team could not force the player to accept the renewal, it did hold the exclusive right to his services and could prevent him from playing for any other team. The player was, in effect, bound to his team for his entire professional career. For teams exercising their renewal options, players effectively had two choices: accept or retire from the game of baseball.

Player contracts were therefore valuable assets, which were bought and sold for cash amongst MLB teams. For tax purposes, the Pirates expensed the cost of the contracts they bought in the year incurred.

The IRS disagreed. Its position was that the Pirates were purchasing not only the right to use the services of the player for a year, but also the right, at its option, to continue to use his services for the entirety of his career. Therefore, the cost of the contracts should not be deducted in full in the year of purchase, but rather capitalized onto the balance sheet and then depreciated over the length of his projected career (contracts at the time had an average life of three years).

The court sided with the Pirates on the grounds that there was no guarantee that the purchasing team would be able to utilize its renewal rights, as nothing could prevent the player from quitting pro baseball(1).

More than a decade later, the ruling would give flamboyant baseball entrepreneur Bill Veeck an idea that would forever change the economics of team ownership, not just in baseball, but in all team sports. He would employ the ruling to fabricate a tax shelter designed exclusively for sports team owners, and then utilize specious logic to convince the IRS of its legality.  Read more…

Salary Cap Smoothing Is As Complicated As It Is Necessary

November 17th, 2014 No comments

“At first glance, [it] is not that attractive, I won’t lie. But we’re studying it to figure out if there really is some advantage for players.”

That was NBA players’ union executive director Michele Roberts last week, describing her aversion to salary cap “smoothing” in the wake of the league’s massive new national TV rights deals.

The new deals with Disney and Turner will pay out $23.4 billion over nine seasons, starting with 2016-17 and running through 2024-25, an average of $2.6 billion per year. That’s a huge increase from the current deals, which pay out $7.44 billion over eight seasons, an average of $930 million per year.

The new deals escalate over time, starting at $2.1 billion and climbing to $3.1 billion. The current deals will pay out just over $1.0 billion in their final season in 2015-16, which means the league’s national TV revenue will jump by nearly $1.1 billion in 2016-17.

The salary cap is tied directly to league revenues, and this will be the largest injection of revenues in NBA history. It alone will cause a $16 million spike, above and beyond any increases from sources other than national TV money.  Read more…

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NBA Strikes Partnership Deal With Daily Fantasy Sports Operator FanDuel

November 13th, 2014 No comments

Fantasy sports is a huge business – 41.5 million people in the U.S. and Canada spend $3.6 billion on fantasy league and related fees each year.

A relatively small(1) but fast-growing sub-segment of the industry is daily fantasy sports. As that part has grown, sports leagues are taking notice and looking to get in on the trend. With that in mind, the NBA announced yesterday that it has signed a four-year strategic partnership with venture-backed FanDuel, the largest player in the space with an estimated 70 percent market share, to promote the one-day fantasy sports website.

The agreement establishes FanDuel as the NBA’s official daily fantasy basketball outlet. FanDuel will unveil the first “Official One-Day Fantasy Basketball Game of the NBA,” that will be free to all fans on NBA.com and FanDuel.com, the prizes for which will include regular-season tickets, unique NBA experiences, NBA merchandise and memorabilia. While the NBA and its properties will only promote the site’s free fantasy games, FanDuel retains the right to have pay-to-play versions of such free games as well, with cash prize payouts. Other fantasy sports websites will still be able to offer fantasy basketball to customers, but FanDuel will be the only such company featured on the league’s digital properties, including its official website and mobile apps.

The NBA is hoping the partnership will drive more engagement with, and more interest in, the league among its fan base. Fantasy participants spend an average of 8.7 hours per week on fantasy and, after placing a bet, increase their weekly intake of sports TV programming from 17.5 hours to 24 hours. The NBA will also receive an undisclosed ownership stake in FanDuel as part of the deal.  Read more…

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NBA Reaches 9-Year, $24 Billion Media Rights Deal with ESPN/ABC, TNT

October 6th, 2014 No comments

The central question of the 2011 lockout, endlessly paltered, parsed and probed was whether the league was actually losing money. While it was a key point of negotiation, its importance was somewhat overstated. A new CBA shapes the future of the league; it doesn’t necessarily need to address the past. It must be asked: How much of the lockout, then, was about owners feeling poor in 2011, and how much of it was about owners trying to get rich in 2016?

2016 is when the NBA’s current national TV deals expire – eight-year agreements that promise pro basketball a total of $7.44 billion from Disney (ESPN/ABC) and Turner (TNT) starting with the 2008-09 season and running through 2015-16, an average of $930 million per year. The deals were originally signed in June 2007.

The NBA was cratering back then. New stars had struggled to grow in the darkness of Michael Jordan’s ever-enveloping shadow. The Shaq-Kobe drama had breathed temporary life into the league, but their eventual break up left the NBA to slowly wither in its wake. Big market teams like the Lakers, Knicks, Celtics and Bulls were brands lacking a product, with no signs of future improvement. The Spurs had just pummeled LeBron’s Cavaliers in the finals, a dismal four-game extermination that limped its way into the record books as the lowest-rated series in NBA Finals history. Things were getting ugly.

