Wednesday, May 24, 2006

It Takes Two To Reason

Over at CanucksCorner, Tom takes issue with my defence of the Richards signing, posted below.

I would have liked to comment, but Tom's spam filter didn't like my reply. And I wasn't even being nasty!

So for the sake of continuing the conversation, here's the comment I tried to post. And if anyone has some tips for me as to why this didn't get past the filter, I'd appreciate it if you'd pass them on.
Tom,

You're correct that the projection is slightly out -- I inflated league revenues by 7.3% not the 7.8% the league actually achieved over the past five years. This is actually a bank error in my favour, but thanks for pointing it out.

However, it's not fair to assert, as you do, that: "The projection [of 7.8% revenue growth] is absurd...when expansion stopped...revenues were maxed out."

NHL revenues increased 6 and 6.4% in the 2002 and 2003 seasons, after expansion was done.

Early reports have already suggested that next year's cap could sit around $42 million, which implies league revenues are growing at a 7+% rate this year.

You don't say why you think the league is incapabable of growing revenues faster than inflation. Do you have a reason, or are you just pessimistic by nature?

A business whose growth fails to beat inflation is a business that's dying. Forget signing free agents: the owners should just cut and run.

My view is that the owners would have to be mildly -- or even extremely -- incompetent to botch the revenue piece. If they can't at least hit 5% revenue growth, they shouldn't be in this business, or any other.

MLB, for example, upped ticket prices an average 5.7% this year, and only once in the past ten years did they achieve year-over-year revenue growth of less than 7%. The NHL can do it too.

My underlying point, however, is not really rooted in the specific projection. The point I'm making is that the CBA formula inflates the salary cap and player maximum at a faster rate than revenue growth, and at a much faster rate than the salary minimums.

Under any scenario where revenues increase, that's going to mean a disproportionate increase to elite free agent prices.

Given that context, locking-in superior talent for five years worth of excess-salary-inflation is a sound strategy. Whether that gets you a 10% discount on the player's future value, or a 30% discount, is a something we'll find out in the future: but if revenues grow, the discount is guaranteed to appear.

9 Comments:

At 5:58 PM, Blogger Andy Grabia said...

It might require something that you didn't give. An email address or something?

Maybe put the link up on Tyler's site, in case Tom doesn't come back here.

 
At 6:50 PM, Anonymous David Johnson said...

The problem is you are basing your projections on best case scenarios. You say that revenue growth in 2002 and 2003 were 6 and 6.4%, not 7.3% you used. You also say that league revenues this year are growing at 7+% rate, but that isn't true either. The $39 million cap was set using a league revenue of $1.8 billion which was well below 2003-04 levels (which were $2.1 or 2.2 billion). It is questionable if this years revenues will reach 2003-04 levels which would mean a revenue decrease.

But, it gets worst. We have to remember that revenues are reported in U.S. dollars where a large portion of revenues are earned in Canadian dollars. If we conservatively assume that CDN$ and US$ revenues are in the same proportion as the number of Canadian and U.S. teams in the league, then 20% of revenues came in in Canadian currency. (This is a conservative estimate since Canadian national TV contracts -CBC,TSN- are in Canadian dollars).

But, the Canadian dollar rose (conservatively estimating again) from 75 cents to 85 cents from 2 years ago. That is a rise of 13.3% on 20% of revenues through plain luck that is unlikely to happen in the future and may in fact reverse. That works out to a 2.6% net positive benefit when comparing this years revenues to 2003-04. So, even if revenues rose 6%, in real terms they only rose 3.4%. And again, this is being conservative.

I still contend that worst case scenario is that you have to offer Richards $7.8 million in August to get him signed. I think the real killer deal was Lecavaliers because clearly Richards has proven himself to be a better player than Lecavalier and thus deserves more in the Tampa pay scale. Unfortunately I think the Tampa pay scale is out of whack with the rest of the league.

