Everything you need to know about what we don't know about the Phillies debt
A primer on the ins and outs of Major League Baseball's debt-service rule, plus the possible factors that could have led the Phillies to violate it.
Everything you need to know about what we don't know about the Phillies debt
UPDATED, 10:47 p.m.: I corrected my math on the Broncos' rate. I had 125 basis points being .125 instead of 1.25.
I'm sure most of you had the same reaction after reading about the Phillies' current noncompliance with Major League Baseball's debt service rule on Friday. I know this because I had the same reaction:
What in the name of Alexander Hamilton does all of this mean?
The short answer is that we don't know. The Phillies are a private company, which means they are not obligated to reveal anything about their finances to the public, even though the public contributed more toward the acquisition of their largest piece of capital ($174 million) than they did ($172 million). When I become President -- I'm not sure where my birth certificate is, but I think I still have a tattered blanket that says "I'm a Lankenau Baby" -- I will push for a federal law that requires any company that receives significant public money to open its books. But that's another blog post for another day. We agreed to give them their printing press, and they can do whatever they want with it. Except host a Common concert. That probably wouldn't fly.
Rather than focus on what we don't know, let's answer some of the questions that we do know:
1) What is the debt rule?
The debt rule was included in the 2002 Collective Bargaining Agreement. During those negotiations, folks on both sides of the table thought there was a possibility of a work stoppage, and there was some concern in the league office that such a stoppage would prevent debt-laden owners from making their bank payments. And nobody wanted to see a day where the National League Central title was won by the Cayman Island Cubs. In an attempt to prevent franchises from leveraging themselves to the points where they were both succeptible to drastic shifts in the economy and unable to use the threat of a working stoppage as bargaining power (and, from the union's perspective, unable to maintain competitive payroll), the league and MLBPA unveiled the debt rule. Given the events that have unfolded in the eight years since, the move appears to have been a prescient one.
Essentially, the rule ties the amount of debt a team may carry to its average net income (revenue minus expenses) over the previous two fiscal years. The limit for most teams is 10 times their net income. The limit for teams who have opened stadiums in the previous 10 years, like the Phillies, is 15 times their net income.
So for every million dollars of net income the Phillies average, they can carry $15 million worth of debt. If their net income over the last two years averaged $10 million, they would be allowed to carry $150 million in debt. And so on.
2) But the Phillies are the ballers of the National League. They could make it rain over the entire Delaware Valley if they wanted to. David Montgomery keeps chlorinated water in a tank in his back yard and instead fills the pool with $1,000 dollar bills. Right?
Well, sort of. Without a doubt, the Phillies are one of the richest teams in the league. You need only look at their payroll, which figures to finish over $170 million. But that is really the only solid indicator we have of the profit the club has made over the past few seasons. Forbes, the business magazine, does an admirable job of attempting to fill in the blanks in their annual franchise valuations. But those numbers are hardly gospel. Some teams provide significant help to Forbes' researchers. In 2009, Forbes reported the Pirates having $144 million in revenue the pervious season. Official team financial documents obtained by Deadspin.com reported about $146 million in revenue. That same year, Forbes pegged the Marlins at $139 million, which was the same number contained in the documents that Jeffrey Loria so graciously allowed Deadspin to view.
On the other hand, there are some owners who would regard living in a fortified compound without running water as keeping a high profile. And since Team Six apparently had its hands full the last few years, you can probably guess which camp the Phillies' phantom ownership falls into.
But for illustration's sake, let's assume that Forbes' estimate of the Phillies average annual net income in 2009 and 2010 -- $11.7 million -- is in the ballpark.
That would provide the Phillies with a debt ceiling of $175.5 million. Except MLB does not count the first X million of debt toward the total debt. In 2007, the first $36.5 million of debt did not count against the Total Debt. The number rises each year based on the growth in league revenue. So the Phillies debt ceiling, under the current illustration, would probably be closer to $225 million and perhaps even more.
3) Well, The Phillies have right around $225 million tied up in guaranteed contracts over the next few seasons. So that explains it, right?
Actually, player contracts are not considered debt under the CBA. Even if the league had wanted them to be classified at debt, the player's association never would have allowed it. So, yes, the Phillies have about $212.45 million in contractual obligations beyond this season. But that money does not factor into their debt load.
4) So what debt could they be carrying?
The Phillies current ownership paid $30 million for the team way back in 1981. I'm no Lenny Dykstra, but I'd say that's a pretty good investment. Sure, they could have dropped out of college and started a software company in their parents' garage. But just because Bill Gates thinks you are a sucker doesn't mean you aren't in a better position than a lot of professional sports franchises. And the Phillies are. Because they own their team outright. They are not forced to pay a huge chunk of their resources to bankers just to keep possession of the team. That's important (so much so that we'll double back on it later). Any of the debt they currently hold is directly involved in the operation of the team.
What might that debt be?
The CBA classifies debt in six categories:
- Funding from MLB's industry credit facility
- Other third-party debt
- Deferred compensation owed to anybody other than players
- Stadium-related debt incurred for or in connection with ballpark construction or improvements
- Loans and advances collateralized by assets of the club
- Any other debt that would normally be classified as indebtedness
5) Stadium Debt: At least $50 million
We'll start here because it is a big obligation we know the team has. In the spring of 2002, two years before Citizens Bank Park opened, the Phillies closed on a $125 million loan to fund their most of their portion of the construction costs. We don't know the terms of the loan, but we can get a pretty good idea judging by other loans given out by the same company to stadium-building teams, as well as David Montgomery's claim in a 2004 newspaper article that the annual payment is "under $10 million. The loan probably covered a term of 10 or 15 years with a rate tied to the LIBOR average (a rate set by London Interbank that other bankers use when borrowing money). For example, when the Broncos took out a loan on Invesco field, they received a rate that started at the LIBOR average plus 125 basis points, then rose after five years to the LIBOR average plus 135 basis points. Usually the LIBOR number is fixed for a period (five years, in this case), then adjustable for the remainder of the loan.
