Hot Debt-Service Action!

It might seem like this week was yet another week of baseball purgatory, but a huge story came quietly out of the West Coast. Yeah, the Dodgers signed A.J. Pollack, but that’s not really moving the needle. No, I’m referring to the Padres opening an edited version of their books to reporters, a move which doesn’t sound very exciting but could teach us a lot about the dirty business of baseball. The San Diego Union Tribune covered it here, and I highly suggest taking a read through. Former managing editor and all-around good guy Craig Edwards also covered the implications of the finances here, and again, it’s worth a read. While Craig focused on the competitive aspects of the Padres’ spending habits, I have something different in mind. Buried in between useful descriptions of when the team might start spending money were allusions to how much money the team was spending servicing debt.

I’ll stop myself right here- I understand that this is probably pretty boring. As someone with a finance background (I know, I know, boooooooooo), though, I was intrigued. The amount of debt the team was seemingly running was pretty surprising to me, and I resolved right then and there to take a deeper look at what was going on. The Padres’ structure is pretty intriguing; and while it might not be representative of other teams’ books, it also might, and that makes it worth taking a look at in my mind.

Let’s start, as the story more or less does, with the current ownership group’s purchase of the team in 2012. It was a heady time for baseball team purchases- the Padres, at the time, sold for the third-most that any team had ever gone for. This is, again, the San Diego Padres, the team with the worst winning percentage of any current team. If I saw news about this at the time, I’m sure it was just reported as the headline $800 million. The actual deal, however, was far more complex. While the sticker price was indeed 800 bucks (want to fit in in finance? Call a million dollars a buck and a billion a yard), the new ownership group only handed over $400 million in cash. Wait, say what? Was John Moores, the previous owner, having a 50% off sale? There was some weird stuff going on in the background, is what happened. First, Fox Sports San Diego had just paid the Padres a $200 million lump sum as an advance on their upcoming 20-year, $1.4 billion dollar TV deal. As part of the sale, Moores walked away with the cash. That’s quite a nice parting gift, and it served to let the new owners buy into the team with less of their own cash. This move, it should be said, was controversial at the time. MLB had blocked Frank McCourt from executing a similar take-the-advance-and-run move with the Dodgers earlier that year, and it was a surprise when Moores pulled it off. Still, though, that leaves us about $200 million off from the final sale price. As it turns out, you see, Petco Park wasn’t fully paid for at the time of the sale. The Padres, in fact, owed about $190 million in debt on the stadium, in the form of some complicated-ish bonds they had sold to local pension and insurance companies. To sweeten the deal for Moores, the new, Ron Fowler-led ownership group agreed to assume the debt.

If that doesn’t intuitively click for you, think of it this way. Let’s say that you, Johnny Baseballreader, owe the Cardinals 100 dollars, and are trying to sell me, Benny Baseballwriter, a ticket. I agree to pay you 100 dollars for the ticket, but I don’t have any cash on hand, so instead I agree to assume your debt from the Cardinals. You used to owe 100 dollars and have a ticket, now you’re in the clear. I used to have nothing, and now I have a ticket and a 100 dollar debt. Fairsies squaresies. When the Fowler group bought the team, they put up $800 million of value, comprised of $400 million in cash, allowing Moores to walk away with $200 million of the team’s cash on hand, and assuming $200 million in debt. That transaction done, they now owned the team (worth $600 million after the cash was taken out) and owed $200 million. With me so far?

To this point, this is a fairly standard financial transaction. A group of rich people wants to buy something that they aren’t quiiiiiiite rich enough for, so they assume a little debt and sacrifice a little of the asset’s value to pay for it. Maybe the $200 million cash payout from the TV deal was a little on the nose, but you could imagine them giving Moores some other type of payment-in-kind (another, less-valuable sports franchise, or some parking lots around the stadium he could charge the team for, or a small stake in the team) to make up for their shortfall. What’s amazing to me is how little other money the team seems to have.

