Better Angels

I am loath to close. We are not enemies, but friends. We must not be enemies. Though passion may have strained it must not break our bonds of affection. The mystic chords of memory, stretching from every battlefield and patriot grave to every living heart and hearthstone all over this broad land, will yet swell the chorus of the Union, when again touched, as surely they will be, by the better angels of our nature.

-Abraham Lincoln First Inaugural Address Monday, March 4, 1861

We seem to be at an impasse.

All the numbers seem to illustrate that the NBA is a profitable enterprise. The league is vehemently claiming otherwise.

To quote from the NBA statement:

  • “Those financials demonstrate the substantial and indisputable losses the league has incurred over the past several years.
  • The league lost money every year of the just expiring CBA. During these years, the league has never had positive Net Income, EBITDA or Operating Income.
  • …. Forbes’s claim is inaccurate. In 2009-10, 23 teams had net income losses. The losses were in no way “small” as 11 teams lost more than $20M each on a net income basis.
  • Our net loss [ for 2009-2010] for that year, including the gains from the seven profitable teams, was -$340 million.
  • “Forbes’s estimates – a $183 million profit for the NBA in 2009-10, and those issued by the league, which claim a $370M loss…”
  • ¶ Forbes’s data is inaccurate. Our losses for 2009-10 were -$340 million, not -$370 million as the article states.

Given that the league would not – and cannot – legally lie on its financial books and tax returns without getting in a whole heap of trouble, they must be losing money. I guess we owe them an apology.

Not so fast.

They may be  losing money on paper but they’re really and truly making a profit.

How in the world is that possible you might ask? It’s all about the tax breaks.

The tax break in question is the Roster Depreciation Allowance (RDA -see here).  To put it very simply, the RDA allows you to claim the value of your franchise as a loss in your books over a period of 15 years and in essence save 35% of that amount on your tax returns (this is know as the 15/100 Rule of thumb see here for more detail). You can claim that loss in whatever schedule you like. You want to claim 90% in Year 5? Go right ahead. No loss claim in Year 11? Good for you.

I want to caveat this by saying I’m not a tax lawyer but my interpretation of the rule is that you get the right to this exemption by buying a franchise (like the Nets or Golden State) or by creating a new fiscal entity to own the franchise (like say for the Knicks or Hawks). The exemption would be at the purchase value of the franchise or the declared value. A quick and dirty example would be:

  • The Golden State Warriors, purchased in 2010 for $450 million dollars, can claim a $450 million dollar exemption over the next 15 years. If we assume a 35% Tax bracket that translates to a real reduction in money owed to the IRS of $157.5 million dollars over that period. This is what we call a tax shelter.

By my count, from the publicly available data anywhere from 50% to 75% of the current value of NBA franchises ($5.5 to $8.3 Billion dollars) is available for this exemption as of now. What this means in practical terms is that if you assume the owners are using this exemption linearly anywhere from $370 million to $550 million of their paper losses are due to this exemption (and are actually gains of $130 to a $190).

Again, we don’t know the exact numbers but we know enough to simulate it by putting together all the available numbers:

Keeping in mind that in certain scenarios the owners would have an incentive to increase the amount of the exemption (like say cashing it out if you were selling the team or negotiating a new Collective bargaining agreement) and the Forbes estimate of a $183 profit for the league, I lean towards a 50% to 55% scenario with some teams up for sale boosting their claims.

Despite claims to the contrary, the NBA in its worst year and in the worst possible economic scenario generated anywhere from $150 million to $210 million in real revenue for their owners (about $5 to $7 million per team) under the current CBA.

Some interesting addendum to the idea of a players’ league from this:

  • Running a professional basketball league entitles you to a $750 million dollar a year tax exemption.
  • You’d be operating a monopoly protected from antitrust laws with access to public money for major capital projects.

It’s very hard not to conclude from this that the NBA is a lucrative and attractive financial venture. Further evidence of this is that the average value of an NBA franchise has increased 78% since 2000 (see page 26 of this report). Here are the teams sold under the current CBA (from here adjusted for inflation) :

  • OKC 2006 $378.6 Million
  • Bobcats 2009 $279.5Million
  • Washington 2010 $550 Million
  • Warriors 2010 $450 Million
  • Nets 2010 $200 Million
  • Hornets 2010 $300 Million
  • Pistons 2011 $400 Million

Sales prices line up to what would be expected from the report (and the Forbes numbers) except for the Nets deal (and that deal is quirky to use a polite term).

The facts paint a clear picture: the owners are not seeking to negotiate in good faith.

I want to make a point very clear: I am not an enemy of the NBA but I am a professional basketball fan.

My take is that the current situation is not conducive to there being a 2011-12 NBA season and it is the owners and not the players who are clearly at fault.  The owners locked out the players because:

  1. They believe they can get away with misrepresenting their financial position (i.e. no one is smart enough to figure it out).
  2. They overvalue their importance to the enterprise at hand.

Their goal is to use that leverage to defraud the talent and get a bigger profit. My incentives are a little different.

By doing this, I’m trying in a very small way to bring this labor impasse to a quicker resolution. I believe that is the quickest and simplest road to having the game back in my living room. Since the owners believe that they have nothing to lose and everything to gain from this situation, disabusing them of these notions publicly and clearly is the best lever at my disposal to try to move the owners to come to a deal that is amenable to both sides and guarantees the upcoming season.

The aim is to shatter the illusions and flimflam that the league is selling, and to hope that by doing that we can help them find the better angels of their nature.

Only time will tell if we made any difference.

-Arturo

P.S. For those asking for evidence:

From the Nets 2005-2006 Tax Statements.

The Smoking Gun


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