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NBA financing is not a bailout for teams

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We interrupt your normal sports reading to delve into the fun and exciting world of finance (but with a sports twist )

 

You may have read recently that the NBA has borrowed a large sum of money ($175m) and is making that available  to ~15 teams. There is some understandable confusion regarding the purpose of this deal which is made worse when the media starts throwing around the bailout term.

In reading the original story from The Sports Business Journal, there a few key points that seem to have been lost in translation:

The Toronto Star reported that the deal "allows the NBA to distribute" which implies something different than the original report that called for teams to be able to borrow against this credit line.

It also failed to mention that this type of league arranged financing is normal and "supplements an existing $1.7 billion leaguewide credit facility that uses the NBA’s media contracts as collateral to secure loans for the clubs".

The story here is the price of the money which is at a considerably higher interest rate then before the financial meltdown last fall. The NBA paying 8.27% interest instead of 5.5% is not exactly a sexy story though.

 

A "loss is a loss" applies to standings and not to business

Another item of the story that seems to be misunderstood is this line:

The 15 teams can use the money for any purpose, but covering operating losses may be high on the list.

Operating losses simply mean that the team (or company) spends more in a given year than it takes in. If you look at the Forbes 2008 report of NBA teams, that includes 10 teams in the red.

This compares to 2007 when 10 teams showed a loss and to 2006 when 8 teams were in the red.

Here's the thing about operating losses. They are not the same thing as losing a game were the "L" is marked on your permanent record.

In business, showing a loss for a given year is not necessarily a bad thing. Lots of companies go into the red for a period of time with the intent of building their long term value. In addition, accounting and reporting rules create artificial time periods called years and months. Life (and finances) does not always fit into such neat boxes.

Let's look at the NY Knicks who reported the highest operating loss of any team in 06 and 07 and yet in 08 were in the black by $29m. According to Forbes, during that time the Knicks overall value increased from $592m to $613m (which even assumes these numbers are close to reality which is always a moving target with business valuations).

The point is, in any given time period any given business might be showing a loss and it might or might not be bad and it certainly isn't permanent..

Cash flow - size does matter

Another very common use for credit is short term cash flow financing. The idea is simple...

In any given month you have a set amount of money you need to spend on things like payroll, rent, supplies, etc. Some of those costs are variable (they change based on how busy you are) but in a lot of businesses the vast majority are fixed (they don't change).

In some months you make more money then others and for those months that you spend more then you make you borrow to cover the difference.

In the months that you make more then you spend you party...err..pay back your loans. There are lots of complexities on top of that but the basic idea remains the same.

Lets look at the Suns

On the expense side, the player salaries are about $72m which comes to about $6m per month. Then you add in the other 400 or so employees and other costs like lease payments and banana costs that you figure at another $4m per month for a total of about $10m per month going out the door. That pays for a lot of tweets.

On the revenue side, ticket sales generate $53m per year or $4.4m per month and other income (merchandise, TV deals, player fines, etc) generates about $7.9m per month for a total of about $12.3m per month coming in.

Looks good right. $12.3m coming in versus $10m going out. The problem is that the NBA season isn't 12 months so those gate receipts are compressed into the six month season as are a lot of other revenue (beer, jersey's, etc). 

Short term cash flow financing like we are talking about here covers the gap for the slow months. Almost all companies have some form of borrowing for this purpose which is known by the fancy term - operating capital financing.

The so-called "credit freeze" which has accompanied the gigantic mess made by the Wizards of Wall Street has left businesses that could easily find such financing out in the cold due to no fault of their own.

This is the basic reason why bailing out those banking bastards is so important no matter how distasteful it might be.

No credit. No business. No jobs. No Suns games. No beer.

Don't panic....yet

It is all very simple and straight forward and does not indicate anything regarding the financial health of the league and the teams. The real numbers to watch for will be a decline in ticket sales and other revenue which would increase the operating losses faster then expenses (payroll) can be cut.

Funny thing though. What we saw at the trade deadline was a lot of teams looking to save money in part to clear space to get better players but in part due to anticipation of or perhaps already in reaction to a decline in sales.

The Sports Guy (if you can read 5500 words to get there) reported that the number of teams losing money will double from 10 to 20; that attendance is actually down already; that sponsors are fleeing (hopefully to blogs); and oh yes, there could be a lock out in 2011. Or there could not be. Or the refs suck. I kind of got lost reading this story, but I digress (Simmons has a way of doing that to me).

Facing a tough economic climate, each team's owner needs to figure out their own situation and their own ability to tolerate for short term losses.

In the long run, the economy will rebound (I think we've already hit bottom) and the NBA will emerge as the 2nd strongest sports league with a healthier game that doesn't over pay for mediocre talent and is built around a handful of highly paid super stars and a lot of medium paid very good players that perhaps can stay together as a team and compete for at least three or four years.

[Note by Phoenix Stan, 02/27/09 3:06 PM MST ]

In related news, the Suns announced just in the last few hours that they are freezing season ticket prices for the upcoming season and offering a financing package of their own to fans.

"It is not 'business as usual' for our season ticket holders in this challenging economy," said Rick Welts, President and COO of the Phoenix Suns in a press release Friday. "We want our most devoted fans to know that their team is listening to them and that the plan we are unveiling today addresses their concerns. Our goal is to ensure that our fans can continue to enjoy the experience of Phoenix Suns basketball at a great value."

 

Along with the price freeze is a new interest-free flexible payment option