 
At 9:22 PM, Anonymous Tom Benjamin said...

vsfomdpIt was the ellipsis (the three dots ...) which for some reason regularly trips the filter.

I've made another comment that explains why I think revenues have stalled. There is nothing new in that. Everyone - Goodenow, Daly, Bettman and Saskin - acknowledged that during the labour dispute. Growth had flattened because US TV money was in decline and all the new revenue streams were tapped out.

As David points out a big chunk of the reported revenues this year aren't real but rather reflect the 17 cent increase in the value of the Canadian dollar. It adds about $150 million to the revenues when reported in US currency. If the NHL reported revenues in Canadian dollars, they've taken a big dip as a result of the lockout.

 
At 12:03 AM, Blogger Avi Schaumberg said...

Part of what I was trying to get through, and which may have gotten lost in the debate over whose revenue number is more accurate, is that a combination of factors is going to disproportionately escalate salaries for talented players. This is true under any scenario in which revenues increase -- whether 3, 5 or 7%. It's just a question of how fast it happens.

It's a combination of the CBA (1) escalating the player's share of revenues from 54% to 57% as revenues increase; (2) suppressing growth in the entry-level salaries and minimums; and (3) lowering the age for free agency.

Item (1) means a big increase in the money available for player salaries.

But that money can't go to the kids in the league because of (2). The CBA forces owner to spend it on the top-level players. And everyone is chasing the same players.

We're going to see significant wage-inflation for those UFAs, and teams are going to lose these players a lot sooner (the increase in UFA availability should have some dampening effect on salaries, except that top-talent is always a scarce resource).

As I mention back on Tom's site, I think the currency debate is a red-herring. If the league (and individual owners) aren't hedging their currency positions, it's their own fault.

To David's point -- could Tampa have waited until August and paid the maximum then? Sure. But they were probably on the hook for $7.8 anyways (what would the Leafs have offered?), and why risk damaging the relationship between player and team by having Richards go through the mating dance in Toronto, only to have him come home in the end.

 
At 5:28 AM, Anonymous David Johnson said...

But that money can't go to the kids in the league because of (2). The CBA forces owner to spend it on the top-level players. And everyone is chasing the same players.

But also remember that the league minimum is also rising. No longer can you fill out your roster with $250,000 rookies (only a few rookies made the big bucks). Instead you have to pay them $500,000.

As I mention back on Tom's site, I think the currency debate is a red-herring. If the league (and individual owners) aren't hedging their currency positions, it's their own fault.

Hedging only works if you gamble correctly. What if they hedged the Canadian currency at 75 cents. That would hinder their ability to spend. And it does matter because the salary cap and players share is presumably based on unhedged revenues.

We're going to see significant wage-inflation for those UFAs

Only if revenues increase.

Sure. But they were probably on the hook for $7.8 anyways (what would the Leafs have offered?)

Leafs would have offered nothing. Neither would have the Rangers, Red Wings, Avalanche, Bruins, or any other team. Teams are just not willing to give up 4 first round picks. The only leverege Richards had was holding out.

 
At 8:54 AM, Blogger Avi Schaumberg said...

But also remember that the league minimum is also rising. No longer can you fill out your roster with $250,000 rookies...

It's already risen. We're talking about the future, where the CBA limits further increases.

Hedging only works if you gamble correctly.

Um. No.

It would be correct to say that failing to hedge is a gamble.

Hedging is the opposite of a gamble: you can lock-in your preferred result.

If the Oilers have $X in USD denominated player salaries coming due in September, and an expectation of $Y in CAD denominated revenue arriving (for example, from season ticket sales), and at the current exchange rate those figures balance, then they don't need to wait until September and pray that exchange rate movement doesn't screw them in the meantime. They can lock in their effective exchange rate now.

There are any number of ways to do this, but the most common would eliminate the down-side risk, and still leave them with a possibility to capture favourable movement in the exchange.

Only if revenues increase.

If at the end of the day this boils down to a disagreement about whether league revenues are going to increase -- or at what rate -- then this turns out to be an incredibly boring discussion.

