On Wednesday, Forbes released its annual “The Business of Baseball” report, which illustrates how well—or, in some cases, how poorly—the 30 Major League Baseball teams performed financially in 2011. There’s a lot to absorb within the piece, but for Indians fans there’s one thing that is sure to stand out first and foremost above all others.
On their MLB valuations table, you can see that the Indians currently rank as the 26th-most valuable franchise in Major League Baseball. This isn’t all that surprising given the current landscape of the game. As expected the big market franchises rank near the top of the list led by the Yankees, Dodgers, Red Sox, Cubs, and Phillies in that order.
The surprise comes is when you sort the list according to operating income, highest to lowest. The Indians soar to the top of the food chain, ultimately leaving fans with one and only one question on their minds: “Huh?”
The gut reaction for many Tribe fans is probably to question how a team that earned an MLB-high $30.1 million in 2011 can operate on such a shoestring budget. Well, before everyone gets all up in arms over this, I can assure you that there is a reasonable explanation. Allow me to put my M.B.A. in Finance to use for the first time in four years to explain what’s going on.
Warning: It’s about to get super nerdy up in here.
Yes, the Indians earned $30.1 million in 2011 through their operations, more than anyone else in baseball. However, that doesn’t mean they turned in a profit of $30.1 million. And it definitely doesn’t mean they had $30.1 million free to spend this offseason.
Firstly, the Indians probably didn’t expect to earn $30.1 million in operating income last year. That figure is inflated by the jump in attendance from the Tribe being a surprise contender and the acquisition of Jim Thome for the late-season push. More butts in the seats means more ticket revenue as well as higher concessions and merchandise sales, more sponsorship, etc.
Also, given Cleveland’s recent fluctuations from contender to pretender on an almost yearly basis, the team can’t afford to go nuts when it comes to spending. Just because the Indians did well last season doesn’t necessarily mean they’ll be successful in 2012. They lack the sort of consistency we’ve seen from the Yankees, Red Sox, and Phillies and there is no guarentee of a repeat financial performance in 2012. They could fall out of contention by mid-May and suffer huge financial losses.
The Yankees, Dodgers, Red Sox, Cubs and Phillies can be more frivolous because their attendance numbers and revenue streams probably don’t fluctuate as much year-to-year. They also have greater overall franchise values to fall back on or they can adjust operating expenses in order to improve their net incomes. (As you can see from Forbes‘ list, the Indians ranked near the bottom in both value and revenue in 2011, despite showing a 16 percent improvement from 2010).
But regardless of the Dolans’ original plans the Indians now have $30.1 million to spend on players, right? Not so fast. Operating income is not profit. I repeat: operating income is not profit.
The $30.1 million figure does not represent the team’s true net income (profit) once everything is said and done. All this really means is that the Indians made more money than anyone once you remove their operating expenses from their sales revenue. That’s the first step towards calculating profit, but we still need to take it a few steps further before we can really see how well the Indians are doing financially.
A good example of what I am talking about can be seen in the statement of operations in the 1998 annual report for the Cleveland Indians.* In the statement of operations you can see that the operating income, denoted by the red arrow, does not equal the net income for each given time period. In 1996 and 1997 net income was substantially higher than operating income. In the first half of 1998, the team suffered a net loss of -$9,658,000. During the second half of 1998, its operating income ($22,152,000) was almost $15 million higher than its net income ($7,158,000).
*Dick Jacobs decided to take the team public in 1998 and issued 4 million shares of stock at $15 per share. This was revolutionary at the time. The Indians became the first publicly traded team in Major League Baseball and it netted them an additional $60 million dollars from doing nothing but issuing some collectable stock certificates. It also meant they had to follow strict guidelines set forth by the Securities and Exchange Commission and the National Association of Securities Dealers since they would be listed on NASDAQ. Among these guidelines was releasing quarterly and annual reports to shareholders and the public just like any other publicly traded company. In 2000, the team was sold to a private investor (Larry Dolan) and shareholders tendered their shares back to the team at a price of $22.61 per share in a structured cash out merger.
Where does the discrepancy come from? First, any non-operating income and expenses need to be added in. These include things like interest income from investments and gains or losses accumulated during player transactions. Once those are taken into account, you have the earnings before interest and taxes, or EBIT.
Once EBIT is calculated, the net difference of interest expenses versus interest income is added or subtracted. This final figure provides you with what is considered “net income.” A positive net income is profit, whereas a negative net income would be a loss. Depending on how well the Indians performed with their investments and the amount of taxes paid, their net income for 2011 could be higher than the $30.1 million figure reported by Forbes or it could be significantly lower. We don’t know.
The 1998 annual report illustrates this quite well. During the Dick Jacobs era, the Indians had years where they generated a rather large profit and years where things didn’t go so well. Keep in mind that was also more than a decade ago. The economic climate for both the United States and Major League Baseball has changed substantially over that period of time. In addition, ownership of the Indians has also changed since this report was released. The current ownership goes about things differently, and I’m sure that includes accounting practices, investment strategies, and other financial decisions.
In other words, the fact that the Indians had the highest operating income in baseball does not mean that fans should jump all over the Dolans for their perceived lack of spending. We don’t know the state of the team’s current investments and we don’t know how much they had to pay in federal and state taxes. They also make their home in Ohio, one of the least tax-friendly states for big businesses. Simply put, there are a lot of variable factors in play here about which the Indians—a privately owned company—have no obligation to divulge details.
Building a strong and reputable brand off the field is essential for MLB teams, just like it is in any other industry. This is something the Indians haven’t been able to do in recent years, but they are showing signs of improvement. Just don’t think Forbes‘ numbers mean that the Dolans pocketed $30 million.