Is Major League Baseball Profitable?

This is a question asked by many of my students over and over. This question has been more popular lately, given the recent Congress hearings on MLB contraction.During those hearings, we heard experts disagreeing about a very basic business question: Is MLB profitable?

According to MLB owners and, their main speaker, the Commissioner Bud Selig, professional baseball has been suffering significant losses. In December 2001, Mr. Selig told the U.S. Congress that MLB had USD 232 million in operating losses last year and only nine teams made money. On the other hand, Forbes Magazine (April 2002 issue) reports that in the 2001 baseball season, the 30 MLB teams had an operating profit of USD 75 million. In addition, Forbes reports that 20 of the 30 teams were profitable in the 2001 season.

Mr. Selig also testified about the bad shape of many franchises, especially the small and medium market franchises. Surprisingly, MLB franchises have seen their values increase on almost yearly basis. The Florida Marlins, one of baseball "small" franchises, were sold to former Montreal Expos owner Jeffrey Loria for USD 158.5 million. Forbes Magazine and other economists have estimated that the value of the average MLB franchise has grown significantly in the past 20 years. For example, Forbes reports that in early 2002, the value of the NY Yankees increased in value 15% to a staggering USD 730 million. For the average MLB franchise, 2001 was also a good year: according to Forbes Magazine, the average MLB franchise experienced a 10% appreciation.

Using a Present Value Model to value an MLB franchise

The owners of a firm have, in general, a very simple objective: maximization of the value of the firm they own. Managers of a firm should attempt to maximize the market value of the company, not the accounting or book value of the company. This concept is so fundamental, that students learn it in Finance 101.

Now, how do we determine a value of a firm? The market value of a firm is determined by three factors: amount of cash flows expected to be generated by the firm (CF_t for i=1,2,...,T); the timing of these cash flows; and the risk of the cash flows (k). Once these three factors have been quantified, we can easily estimate the value of a firm by using a Present Valuation Model (PVM):

Value of a firm = SUM_t=1^T [CF_t/(1+k)^t].
This formula is very simple. According to this model, and if other things remain equal, if the cash flows of an MLB franchise increase, the value of the franchise also increases.

It can be easily recognized that there is a one-to-one relation between future cash flows and the value of an MLB franchise. This is very good news to the people who have no access to the MLB books. Without looking at MLB books, estimating cash flows might be very tricky. (And, given that many MLB franchises are part of larger organizations, that for some reason might want to undervalue or overvalue intercompany transactions, the task of estimating MLB's true cash flows is even more complicated.) But, according to the basic PVM, having access to the real MLB books is irrelevant. Given that the value of the average franchise is increasing, the average MLB franchise should be profitable.

Note that the February 2002 purchase of the Florida Marlins by former Montreal Expos owner Mr. Loria confirms the PVM results. Mr. Loria, as an established baseball owner, should have very good information about the true cash flows associated with a baseball team. And given that Mr. Loria paid a positive price, it should be clear that the discounted sum of future cash flows should be positive.

Other sources of MLB franchise value

In addition to the value of the cash flows associated with the normal operations of a baseball team, baseball owners enjoy other valuable benefits from owning a major league team. I place these valuable benefits into three categories. First category, network value (NV): MLB owners develop very valuable connections with local, state and national politicians; and local and state business leaders. These connections can increase business opportunities to the MLB owner, that otherwise would not be there. Second category, free publicity (PuV): MLB owners receive almost daily free publicity for their other business. These network connections and free publicity have a positive value. The third category is related to the vanity of a franchise owner, ego value (EV): MLB owners enjoy daily publicity in the local and state press. For example, Drayton McClain, billonaire owner of the Houston Astros, was an unknown name for millions of Houstonians before he bought the Astros franchise in 1993. Today, he is one of Houston most popular residents, he is seen regularly on Houston radio and TV, he is asked regularly to speak at different events, etc. Ego value also includes the value of fullfiling the dream of millions of Americans: owning MLB players! Of couse, ego value is dependent on the personality of the owner. I am almost sure that Mr. McClain has a much, much lower ego value than his fellow Texan and Dallas Cowboys owner Jerry Jones.

Thus, the total value of an MLB franchise is given by:

Value of an MLB = SUM_t=1^T [CF_t/(1+k)^t] + NV + PuV + EV.
This formula can reconcile the numbers crunched by Mr. Selig and the increasing value of MLB franchises in the recent past. That is, MLB franchises can have negative cash flows, but the other three components of a MLB franchise value can be so big, that they more than compensate for operating losses.

Now, how the size of the NV, PuV, and EV is an empirical question. In order to truly determine these three values, we need information on the real cash flows of the firm. And, as we have mentioned before, getting the real cash flows of MLB franchises is a very difficult task. My estimate is that the combined value of NV, PuV and EV is not sufficiently big to compensate consitently negative cash flows. This estimate is based on the observation that many major corporations, such as Walt Disney and AOL Time Warner, own MLB franchises. For these big and well-established companies, the value of the last three components should be small. For example, it is hard to believe that a company like Walt Disney, owner of the Anaheim Angels, puts a lot of value on the publicity generated by the Angels. It is also hard to believe, that AOL Time Warner, owner of the Atlanta Braves, needs a baseball team to extend their already extensive network of business and political contacts.

Conclusion: The numbers of Forbes Magazine should be right. The average MLB franchise is operationally profitable.

Read AP Article about this issue (April 2, 2002)

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written on March 29, 2002.