2011 NBA Lockout: Who We Root For, Why We Hunt, and What Happened in 2010

Consider today the indomitable Jeff Clark of CelticsBlog's post, which tackles the issue of what exactly happend to the Celtics' finances in the past season, and what it means for the franchise's future.

Why Is Wyc So Willing to Cancel the Season? | CelticsBlog

Jeff delves into the financials as reported by Forbes, who applies their own methodology of calculating a team's net worth and income. Are their calculations wrong? Most likely; however, in the absence of actual audited financial statements, they're as good as anything else. More-so, Forbes has been doing these types of franchise calculations for years, and I've never seen the NBA publicly contest them or force a correction. Should we take those numbers at face value? Unless the NBA is going to put forth its own numbers that have been certified by an accounting firm, there is no reason not to. 

What does Forbes uncover?

It is difficult to draw too many blanket conclusions, but Jeff hits on an important one - operating expenses in the last two years have cause many of the teams' finances to yo-yo. If you consider the Celtics, which is what Jeff is focusing on, you can see that in the years 2009 and 2010, there are drastic dips in operating income. While 2009 makes a bit of sense, since you would expect income and revenue to move together, 2010 makes less sense. Expenses continued to rise at a steady rate and revenue reached its highest in team history, but for some reason operating income shrank. Why?

If we piece together some of the information we have gleaned from the league, Stern & Co. have argued that it has to do with the rising cost of non-player expenses, and I think this makes sense. Salaries, which comprise the most of a team's expenses, are directly tied to league revenue. In other words, if revenue goes up, the salaries go up with it. So that can't be the sole reason in the Celtics' drop; it has to be in some of these other operating expenses that remain undisclosed. What could those other expenses be? If I had to speculate using real world examples, it would include rising costs in things like:

  • Team security (air travel)
  • Energy prices (airplanes, private cars, office buildings)
  • Consumable goods (food vendors)
Team operational income drops

I perused some of the other team calculations in the Forbes report, and while there is no uniform statement to be made across the board, I did discover that seven teams showed similar plunges, and I extracted a few of them here. In choosing the teams, I didn't do anything more scientific than look at the numbers and ask myself, "Does this make sense?" As an example, if you consider the Knicks, their revenue went up and their expenses went down. As a result, they enjoyed a huge jump in 2010 to the tune of $64 million in operating income ($43 million more than in 2009). That increase makes intuitive sense. To contrast using purely back-of-the-envelope calculations (all numbers in $ millions):

Team_loss_medium

all data provided by Forbes.com

A few thoughts:
  • There are only seven teams here, which comprises less than 25% of the league. This sample set is in no way predictive; many other teams' calculations did make intuitive sense.
  • The reason for comparing the net change with the change in net income is to see what we would expect to see if all other operating expenses were removed from the equation. So if a team had no other expenses other than player salary, how much money would they make?
  • By parsing it out this way, we can see which teams have greater unknown operating expenses that may tie into my speculations above. So for example, looking at the Lakers' numbers, you would expect the change in their operating income to decrease, given their change in both revenues and expenses. However, we can see that their operating income decreased by $18 million, substantially more than the $3 million drop calculated from revenues and player expense. So while the Lakers still made a lot of money in 2010, something in their operational make-up drove their income down disproportionately. 
  • Could any of my speculations contribute so drastically to a decrease in income? Certainly, gas prices could have influenced the bottom line, as five of the teams above reside on the coasts. We know that gas prices rose about 14% during 2010, and that could have influenced the final outcome. The question though is not whether it did, but to what degree.
Bath Time

It is difficult to draw anything conclusive from this data, but if you're the cynical type, take a walk with me for a moment. This lockout has been anticipated for a long time now. Everyone knew it was coming, and it can be argued that the owners wanted it to come in order to force the NBAPA to renegotiate the labor deal. If an organization knows something is coming that has the potential to cause a public reaction, the organization become more vested in what that public reaction might be and how they can use it to their own benefit. 

If we step outside of pro sports and into the life of a publicly traded company (those that are traded on public exchanges, like Microsoft or Apple), we know that every quarter, a company has to release its financials to the public, as mandated by the SEC. Those financials contain basic numbers called earnings per share (EPS), simple calculations that allow investors and analysts to compare companies to each other. Since these EPS numbers are highly anticipated, they are also forecast by those analysts at companies like Goldman Sachs and Credit Suisse, and those forecasts form the basis of stock recommendations. A favorable recommendation will likely cause a stock price to go up, and an unfavorable one will cause it to drop. As such, a company has a highly vested interest in making sure it either hits the analysts' earnings estimates or beats them. If they hit or exceed the analysts' estimates, everything is presumed to be ok with the company and their stock price goes up.  However, if the company fails to hit the forecast numbers, warning signals go off and the stock price drops. This relationship all makes good sense.

