Diamond Dollars: The Economics of Winning in Baseball (Part 2)

One strategy that has the potential to shift the marginal revenue curve to a higher level is the team-owned regional sports network (RSN). Of the 12 teams linked to an RSN, four are among the wealthiest teams (Yankees, Mets, Red Sox, and Cubs), and another four are in the top half of the MLB economic food chain (Orioles, Phillies, White Sox, and Indians). The Royals are the only team among the true have-nots to have an RSN. (The Royals have announced their intention to exit the RSN business in favor of a contract with Fox Sports Midwest, beginning in 2008) (See Figure 1)

In a classic case of the rich getting richer, teams endowed with a strong economic base are venturing into the broadcast business to further enhance their economic prowess. I don’t think it’s an overstatement to say that RSNs are re-writing the economics of MLB teams.

Figure 1 - Regional Sports Networks
NETWORK                            TEAM AFFILIATION
New England Sports Network (NESN)  Red Sox    
Mid-Atlantic Sports Network (MASN) Orioles, Nationals
YES Network                        Yankees
Rogers Sports Network              Blue Jays
Turner Broadcast Station (TBS)     Braves
Comcast SportsNet Philadelphia     Phillies
Comcast SportsNet Chicago          White Sox, Cubs
Royals Sports Television Network   Royals
SportsNet NY                       Mets
Sportstime Ohio (STO)              Indians
WGN                                Cubs

How has the RSN altered a team’s link between winning and broadcast revenues? The traditional approach has been for teams to sell their broadcast rights to a regional Fox Sports affiliate (or their competitor) in exchange for a rights fee. These contracts are generally multiyear, for a fixed amount of dollars over the life of the agreement, with some “bonus” provisions for the team reaching the postseason or other on-field success.

The broadcast company—we’ll call it Fox Sports North (FSN)—pays a rights fee to the team and sells the advertising time on team telecasts to consumer marketers. FSN figures that if the team wins (e.g., reaches the postseason), there will be greater fan interest, leading to higher ratings and more viewers. As a result they will be able sell advertising at higher rates and pass some of the increase back to the team in the form of a bonus. FSN is not willing to give up the entire upside resulting from an exciting playoff chase, since they are bearing a financial risk with a fixed rights fee. If the team plunges into the cellar and no one watches their games, FSN is still on the hook to pay the team the fixed fee.

The alternative broadcast arrangement that is gaining in popularity over the last several years is the team-owned regional sports network. RSNs have rewritten the economic rules of the game by giving team ownership a more direct vehicle to monetize fan demand. Understanding how revenues flow through the RSN when a team’s on-field performance varies is more complicated.

Under this scenario, the RSN gets subscription fees from cable distributors and satellite providers to “buy” their channel and carry it on their delivery system. The RSN then sells advertising time on telecasts for a second revenue stream. While this may not sound much different than the way in which a Fox Sports affiliate would operate, the big difference is the team owns all or a large portion of the RSN. As a result, this arrangement places teams in the broadcasting business, with an equity position in any value created in the broadcast entity.

To determine the impact of a team’s on-field performance on broadcast revenues we need to account for the ownership structure of the RSN. To the extent the team (or team owners), has an ownership stake in the RSN, we can “impute” a share of the profits to the team, as if the team and the RSN were two divisions of the same company. We’ll call this “creating transparency” regarding the ownership structure of the RSN.

For example, the Boston Red Sox have an 80% ownership stake in the New England Sports Network (NESN), their RSN. In addition to the rights fee NESN pays the Red Sox for the right to broadcast games, by imputing a portion of NESN’s profitability to the Red Sox, we can better understand their underlying economic payoff to win games. We could not accurately assess the Red Sox true financial gains from improving the team, if artificial partitions blocked the flow of this important revenue stream.

In addition to their rights fees, which show up on the Red Sox financial statements, we may need to add another $10 to $12 million for the Red Sox share of NESN profits. It is critical to include the full value of the broadcast relationship when measuring the value of a win. The Red Sox share of NESN’s profits could mean an extra half-million to million dollars per win over key segments of the Red Sox win-curve.

Another way in which RSNs alter the win-revenue relationship is by creating asset value in a broadcast network. In addition to the revenue impact, the team maintains an equity stake in a network (either directly or indirectly) and bears the risk and reward of the valuation of the network as an asset for potential future resale. Depending on the size of the market and popularity of the team, the Fox Sports-type arrangement would net a team a steady revenue stream of anywhere from $5 million to $50 million in straight rights fees.

With an RSN a team has a variable revenue flow that is more closely linked to their on-field performance and their popularity and an asset that can be worth anywhere from $100 million for the newest upstart RSNs to nearly $2 billion for the mega-RSNs like the YES Network. This asset value rises and falls with broadcast ratings and advertising and distribution fees, which can be greatly affected by a team’s wins and losses.

