Can the Royals afford Alex Gordon?

Last week I tried putting a value to Alex Gordon. That's step one of evaluating a free agent, finding his worth. in my analysis, I concluded Gordon is absolutely worth $100 million. The second question becomes can the Royals afford Gordon at that price, and if so what would be the impact to the rest of the team?

Can they afford him?

Last March, Forbes estimated the Royals were worth $700 million in team value. Most importantly in that valuation, Forbes estimated the Royals had something like $231 million in revenue, a figure that includes money from the 2014 World Series appearance.

Revenue	$ 231.0 million
Others Expenses	$   91.4 million
Payroll	$ 113.0 million
EBITDA	$   26.6 million

Since the Royals are not required to make their financials public, these are just estimates, but according to these figures, the Royals netted around $26 million before any taxes, interest, depreciation, and amortization. We don't have what those taxes and other expenses are exactly, but we can make some loose assumptions.

In 2010 the Pirates financial documents from 2008 leaked. According to Forbes, the Pirates operating income in 2008 was $17.6 million. The leaked document however has operating income at $21.8 million, a $5 million jump from '07-08. That document show that the Pirates had very little in federal/state taxes owed (just $57,000 on a $145 million revenue). The big killer to their net income was interest expenses (interest owed on debts issued) at -$6.1 million. Forbes lists the Pirates debt/value at 10% in 2015 (remember these documents are from 2008). The Royals debt/value in 2015 was listed at 8%. That could represent $4 million or so depending on the debt owed.

The Pirates PNC Park opened in 2001, which the Pirates financed $44 million of a $262 million project. However they used $30 million from selling the parks naming rights PNC Bank to pay for most of that. The Pirates did not have to apply the $30 million directly to the debt though. However they are paying $6 million in interest expense seven years later. That might not solely be for the stadium though, because teams finance many different projects.

In 2006, Jackson County voters elected to take on a huge debt burden when they decided to finance a stadium renovation to primarily benefit a private organization with public money. The Royals were only saddled with paying $25 million of a $250 million renovation, more than what the Pirates owed net of their PNC money.

One thing I used to do on a somewhat monthly basis for a former employer was to sift through municipal bond offerings for disclosure details and material events for clients. The beauty of modern transparency and regulation brings just about every municipal bond issued to your fingerprints thanks to EMMA/MSRB. One such bond: the Jackson County Truman Sports Complex issue.

I won't make you dig through that PDF or the document from the refinancing of the debt in 2014. Here are some takeaways.

1. The Royals pitched in $25 million or the stadium costs with interest

2. The Royals pay a leasing fee, parking fee, and ticket fee to Johnson County (the Chiefs just lease/parking)

3. The Royals also pay a percentage rent to Jackson County Sports Authority (this may be part of the parking/ticket fee)

4. The Royals and Chiefs were responsible for any overrun costs above the $575 million renovation plans. Though I can't find exact numbers, often times construction costs do go above the planned amount.

5. The Royals are in charge of any maintenance, repairs, management and operations. It is likely that the Royals put money aside every year into a pool (titled the Maintenance, Repairs, Management, and Operations Fund) and then upon an authorization from both the Royals and the Authority (Truman Sports Complex Authority) they take money from the pool. This payment seems to be something along the lines of $615,00 a year + a 3% increase yearly from 2014.

According to FanGraphs the Royals revenue was estimated to rise an additional $30 million this year based on increased attendance before any new playoff money.

A little more on those fees I found in the 2014 refinance document:

2013 Royals Lease	$ 1,593,639
Royals Ticket Fees	$    562,791
Royals Parking Fees	$    264,020
Royals Total	$ 2,420,450
Chiefs Lease	$ 1,578,196
Chiefs Parking Fees	$    995,781
Chiefs Total	$ 2,573,977
Team Totals	$ 4,994,427

The Royals paid about $2.4 million to Jackson County in 2013 for their lease, ticket, and parking fees (before taking into consideration any percentage rent if applicable). We'll try a very rudimentary way to figure out what ticket/parking fees the Royals may pay in 2015. The Royals attendance in 2013 was 1,750,754 and they paid $562,791 in ticket fees ($0.32 per ticket) and $264,020 in parking fees ($0.15 per fan). In 2015 the Royals total attendance in the regular season was 2,708,549. Using the same rates as 2013 that yields $866,735 in ticket fees and $406,282 in parking fees. Now again this isn't an exact formula at all. Ticket prices went up and tickets per car varies a ton on just a game-by-game basis. If the same principles apply to the playoffs as well the Royals brought in 322,054 fans during the playoffs ($103,057 ticket fees/ $48,308 parking fees).

We don't know how much of every dollar the Royals earn they actually get to keep. Yes, revenue likely went up after winning the World Series, but so did the costs. Ticket/parking fees increased, as did staffing, production, and expenses.

This is all a long way of saying yes revenues increased, but how much? Also that money isn't of course pure profit. The Royals had an estimated operating income of $26 million after playing seven games of a World Series. Sam Mellinger of the Kansas City Star wrote in 2014:

Every night the Royals host a playoff game, they make a little more than a million dollars. That's pure profit, money the team did not put into its 2014 budget.

Mellinger doesn't mention how he arrives at this figure other than "club sources", however I'm assuming the money is before taking into account the other expenses after operating income. How much go towards the extra tax/expenses? I don't know, but I don't expect the Royals to have $8 million extra from the eight playoff games they hosted in 2015 to tack on to their 2016 budget.

Clubs don't run at a zero dollar balance budget. Let's agree that the Royals generated $26 million in operating income for 2015. Then let's say they spent $4 million in interest expense/income tax and another $2.4 million in leasing/revenue fees. That $26 million goes down to $20 million, although these are just estimations.