Here is where it gets a little funny though. If a company is afraid that it is not going to meet analyst EPS expectations, there is actually an incentive to miss them entirely. The reason why is because a company's failure to meet expectations sends the signal to the market that things aren't going well. Once that signal is sent, the market reacts accordingly and then begins to examine why the shortfall happened. Since the company has endured the negative stigma of earnings expectations failure, it is in a sense free to expunge all the other bad stuff that might be on its balance sheet without fear. The company will take the opportunity to cleanse its balance sheet from bad assets that might hinder it in the future, which makes it more likely for higher EPS in the future. This technique is called a Big Bath, and although discouraged by auditors, is frequently used to "clean" a company's financials, and to do it with little pushback since their quarter is already seen as a failure anyway.

Of course we cannot definitively say that any NBA teams engaged in such a practice, but would it really be that surprising if they did? If teams knew they were in for a round of hard negotiations where they had to demonstrate they were in a bad financial place, wouldn't it be in their incentive to make it look as bad as possible? In fact, the NBAPA has wondered the same thing.

So, you might ask, if the NBA teams engaged in a little asset dumping, is that such a big deal, since public companies do the same? Of course it is fine to use the technique, and it adheres to GAAP accounting principles, just as the league attested. The difference though is hidden in this statement:
"Precisely to avoid this issue [of bad calculations], the NBA and its teams shared their complete league and team audited financials as well as our state and federal tax returns with the players union,'' Bass said. "Those financials demonstrate the substantial and indisputable losses the league has incurred over the past several years.'' - NBA Spokesman Mike Bass
Bass is trying to argue two things at the same time - 1) that the financials the league has given the NBAPA are credible; and 2) that the media should trust that they are credible. However, #2 is not a credible statement because the media was never allowed to see the financials. They/we have every reason in the world to be skeptical of the NBA's claims that the league has lost money this past decade. The days of private negotiation are over.

And that is precisely the difference between the league's financials and a public company's - with a public company, the analyst and investor gets to see the financials each quarter to see exactly why that company missed its earnings and then decided to take a bath. With the league though, we don't. We are left dangling in the wind wondering why there is such a huge gap between expected earnings and actual earnings as provided by a magazine that doesn't even have access to the financials anyway. For better or worse, we live in a world of instinctive skepticism, and the NBA's version of "scout's honor" no longer carries any cache. 

Continuing the hunt

In consideration of the CBA situation and the various parties involved, it dawned on me that of the three major constituents, we all want different things. Those constituents are the owners, the players, and the consumers (us). The owners want to win. The players want to win. For us though? What we truly want is resolution. We want somebody to win, and I daresay, at the end of the 4th quarter, we really don't care who.

To be sure, if you side with the owners you would feel glad if they secured the labor deal that allowed them to earn maximum profits, and if you side with the players you would be thrilled if they were able to keep more of the revenues that they help generate. However, for the vast majority of us, there is nothing vested in either side; it is merely a matter of opinion. It is as if to say you would prefer it if (warning - "Wire" reference) Omar got his revenge and Marlo Stanfield got the bracelets. However, they didn't, and you eventually come to terms with this fact that though the story arc didn't end the way you had hoped, it did end, and it ended in a way that gave you some closure.

So it is the same way with this lockout; in the end, we are merely spectators, and our goal is probably just to see it end, because I doubt that any fan of the NBA would say, "the players/owners got robbed and jobbed; I refuse to watch the games next season." Not likely. Instead, we say, "Well, it doesn't seem fair to the owners/players, but at least it's over and we can get back to watching games."

From that perspective, we can see where our allegiances lie - it is to see the lockout end. In that sense, both the players and owners are our adversaries. I think that is one of the motivations we have then as writers, bloggers, and interested parties - to see if we can uncover the pieces to the puzzle that remain hidden in the minds and vaults of team headquarters and Fifth Avenue. The more pieces we uncover, the closer we get to undoing one party or another's leverage. Sure, we would like to undo the league's bargaining leverage, but that probably has as much to do with our sense of drama and too many John Grisham books (although, the league's less than transparent approach does little to assuage the notion).  

Consider as a comparison the sordid tale of NY Congressman Anthony Weiner and his downfall. Without delving too much into the morass, I'll sum it up by writing that his undoing was largely the result of dogged pursuit by the secondary media and their refusal to take anything he said at face value. In the end, Weiner confessed to his lies, resigned, and the news consumer received closure to be able to move on to the next thing worth uncovering. Although the lockout and Weiner are only tangentially related by this tenuous thread, I think it reveals the interest we have as a disinterested party - the desire to solve the puzzle and to help it reach its conclusion. To be honest, it doesn't take much to hook us,either. Whether it is a hokey hunt for a fictitious hamburger hater or the latest Dan Brown novel-to-movie, we like to solve puzzles in the public realm. Whether it is for benefit, bragging, or boredom, very few of us can resist the invitation to solve the riddle. Now, we have a grand riddle before us all, and humble pie be damned; if one of us can crack the code, weaken the player, resolve the strife, save millions, and get David Stern to bow his head in submission, well then...

So hunt we shall.

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