In banking lingo, a "basis point" is equal to 1/100th of a percent. So 125 basis points would be 1.25, meaning if the six-month LIBOR average was 3.5, the Broncos would be paying 4.75 percent.
The six-month LIBOR was a fantastic 1.948 percent in June of 2002. There's a good chance the Phillies got a deal similar to the Broncos, except over 15 years, which is the term the Tigers got from the same company. But because all of this is a guess at this point, and because Montgomery said the yearly payment was under $10 mil, let's just put it at $9.7 million per year to the bank. Now, those are pretty favorable terms. And when you consider that the LIBOR average currently sits at about 0.4, and the Phillies' rate likely began to vary at some point, they could be even more favorable now than they were then. Of course, there is a chance that five years into the loan, when rates had ballooned into the 5.0's thanks to the housing bubble, the Phillies were able to exercise a rate swap in which they locked in a specific rate for the rest of the loan. Which, in hindsight, would have been the wrong thing to do. But whatever the terms, we can safety estimate that the Phillies have at least $50 million remaining on the stadium. There is a good chance that is higher. But again, we jus' illustratin'.
6) Funding from MLB's Credit Facility: Up to $75 million
The league office oversees all facets of the game. But it also acts as a sort of central bank for the clubs, thanks to a credit line that is backed by national television contracts. At the time Citizens Bank Park was built, each club had a revolving account with the league that was capped at $50 million. The interest rates are better than they can get on the open market. Thanks to growth in league-wide revenue, each team's credit limit is believed to be $75 million.
7) Loans and advances collateralized by assets of the club: $Unknown
We don't know whether the Phillies have taken out any more significant loans. But if you think about it, there's a good chance they were forced to after Citizens Bank Park opened. Think about it: They likely maxed out their $50 million credit line from MLB to pair with their $120 million LIBOR loan, giving them $170 million of the $172 million they needed to finance Citizens Bank Park.
The first-year revenue boom they experienced was enough to support a payroll that had risen from about $57.96 million in 2002 to $93.22 million in 2004. But attendance dropped significantly in 2005, from 3.25 million paid in the first year the ballpark was open to 2.67 million paid the following season. But payroll did not drop. In fact, it rose to over $95 million. The Phillies also moved the left field wall back five feet after the 2005 season.
So it is not out of the realm of possibility that the Phillies took out a significant loan from a third-party lender to help operate the club during the early years. That is not a unique occurence among professional sports franchises. But if they took out a $100 million loan or credit line in 2005 or 2006, they would probably still have a good chunk of it to pay off.
8) I just wasted half my life reading this blog post. And all I want to know is, will Citizens Bank Park still be there tomorrow, or will the Phillies be playing half-ball in the Jetro Lot?
Here is where we get back to our original point, which is that the franchise itself is paid off.
Current ownership bought the team for 30 million on 1981, so they shouldn't have any real debt in terms of financing the squad.That seems to be what has dragged down clubs like the Dodgers and the Cubs. Fred Wilpon bought the remaining 50 percent of the Mets for $135 million in 2002, plus he is on the hook for $850 million plus interest in bond payments to the city of New York for Citi Field
Frank McCourt paid $450 million to Rupert Murdoch for controlling interest in the Dodgers in 2004.
Tom Rickets paid $900 million for the Cubs and other assets in October of 2009.
The Marlins' problem is obvious.
Those six teams could concern the league. But the Phillies could very well represent a momentary hiccup, along with a couple of other clubs that made the List of Nine. The Tigers are Mike Ilitch's personal money pit, but the guy is a multi-billionaire. They and the Orioles are probably in the same category as the Phillies, momentarily in violation of debt rules but of no real concern.
Think about it: the Phillies guaranteed Cliff Lee $120 million this offseason and they guaranteed Ryan Howard $125 million last season. David Montgomery went to Wharton and worked his way into the Phillies' partnership. Jaywalking is a risk he might take. Leveraging his team to the point where it presents a serious problem, or causes a drastic shift in personnel spending? Hard to believe, Harry.
More likely, the Phillies ended up locking themselves into just enough short term debt that it put them over the line. But there is smart debt and there is dumb debt. The Phillies spent $10 million on a new scoreboard this offseason, and that $10 million might have been funded by one of their various lines of credit. But the scoreboard is something that should ideally pay for itself in the long run: Have you seen the signage on the thing? So it counts as debt right now, even though it is a revenue stream. That's a lot different than using the $10 million to stock the executive wash room with toilet paper made out of hundred dollar bills. The Phillies also signed Charlie Manuel and Ruben Amaro Jr. to multi-year contracts this offseason. The way I read the CBA, those contracts count as debt. Between the scoreboard and contracts, there's at least $15 million potential dollars in debt, effectively lowering their ceiling by a million bucks.
But as we noted in the beginning, all of this is an approximation of a situation. Judging by that approximation, you should not be concerned about the Phillies' debt problems preventing adding a hitter at the trade deadline. Even if they added or subtracted a $5 million salary, it wouldn't have much of an impact on their compliance with the debt rule.
But don't worry. If you show up to South Philly tomorrow and see Citizens Bank Park fading into the disatance on the back of a bank-owned flatbed, I will retract this entire post.
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