And I can't imagine why a GM would base signing decisions on a presumption that revenue growth has stalled. Especially when we have evidence of past and current growth.

If Feaster came to me with a business plan that said "revenues will be flat to 2011," I'd say "come back to me with a plan for growth, or don't come back at all."

 
At 10:03 AM, Anonymous David Johnson said...

It would be correct to say that failing to hedge is a gamble.

You can't hedge currency without a cost. All you are doing is altering the risk/reward equation. It can be a smart strategy but it doesn't always work out to your best benefit. Sometimes it would be better off had you not hedged. But this is irrelevant to out arguement. The only reason I brought up the currency change is to dispute some of your claims of dramatic increases in revenues by stating that 2005-06 revenue numbers will get a boost by the improving Canadian dollar. That cannot be disputed regardless of whatever hedging strategies teams or the league uses.

If at the end of the day this boils down to a disagreement about whether league revenues are going to increase -- or at what rate -- then this turns out to be an incredibly boring discussion.

That was the whole basis of your argument for saying that the Richards signing isn't as bad as some might think. When league revenues rise dramatically Richards contract will not look so bad. That is what the Texas Rangers thought when they signed Alex Rodriguez to a 10 year, $255 million contract.

But I also provided you another arguement of why the contract was bad but you ignored it. That argument was that Richards only leverage was to hold out and so there was no rush to pay him $7.8 million right now because the risk of having to pay him more in the summer in negligable and the liklihood that his market value will prove to be lower is significant. I can't see Elias getting $7.8 million. I can't see Chara getting $7.8 million. I can't see Redden or McCabe getting $7.8 million. Or Simon Gagne or Jonathan Cheechoo or Jason Spezza or Marc Savard. Nicklas Lidstrom might not even get that much. If none of those guys get $7.8 million, is Richards worth that? Olli Jokinen signed a 4 year deal worth $5.25 million per year. Is Richards a dramatically better player than Jokinen? I don't think so.

 
At 10:38 AM, Blogger Avi Schaumberg said...

You can't hedge currency without a cost.

Neither can you ride an unhedged position without a cost.

"When league revenues rise dramatically Richards contract will not look so bad."

I don't consider a 7% annual increase in revenue "dramatic." We completely disagree about what's realistic. And yes, I think the league can beat 5% or 7% before factoring in any currency shifts.

"I also provided you another arguement...that Richards only leverage was to hold out and so there was no rush to pay him $7.8 million..."

I agree it's unlikely anyone else would have lured him away this summer. There's no rush if you think revenues are flat. But if revenues are up, and you wait until the 06-07 cap is set (or worse, the 07-08 cap), then $7.8 isn't the maximum anymore. That's what creates the "rush."

I think that Feaster, with his inside knowledge, is much more likely to know the true revenue picture than either of us. And his actions suggest that he has reason to believe revenues are going up.

 
At 10:50 AM, Anonymous David Johnson said...

But if revenues are up, and you wait until the 06-07 cap is set (or worse, the 07-08 cap), then $7.8 isn't the maximum anymore. That's what creates the "rush."

It is irrelevant what the cap is. What matters is what the market rate is. The cap was $7.8 million last summer. How many players signed for that amount? If the player cap goes up to $9 million this summer, do you think that this summers top free agents will all of a sudden start signing $9 million per year contracts. You need to stop focusing on the maximum a player can make and the amount of money players are making and going to make.

Again, the only way this deal makes sense is if the going rate for Richards type players rises beyond $7.8 million this summer.

I think that Feaster, with his inside knowledge, is much more likely to know the true revenue picture than either of us.

Again, it isn't just about revenue, it is about the market rate. Even if Feaster thinks that the team cap will rise to $80 million 4 years from now, that doesn't make it a good deal. Regardless of what happens in the future, if he signed him for $7.8 million per year when he could/should have signed him for $6.5 million per year, it is a bad deal.

 

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