Teams also save money for a rainy day. The Royals put aside money into their repair fund and other projects. They also pay back money and interest in loans they may have outstanding as well as insurance premiums, which may be a part of operating expenses. Part of the privacy of being an MLB team is they don't have to file their income statements and balance sheets publicly, unlike non-profit organizations and public corporations.

Take this all with a grain of salt of course. I'm most certainly not an expert. I'm not even an amateur. I could be, and likely am off on many of the above numbers. Please correct me, smarter people.

So can they afford him?

Yes, I think they can, that is, if they want to bring him back. Doing so however either would cripple the budget or take some maneuvering with the money.

Let's assume Gordon and the Royals meet at five years, $80 million. As shown earlier, that's well under value for Gordon and the Royals should see surplus on each of the five years of the deal if the money is split evenly over the course of the contract.

However, to fit under the current budget, the contract is likely going to need to be backloaded for the Royals. If you assume the team will have an Opening Day payroll of $130 million, a 16% increase over last year's $112 million payroll, they have about $30 million to spend after taking care of the players already on the roster. Already, the club has spent $11 million of that on salaries for Joakim Soria and Chris Young next year. With the remaining money, the Royals will need to find at least another outfielder (unless they really do start Jarrod Dyson) as well as a starting pitcher.

Signing Joakim Soria

My biggest problem with the Soria signing is not in Soria himself, but in opportunity costs. The Royals didn't need another bullpen piece necessarily. They certainly didn't need another bullpen piece before signing two starters and two outfielders. They certainly didn't need to spend $25 million over three years on a reliever.

It's a bit wrong to say "that $7 million on Soria in 2016 could have been spent on Gordon!" The Royals may not even want to sign Gordon for any amount that isn't a deep discount on his value. It's not 100% accurate to say they were going to spend X% of their budget on Gordon.

However, the Royals biggest needs are starting pitching and outfield. The Royals have a finite budget. Seven million spent on Soria is money that cannot be spent on Alex Gordon, Denard Span, Scott Kazmir, or any other of the priorities this team needed to fill first.

Backloading the deal

To get around financial obstacles and fit Alex Gordon in next year's budget, they could heavily backload the deal:

Year	Salary
2016	$   8,000,000
2017	$ 11,000,000
2018	$ 20,000,000
2019	$ 20,000,000
2020	$ 21,000,000
Total	$ 80,000,000

That gives them room in 2016 to spend $12 million additionally on a starting pitcher (assuming Dyson starts in the outfield). For 2017, it doesn't hurt the Royals payroll much either, assuming they make some moves.

Before any changes, this takes the Royals 2017 payroll from $148 million to $159 million before any additional signings for the 2016 books. However, the Royals have three mutual options on the ledger for 2017. As you may know mutual options almost never get exercised from both sides. Mutual options imply a win-win deal for both sides...a thing that never really happens in sports negotiations. The player either thinks he's worth more or the club thinks the player is worth more and getting a discount or less and declines their side. If all three mutual options get declined, the Royals would $28 million in salaries off the books, bringing them down to about $120 million in payroll, lower than their expected 2016 payroll.

Deferred Compensation

The Royals could also get creative and use deferred compensation to fit Gordon into the budget. Deferred compensation has been around for a long time, at one time used in the"lifetime contracts " given to George Brett, Willie Wilson, and Dan Quisenberry. These kind of deals have become popular again in recent history. For instance Max Scherzer signed in 2014 with the Washington Nationals for seven years and $210 million. However, Scherzer and the Nationals agreed to defer half of his compensation, effectively making the contract a seven year, $105 million deal to pitch and then another seven years $105 million in what will probably be retirement for Scherzer.

If the Royals were to do a similar deal for Gordon, they would probably have to pay him a bit more than $80 million to defer. Scherzer was expected to get around $170 million. He instead got $40 million more, about 25%. Using that same increase for Gordon, the Royals would be looking at something like five years, $100 million with five years deferred.

However, anyone who has taken an economics  or finance class knows that future money is not worth the same as present money (net present value or discounted cash flow). If you assume a 5% discount rate, the five year, $100 million deal with deferment for Kansas City would look something like:

Taking a normal five yeare, $80 million backloaded deal (like above) would net less money for Gordon after a discount rate. The best deal for Gordon is actually taking the ten year, $100 million straight payout (10 payouts of $10 million annually). The Royals would be deferring a large chunk of money into the future, effectively $45 million from 2021-2025 after the 5% annual discount. However they would retain Gordon at $10 million per year for five years of playing and an additional five years of retirement.

Having Gordon at 5/$50 million would give the Royals immense surplus value:

Year	Salary	WAR	$/WAR	Value	Surplus Value
2016	$ 10,000,000	3.5	$   8,000,000	$  28,000,000	$   18,000,000
2017	$ 10,000,000	3	$   8,400,000	$  25,200,000	$   15,200,000
2018	$ 10,000,000	2.5	$   8,800,000	$  22,000,000	$   12,000,000
2019	$ 10,000,000	2	$   9,300,000	$  18,600,000	$     8,600,000
2020	$ 10,000,000	1.5	$   9,700,000	$  14,550,000	$     4,550,000
Total	$ 50,000,000	12.50	-	$108,350,000	$   58,350,000

The discount value isn't quite as important here because the inflation rate on the $/WAR value is ~5% anyways which eats the discount away.

Before this winter began, I was fully expecting the Royals to not return Ben Zobrist, Alex Gordon, or Johnny Cueto. Personally I think the Royals will thank them all for their service, say goodbye, and collect a draft pick for losing Gordon.

The Royals can afford Alex Gordon (depending on normal offers), but they don't have to sign him. Not spending all that money on Joakim Soria and Chris Young would have helped immensely. That is what leads me to believe they never planned on signing Alex Gordon all along.