This broadcast arrangement impacts the business of baseball in at least four ways:

  • RSNs provide a more direct connection between winning and broadcast revenues. In contrast to the traditional broadcast model, where a team is generally paid a fixed rights fee, regardless of their win-loss record, thereby disconnecting broadcast revenues from the team’s on-field performance, teams with RSNs get immediate financial feedback. Since ratings, and therefore advertising revenue, rise and fall with on-field performance, team-owned networks participate directly in the revenue stream that winning or losing generates. In a sense, RSNs raise the stakes of winning and losing for an MLB team.
  • RSNs are a team marketer’s dream, as they provide a unique vehicle for marketing the team and building its brand. Instead of selling only telecasts to an independent network, teams with RSNs can inundate their fans with team-related entertainment and brand-building propaganda, all rolled into one programming schedule. Does the Yankeeography of Derek Jeter entertain viewers, or tout his marquee value and build the Yankees brand in the eyes of fans? The answer is “yes” to both questions.
  • Until MLB changes the way in which it treats “related party transactions,” teams with RSNs may get a break on their revenue-sharing payments. The new Collective Bargaining Agreement (CBA) is thought to contain provisions which may prevent a team from receiving an artificially low rights fee, reducing their revenue sharing contribution while they rake in the cash in their RSN. This issue will likely get solved soon, and even if it does not, it ranks among the least important ways in which RSNs are changing the economic face of baseball.
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  • The most important role the RSN plays is to be an additional vehicle for a team to create financial value, thereby dramatically altering the economics of owning and operating a big league club. RSNs represent an additional separate asset of significant tangible value, while still being intertwined in nearly every way, with the team. In the same way companies create value by entering into businesses that have synergies with their core business, teams have branched out into the broadcasting arena.

    A successful RSN can generate more financial value for a team by turning one of the team’s assets—its broadcast rights—into a full-fledged operating business. This strategy creates value because there are true synergies between the team and the RSN and because an MLB teams’ broadcast rights are a substantial enough product to form the basis of an entire network. The RSN also creates an additional option for liquidity. A team can build up the RSN, and then sell it, reaping its value, while still owning the team, or vice versa. In many ways, the RSN is a brilliantly conceived brand extension of an MLB franchise.

The ultimate payoff for launching an operating a successful RSN is the creation of an asset that can be of equal or greater value than the team itself. Valued at 10 to 12 times profits, or five times revenue, an RSN could achieve a valuation of several hundred million dollars or more for a mid-market team after just several years of operation. Let’s use the St. Louis Cardinals, fresh off their 2006 World Championship, as an example. Cardinals telecasts are currently seen on Fox Sports Net Midwest (FSNM), with distribution into about 4.3 million homes, via satellite and cable, in six states.

If the Cardinals were to start their own RSN, when the current FSNM agreement expires, by charging cable and satellite operators a modest $1.50 per month, they could generate a potential of $75 million or more in annual fees. In addition, a conservative estimate of the ratings of a 90-win Cardinal team could lead to another $15 million in advertising revenue. A $90-million-annual-revenue RSN, owned by the Cardinals has the potential to be valued at about $450 million. As long as the network’s operations could cover the current FSNM rights fee to the Cardinals and turn a normal profit, the Cardinals would have a new asset, which they could factor into their win-curve.

Since the RSN’s asset value would rise and fall with the team’s on-field success, I estimate the RSN could add as much as 50% to the value of a win in the “sweet spot”—the 85- to 95-win range. Over that range a five-win improvement could generate an additional $7 million, allowing a team like the Cardinals to justify competing for top dollar free agents.

So what is the downside of a team choosing to go the RSN route instead of selling the rights to a Fox Sports-type of affiliate? Why doesn’t every team do this? If a team is in a small market, or its team lacks the popularity and ratings to achieve some critical mass level, they may not have enough clout to secure distribution agreements with cable operators for the subscription fees that ultimately make the math work for the team.

If the Pittsburgh Pirates, coming off consecutive 67-win seasons, tried to charge a $1.50 per month subscription fee to carry a Pirates-owned sports network, cable operators might say, “No thanks.” Even if cable operators went with the plan, but offered the channel only as a premium channel to its customers, how many Pirates fans would pay to see their games on television?

If the distribution into households is too low, there would not be much appeal to advertisers, cutting into an important portion of the revenue stream of the RSN. It adds up to a lot of risk to bear for a small market, historically weak-performing team. As a general rule of thumb, if it’s a great challenge to sell tickets to games, it will be an even bigger challenge to sell your own RSN to cable operators and advertisers.

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