See, when the Padres talk about their operating expenses, they talk about all the revenue the team makes and then all the expenses they have to pay. The revenue is reasonably straightforward- the team makes money from their TV deal, local attendance, merchandise, revenue sharing, and MLBAM. The team will tell you that they spent 33% of that revenue (which Craig estimates around $240 million) on Major League salaries, 32% between minor league expenses and front office costs, 22% on ballpark and non-baseball expenses, and 9% on debt reduction and interest payments. Astute readers might notice that there’s 4% left, which the team has spent improving Petco Park. It looks, to all outward appearances, like the team is plowing all the money they make on the team back into it, which seems like a somewhat equitable state of affairs, even if you might quibble with the way the money gets split up.

Wait a second, though. There’s something sneaky afoot here! The team essentially took on debt to get a discount on their purchase price. The existing debt, which the team has, has absolutely nothing to do with the day-to-day operation of the Padres. It’s just a fancy financing tool the Fowler group used to allow itself to post a little less cash on day one. If they had another $250 million lying around (the bond covenant had some confusing early-termination make-whole penalties, because finance is dumb and complicated), they could have just given that instead. Again, though, they didn’t have that money lying around. Instead, they’re taking a little money out of the team’s revenue every year to pay off an IOU they incurred six years ago. Frankly, this is some sketchy accounting. Imagine I told you (you’re Johnny Baseballreader, remember?) that I was going to buy a house and put 100% of the money I got from renting it to you into maintaining and improving the house. This seems like a great deal for you, right? 100% of the money you spend on rent goes right back into making the place you live nicer. Joke’s on you, though, Johnny (it usually is when you’re labor and I’m capital). I took out a mortgage that comes to 85% of your rent, and I’m counting that as an expense, so I’m putting 85% of the money you give me into debt service and 15% into actually improving the house. The house doesn’t get much nicer, but as my mortgage gets paid down my asset value sure appreciates.

In essence, this is what the Padres did. They took out a mortgage to buy the team, and they’re writing off team revenue to pay off that mortgage. This is ridiculous on its face, and it’s ridiculous in the details too. The team is claiming it runs a balanced budget, and while that’s technically true, they’re essentially subsidizing their past purchase by under-spending on the team in every year since then.

Some of the other details of the article get into the nitty-gritty of day-to-day operations, and they only underscore how hesitant the ownership group is to put in their own money. When the team wants to spend more than it takes in in a given year, they put out a capital call to the ownership group, which is principally the O’Malley family but also a few other people. Essentially what that means is that the team has a contractual right to get a check from the ownership group when they need to spend more than they take in. They’ve called for $35 million from the ownership group in total over the last six years, and remained notably quiet about how much capital they’ve returned. Thus, the Padres really are spending only what they take in- the owners aren’t chipping in money to run the team at all with the exception of that $35 million. Second, the team has claimed for a while that it wanted to get out from under the debt burden- a burden, remember that was of their own making as a way of getting a discount on the initial purchase. When did they finally pull the trigger and reduce the debt? When MLBAM’s sale gave every team a one-time $50 million gain, the team took the cash on hand and used it to pay down debt.

Look, I’ll be honest with you. When I first read the Union Tribune article, I wanted to agree with the team. It looks, for all intents and purposes, as though they are running the team for no gain. That’s not the right way to think about it, though. In reality, they’ve put 91% of the revenue the team makes back into improving the product, and 9% into enriching themselves via reducing their debt burden. It’s worked! The team is now valued at $1.2 billion according to Forbes, and with the debt substantially reduced the Fowler group could collect most of that free and clear without having to pay much back to their bondholders. It’s an illusion, essentially- using debt-service assumption as an IOU to get the team for cheaper, then claiming paying off their previous IOU as a business expense. Hey, rich people tend to be pretty good at being rich.

That’s basically all I’ve got for you today. Maybe the Padres ownership is full of good people who really don’t understand the machinations I’ve just outlined, and who really want to plow every dollar they earn back into the club in one way or another. I’m skeptical, though. I’m skeptical of the timing of the story (when they had just paid down debt but before taking any cash out of the team) and I’m skeptical of the accounting gymnastics used to make debt-service of bonds they incurred during the purchase part of operating expenses. I’m skeptical of the team citing improvements to the stadium as a benevolent move rather than as the terms of their lease. Mostly, I’m skeptical of billionaires airing their good intentions to the world. Hopefully, not every team in baseball is run like this. Be careful, though, before you believe what ownership says. Billionaires tend to be a self-enriching, self-serving lot. As Alexander Pope said, “we may see the small value God has for riches by the people he gives them to.”