The Business Of Basketball

You could not blame basketball fans for thinking the National Basketball Association is in big trouble. Just look at the news that has dominated the headlines the past several months. Ratings for the NBA Finals between San Antonio and Cleveland hit an all-time low. One of the league’s biggest stars, Kobe Bryant, went public with demands to be traded from the Los Angeles Lakers. A betting scandal involving a referee has scarred the league’s image. Seattle filed a lawsuit against the SuperSonics to prevent the team from leaving town. The scandalous New York Knicks, a vital market for the NBA, have proven to be completely inept both in a court of law and on the court.

But numbers compiled by Forbes tell quite a different story. The value of the typical NBA franchise rose 6% this year, to $372 million, as the Knicks became the first basketball team worth $600 million. NBA teams posted an average profit (in the sense of earnings before interest, taxes, depreciation and amortization) of $9.8 million, on revenues of $119 million. This is the highest income since Forbes began tracking basketball team finances 10 years ago.

The NBA's financial success is a result of three components: a steady increase in gate receipts; bigger TV deals, despite sagging ratings; and a collective bargaining agreement that tightly controls spending on players.
By The Numbers: The NBA's Most Valuable Teams

Ticket sales are not sexy--like streaming basketball games on the Internet or opening up offices in China--but they still pay the bills for teams. The NBA remains a gate-driven league. Gate receipts for the league rose 6% last season to $1.2 billion. At 33% of the league's $3.6 billion in revenue, it represents the NBA's largest revenue stream; national broadcast deals are next up at $1 billion or 28%. Last season, the league set an attendance record with 21.8 million fans, filling arenas to 92% capacity.

TV execs hoped LeBron James' first trip to the NBA Finals would goose falling ratings. But the 2007 Finals, which featured two small-market teams and a four-game sweep, proved to be a ratings disaster. The record-low rating of just 6.2% audience share was 27% lower than the previous year's Finals rating.

Yet two weeks after the Finals wrapped, the NBA and ESPN, ABC and TNT announced an eight-year, $7.4 billion extension to the agreement set to expire after the 2007-2008 season. It was a record both in terms of length and dollars for a national NBA TV deal, representing a 21% monetary increase over the current contract. The networks justified the increased payout by pointing to the value of the digital rights in the agreement. Networks continue to lust after sports programming because sports remain one of the few Tivo-proof options on television.

The NBA has had a salary cap for more than 20 years. It is a soft cap though, and usually exceeded by teams--only two team payrolls are below the cap this season. Starting with the 2001-2002 season, a new system was put in place as a result of a collective bargaining agreement between owners and players. This system rewarded owners who kept spending on players in check. Last season the Charlotte Bobcats and Utah Jazz both went from showing a loss to posting a profit thanks to a $6.3 million check from the league for keeping player spending under control.

One component of the new system is an escrow tax. The escrow tax is designed so that teams only spend 57% of league-wide revenues on player salaries. Last season, players contributed 9%, or $177 million, of their $2 billion salary haul to an escrow account. That money is split between owners and players, so total player salaries and benefits are reduced to 57% of league-wide revenue. Last season, owners divvied up $155 million of the escrow account, while $22 million went back to the players.

The second component of the system is a luxury tax. The luxury tax threshold is proving to be much more important than the salary cap number, as teams are loathe to pay the tax. Teams must pay one dollar in tax for every dollar they spend on players over a certain threshold--last season, it was $65.4 million. The tax is a double-whammy in that tax-paying teams are ineligible to receive distributions from the tax revenues collected. Five teams paid the tax last year, with the Knicks leading the way with a $45 million tax bill. The other four taxpaying teams chipped in $10 million.

The Knicks, like the New York Yankees in baseball, are its league's most valuable franchise, but still managed to post the biggest operating loss in the NBA last year. The reasons are similar: Both teams spend big money on players and are looking to build asset values of their teams as well as media properties. The Knicks spent $166 million on players last season, including luxury taxes, and lost $42 million--the $18.5 million severance for coach Larry Brown didn't help the bottom line either. In contrast, the Chicago Bulls spent $59 million on players and earned a profit of $59 million.

Several former bottom-feeding teams in the NBA saw big gains in our 2007 valuations. The Cavaliers, who rode on LeBron James' back to the NBA Finals, are now worth $455 million, up 20%. The Cavs also gained as a result of a new cable deal with FSN Ohio, worth $25 million a year on average--more than double the old contract. The agreement kicked off last season.

The Toronto Raptors' value jumped 18%, thanks to a surging Canadian dollar and better play on the court, where the team's win total went from 27 to 47. The Golden State Warriors value rose 16% thanks to improved play, and the value of the Orlando Magic increased 14% to $322 now that a new arena for the team has been approved.
(Source forbes.com)