An eight-year, $930-million-per-year combined deal? Sold!

Then-commissioner David Stern had negotiated for an increase of more than 20% from the previous average of $767 million despite declining viewership (which itself represented a nearly 25% increase over the $614 million per-year deal signed in 2002, then, also, despite declining viewership). The networks were more than willing to comply with what amounted to a modest 2.5% compounded annual growth rate in rights fees in exchange for an atypically long eight-year deal. The preceding six-year 2002 deal had been the longest one Stern had ever signed.

The agreement looked even better for Stern and the league as the economy got even worse. In 2008, credit froze because mortgage insanity stirred by (us) Wall Street evil-doers planted massive hidden debts packaged in complex synthetic financial products throughout the business world. The ensuing global economic meltdown blazed its way into the NBA, spurring widespread layoffs and igniting fears that league revenues could collapse by, as Stern described it, “maybe as much as 10%.” The league seemed fortunate to be able to cling to a $930 million lifeline every year.

Times have certainly changed.  Read more…

When Should Kevin Love Lock In His Long-Term Contract?

September 15th, 2014 No comments

With the Cleveland Cavaliers on the verge of completing a blockbuster trade for Kevin Love, the Minnesota Timberwolves granted permission for Cavs owner Dan Gilbert to meet with Love. Whatever was discussed at that lengthy July meeting in Los Vegas gave Gilbert enough comfort to finalize what became the biggest trade in franchise history.

The problem Gilbert had to overcome? Uncertainty.

Love has as few as one year remaining on his contract. To trade away a potential future superstar such as Andrew Wiggins in exchange for a man, perennial All-Star though he may be, who could walk away in just one year represents a substantial risk.

Did Love affirm his desire to remain with the Cavs over the long term in that meeting? Maybe. But you’re not going to hear about it. That’s because Love its still under contract. It’s technically against the rules (and among the most serious violations a team can commit) to strike a future deal. But something made both parties comfortable that this was a long-term arrangement. In the news conference to announce his arrival, Cavs general manager David Griffin welcomed Love by saying this was a “long-term relationship.” Moments later, Love himself said he was “committed to this team, committed long term.”

So when will Love lock in the long-term deal that solidifies his commitment? Love’s age, tenure and skill-set have created a perfect storm of interesting – a fascinating story that figures to be unlike any other in the NBA in the years ahead.

Stating the obvious: The higher the starting salary in a long-term contract, the higher the salary can be in all subsequent years of the contract as well. That’s because annual raises in any contract are limited to 7.5% of the starting salary. The maximum length of a contract is five years. In what summer, then, will Love strike the optimal balance for himself between locking in the highest starting salary and locking in a full five-year deal, while taking into account risks associated with such things as his health and inevitable basketball mortality?(1)

It won’t be this summer. That much we know. Why? Because he can’t. NBA rules prevent it.

In January 2012, Love signed a four-year, $60.8 million maximum contract extension(2) with the Wolves in which the last season, the 2016-17 season, was to be a player option. Love will make $15.7 million this season and his option for next season is for $16.7 million.

If Love wanted to sign with the Cavs today, it would therefore need to be an extension of his current contract. Contracts cannot be extended until the three year anniversary of their initial signing. That’s next January.

So if not this summer, which?(3)  Read more…

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Los Angeles Clippers: Salary Cap Maneuvering In Action

August 11th, 2014 4 comments

Update (08/29): The Clippers followed the logic presented in this post and created additional room below the hard cap by means of a trade. But how they went about it can certainly be questioned. The trade was rather costly, and their actions thereafter were rather surprising.

The Clippers traded Jared Dudley and a protected 2017 first round pick to the Milwaukee Bucks in exchange for Carlos Delfino, Miroslav Raduljica and a protected 2015 second round pick.

The 2017 first round pick the Clippers sent to the Bucks is lottery protected through 2019, otherwise it becomes a pair of second round picks in 2020 and 2021. With the Clippers all but certain to make the playoffs in 2017, the pick will surely be conveyed to the Bucks in 2017.

The 2015 second round pick the Clippers received was actually the Clippers’ own pick, which was previously traded to the Bucks if it falls within the 31-50 range, to the LA Lakers if it falls within the 51-55 range, and to the Denver Nuggets if it falls within in the 56-60 range. Now it stays with the Clippers if it falls within the 31-50 range. But with the Clippers all but certain to be a top 10 team this year, it will surely go to the Lakers or Nuggets, rendering its return worthless.

The trade therefore effectively becomes Jared Dudley and the Clippers’ 2017 first round pick to the Milwaukee Bucks in exchange for Carlos Delfino and Miroslav Raduljica.  Read more…

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A View Into the Miami Heat’s Local TV Deal

August 4th, 2014 No comments

“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. Read more…

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NBA Sets Salary Cap and Tax Level Numbers for 2014-15

July 9th, 2014 No comments

On Thursday July 10 at 12:01 a.m. ET, the NBA’s 2014-15 season begins. That’s when the league’s salary cap, luxury tax threshold, maximum salaries and other figures all adjust to their new values.

