Max Rieper: The Royals are likely headed towards a rebuild, and may very well be priced out of the running to re-sign free agent Eric Hosmer. These are defensible positions from a baseball standpoint - the Royals probably can’t add enough free agents to make them much of a contender with their existing roster, and a small-market club will have trouble locking up a player to a six- or seven-year deal that will take up one-seventh of their total payroll. The Royals can shrink payroll next year without any screams of “GLASS IS CHEAP” from this corner.
While baseball still has inequities between small- and large-market clubs, the game has made huge strides in leveling the competitive playing field. Greater revenue sharing, a punitive luxury tax threshold, and added competitive balance draft picks have given small-market clubs a better chance to compete, and the Royals have a championship trophy to show for it.
That still hasn’t kept clubs from crying poor, however. In a recent article from Jeffrey Flanagan at MLB.com, Dayton Moore claims the attempt to compete the last two years has cost the Glass family dearly. According to Moore, the Royals lost an estimated $65 million to $68 million over the 2016 and 2017 seasons.
"We got to a World Series with a $96 million payroll, won a championship with a $120 million payroll. Then, we won 81 [games] with a $140 million payroll, and won 80 with a $150 million payroll."
Certainly the Royals have spent like never before the last two seasons. Last year’s $145 million Opening Day payroll was the highest in club history, and just above the league-average. Still, the claim that the Royals lost around $30 million each season is a bit hard to swallow.
This isn’t the first time the Royals have claimed losses. Back in 2016, fresh off their amazing championship season, Royals officials claimed the team was underwater financially.
Their internal projections are that the club will lose money in 2016 without a postseason appearance, will make a profit with another deep playoff run, or will break even with something in between.
The Royals made around $10 million in 2014 from their deep playoff run. The 2016 club, which had a $137 million Opening Day payroll, missed the playoffs. They were at the fringes of contention much of the year, and did draw 2.55 million fans, the second-most in franchise history, although a 5.5% drop from the previous season.
Back then I wrote a bit about why the team’s claims of being underwater were a bit dubious. Since then, attendance has gone down from a franchise-record 2.7 million in 2015, but the club did raise ticket prices. They also asked more from corporate sponsors and advertisers. The revenue-sharing formula has changed under the new labor deal, although few details have come out about that. Payroll has also gone up, to a franchise-record $145 million last year.
It wouldn’t surprise me if the Royals were losing some money. But $65-68 million over a two-year period doesn’t quite pass the smell test. That isn’t to say I think Dayton Moore is lying, but there are many different ways to interpret “losing money” when it comes to sports teams. For that, let’s turn to Shaun Newkirk, who is much better with his money than I am.
Shaun Newkirk: Oh boy, this is a fun one for me to break down because it’s right in my wheelhouse, in a cross section of finance, accounting, and baseball. As Max pointed out, the Royals didn’t actually lose money. Yes, they can claim they did, but those numbers exist solely on paper.
Former MLB President and also former CEO of the Toronto Blue Jays Paul Beeston put it best:
Anyone who quotes profits of a baseball club is missing the point. Under generally accepted accounting principles, I can turn a $4 million profit into a $2 million loss, and I can get every national accounting firm to agree with me
What Beeston is referring to is the little known Roster Depreciation Allowance (RDA). This tax law allows teams to depreciate their contracts. Years ago, owners of sports franchises argued that upon signing a contract, players “waste away” much like a tractor or any other tangible asset a business would buy. After a few years, a player is worth less than they bought them for, much like your car depreciates. Accordingly, owners sought to be able to depreciate the value of a player on the books.
Let me be clear: this idea doesn’t exist anywhere else in business. No other enterprise can depreciate the cost of their employees. It’s worth noting that the RDA only applies for players, not administrative staff. For Janet in accounting, her salary is an operating expense, not a depreciable asset.
Depreciating is a “non-cash expense” (this will make more sense in a bit) and is part of Generally Accepted Accounting Principles (GAAP). Every business has some sort of depreciating asset, whether it be a copier, a tractor, a piece of machinery, or an office building. Depreciating those assets is commonplace, and GAAP likes companies to typically be conservative, which means depreciating them over a shorter time period, while aggressive depreciation would be over a long period.