Most NBA business ceases for the first several days of July as the league conducts its annual audit to determine the league’s revenues from the previous season. With that figure in hand, the league huddles with the players association to project revenues for the coming season, and uses it to calculate the new cap, tax and related figures.

Revenues on the season came in at an all-time high $4.52 billion, up 5.3% from the previous year and more than $50 million higher than initially projected. On that basis, the league then projected revenues for next season to increase another 4%, to $4.71 billion.

To get the salary cap for the season ahead, they took 44.74% of that projected amount, subtracted projected benefits, and divided by 30 (the number of teams in the league). Adjustments are then made to the cap if players received too much (or too little) in salaries and benefits for the completed season relative to the finalized revenue figure; this serves as a mechanism to maintain the integrity of the agreed-to revenue spit between owners and players. The luxury tax uses a similar formula, but is based on 53.51% of projected revenues.

The finalized figures were announced at 5 p.m. Wednesday in a memo distributed by the league to all member teams.

The new salary cap has been set at $63.065 million, a 7.5% increase from last season. That is slightly less than the $63.2 million estimate teams had been using since April, but higher than previous forecasts. Last year at this time, the league initially forecasted a cap of $62.5 million, before increasing it to $62.9 million in November and again in April.

The new luxury tax line will be $76.829 million, a 7.1% increase from last season. Tax projections started at $76.1 million last year at this time, before rising to $76.6 million in November and $77.0 million in AprilRead more…

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Miami Heat’s Great Hope Is … Josh McRoberts and Danny Granger?

July 8th, 2014 No comments

The Big Three era Miami Heat were always the ideal test case for a new collective bargaining agreement designed primarily as a cash grab for owners, but also with a secondary goal of engineering greater competitive balance around the league.

The new CBA went about achieving its secondary goal in large part by implementing a far more punitive luxury tax(1). Spend a lot on players, and you’re going to face a crippling “incremental” tax penalty that gets more severe as you add payroll. Keep spending year after year and eventually you’ll tack onto it the dreaded “repeater” tax.

It’s working. Just five NBA teams paid the tax this past year; that’s tied for the fewest ever in a tax-triggered season. Competitive balance is more prevalent today than at any point in recent history. Team salaries around the league have leveled out dramatically. The spending habits on the high end are down significantly, with particular emphasis for those in smaller markets which can’t support the weight of such enormous tax bills.

No one team has felt the burden of the new tax structure more than the Miami Heat. Some would say that was always the plan – a plan brought about by the demands of envious fellow owners in the wake of the Big Three formation. The Heat have had to make several painful and wildly unpopular cost-cutting (e.g., waiving Mike Miller via the amnesty provision) and cost-controlling (e.g., not utilizing the mid-level exception this past season) moves since the lockout, as a direct consequence to the harsh realities of the new CBA.

It wasn’t all that difficult to forecast. People have been predicting the inevitable demise of the Heat, as presently constructed, for three solid years. Whether owner Micky Arison could afford to keep his team together was never in question; he’s a six-billion-dollar man. But the limitations of his market – the Heat’s designated market area is good for just 17th overall, among the league’s 30 teams; smaller than, for example, that of the Minnesota Timberwolves – have made it virtually impossible to maintain some semblance of profitability while spending deep into the tax (at least in the near-term).  Read more…

Miami Heat Struggling Early In Free Agency

July 3rd, 2014 10 comments

The Miami Heat would love to get younger.

The Heat would love to get some youthful assistance on the wing, as protection for Dwyane Wade as his advancing age and health restrictions cause him to miss so many games and render him so ineffective in so many others.

The Heat would love to get a youthful presence down low, a big man capable of imposing his will on the block and the boards.

But for as much as we, as fans, have dreamed it to be so, it was never truly possible. Supremely talented youth is almost never a possibility on the open market. The very nature of NBA rules makes it virtually impossible to attract youthful talent in free agency.

The intensity of recruiting these days is such that the vast majority of all of the best free agents will have once been first round draft picks. Such selections provide their teams the promise of cheap labor over an extended period – via four year “rookie scale” contracts which make it categorically impossible for them to shake free during the interim. If not for being operated under a set of rules which were collectively bargained, the concept alone would surely violate anti-trust laws.

And, yet, it doesn’t get much better for these players after just the four years. At that point, the door opens, but only very slightly. The player is then to enter free agency in restricted fashion, such that any agreement he strikes with any team can be matched by his prior team and, in-so-doing, obligate said player to play for his prior team under its terms. These rules are so restrictive that, typically, the only option for any team desiring such a player is to severely overpay for him, in the hopes that his prior team refuses to match such ludicrous payouts. Most teams don’t even bother to bid on such players. And, thus, by the time the better former first round draft picks are truly free to consider other alternatives, somewhere between eight and nine years will have already passed them by.  Read more…