Without getting too deep here, straight line depreciation is the default method. You estimate how long you think the life of the asset is - say, ten years - and then depreciate the cost evenly over the life of it. With RDA, teams can actually take an aggressive method and depreciate their contracts over long periods of time. This means they can manipulate profits/losses easier (this is also a standard protocol for publicly traded companies), as the more you spread out the depreciation, the more profit you make on paper.
Let’s look at an example here:
Say I run a mowing service, and I buy a nice tractor for $5,000. I estimate that I’ll get five years of life out of the tractor, so I’ll depreciate it over five years ($1,000 a year). I charge $10 a lawn and I mow 50 lawns one summer. I of course have to pay for gas, and at the end of the summer I paid $100 for gas. My income statement would look like this:
Revenue: +$500 (50 lawns for $10 each)
Operating expense: -$100 (gas)
Operating income: +$400
Net income: -$600
Wow, you mean I lost money this year? Well, no I didn’t, because as I mentioned, depreciation is a non-cash expense. I didn’t actually pay $600 for it, but the IRS thinks I lost money this year, and I can tell reporters I did. Not only do I not owe any taxes, but I can recognize a loss and potentially carry it forward next year to offset taxes. This example ignores the fact that I paid $5,000 for the tractor in the first year (a capital expenditure), but you can just move the example to the second year, and it would work just the same.
What’s even more interesting is that teams can claim a contract twice. Once for the player's annual salary (operating expense), and then a second time as RDA (loss). This reduces taxes owed even further for a team.
So let’s try an example with a baseball team, while realizing we have to make a bunch of specific assumptions here:
Operating expenses: -$10M (employees, ballpark operations, advertising, etc...)
Player Salaries: -$200M
Payment to shareholders: -$20M (this could come out of net income instead)
Operating income: $20M
Depreciation: -$40M (five-year depreciation of $200M in salary)
Net income: -$20M
And just like that, we’ve turned a $20M operating profit into a -$20M net income loss on paper through depreciation.
In leaked documents to Deadspin in 2010, we got a glimpse as to how teams were using depreciation of player contracts. For the Angels, you can see they list player contracts as assets, right alongside naming rights, sponsorships, and television rights.
The Texas Rangers even went so far as to count managers and bench coaches as depreciating assets.
It is hard for anyone to claim a baseball team is an unprofitable enterprise. In reality, with revenue sharing, central fund sharing, and television contracts (both national and local), the Royals are likely at least breaking even before they even sell a ticket.
Max: Thanks, Shaun. Even if you were to believe the Royals truly were living beyond their means, what about all those seasons they were living well under their means?
Weird you didn’t hear many stories in 2011 about how large Royals profits were back then.
David Glass also stands to make some $50 million from the sale of BAMTech, a business spun-off from MLB Advanced Media that Disney paid $1.58 billion for a 75% stake last year. Additionally, the franchise he once paid $96 million for has increased its value tenfold, in part due to publicly-financed stadium renovations. Sure, the increased valuation in the franchise isn’t money in Glass’ pocket, but the team has been a fantastic investment he can cash in on someday (or pass on to his heirs) or even use as collateral to leverage funds (as other owners have done in the past and possibly present).
David Glass has been an exemplary owner the last few seasons. He has put his money where his mouth is, put the right people in place, and won a championship. Even better, he didn’t tear it all down immediately, instead providing even more resources to win it again. He has built up a lot of goodwill, and perhaps he worries that will be squandered if the club decides to make a baseball decision to rebuild.
There is no need to cry poor. The fans don’t believe it. The fans don’t need to believe it. We understand what the franchise has to do. Even with an improved financial landscape for small-market clubs, there are unfortunate financial limitations for the Royals, compounded by poor management decisions in free agency and the draft in recent years. Go ahead and rebuild. Just don’t expect us to believe an organization in a $10 billion industry can manage to lose money
Shaun: Particularly one that is as deeply subsidized as the Royals are!