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The $680 million question....

So, Jim Crane and Drayton McLane have reached agreement on a purchase price for the Astros. The reported $680 million purchase price is considerably more than Forbes' magazine's 2011 estimate of the the team's value: $474 million. So, the natural question is "why is the sales price so high?" Or even, as David implied in his open letter yesterday, "why did Crane overpay by about half?" As for the latter question, I don't think we have adequate information to say that Crane overpaid to buy the team, particularly since the Forbes' valuation is just one person's opinion based upon information of uncertain accuracy.

But $680 million does seem like a lot of money for a mid-market baseball team. And Drayton McLane has done very well on his investment. Reportedly, McLane will get paid an additional $93 million for his stake in the Comcast broadcasting venture, which raises his proceeds to $770 million, a figure that is relatively close to the $800 million asking price reported last year. McLane purchased the Astros in 1993 for $103 million.

Forbes last year declared that the Texas Rangers' sale during bankruptcy, with the price reflecting a $593 million enterprise value, was "an all time high valuation for a major league baseball team." Crane's purchase of the Astros is even higher than that former record valuation.

Sure, Forbes estimated a healthy 5% growth in the Astros' value this year, and projects an annual 8% growth in the team's value. But still the gap between the Astros' sales price and Forbes' valuation is sizeable. Let's take a quick review of the possible reasons that the sales price exceeds the Forbes valuation of the Astros.

We can start off with the fact that a very limited number of baseball teams exist, and only a handful are available for sale every decade. And there seems to be a bigger pool of potential buyers who really want to own a baseball team. Jim Crane's history, with unsuccessful efforts to buy the Cubs and Rangers, provides an example of one such buyer.


It also appears that recent MLB team sales have involved higher price tags than the Forbes valuation at the time. The team sales during the last three years typically exceeded the Forbes value by around 20% . The Rangers' enterprise value established in the bankruptcy bidding is 25% higher than Forbes' estimate of the team's value at the time. In another recent example, the Padres sold for almost 20% more than the Forbes value. A 2007 Hardball Times article examined all of the club sales between 1993 and 2006 and found that the average variance between the Forbes valuation and a team's sales price was 20%. (That's not to say the variance is always higher or lower--for example, the Angels sold for 31% lower than the Forbes valuation in the early 90's.) Drayton McLane paid 18% more than the Forbes valuation of the Astros in 1993. According to the same HT article, the Forbes' undervaluation of the Red Sox sale was spectacular, and (it turns out) very similar in magnitude to the the current Astros' sale.

The Forbes' valuations are based on applying multipliers to estimates of team revenues. However, team revenues, largely speaking, are not publicly available. Forbes seeks information from the teams, but the degree of cooperation is spotty. Forbes may use reasonably close estimates of team revenues, but the HT article finds some evidence that the variance between estimated and actual revenues may be 10% - 15%---differences which could produce an even larger percentage differential in the valuations. Other monetary impacts, like federal tax benefits specific to the buyer, also can't be incorporated into the Forbes valuation.

Although the Astros' on-field product seems to be depressed right now, I think that has less impact on the purchase price than many fans think. For example, the Rays' franchise seems to be in better shape than the Astros, in terms of field talent, having produced winning teams over the last three years and enjoying a good farm system. Yet the Rays are 28th--only above the Pirates and A's--in the Forbes' valuation. The Rays' sub-par stadium and low attendance offsets the admirable quality of their major and minor league talent. The Astros have a good ballpark and a market which would respond well to winning.

Regional Sports Network

At yesterday's press conference, Jim Crane mentioned the Houston market and the regional sports network (RSN) as economically appealing reasons to like the Astros. Those are both good points. But I will focus on the RSN, because I think it may the biggest factor in producing a sale price higher than the Forbes valuation. The Astros and Rockets have parted ways with Fox Sports Houston for future live coverage, and created a jointly owned regional sports network with Comcast. The Astros' RSN will take over live televised broadcasts of Astros' games in 2013. Forbes doesn't include the value of the RSN in its estimates.

In the case of the Texas Rangers, that team's billion dollar broadcast deal with Fox Sports Southwest was not negotiated until several months after the team's sale. One could guess that the higher broadcast revenues from the Fox contract might have produced a substantial bump in the Rangers' sales price if the contract had been in place earlier. If the extension of the Fox Southwest contract were added to the Rangers' sales price, the 15% gap between the Rangers' and Astros' sales price would be considerably smaller.

Another 2007 Hardball Times article discusses the economics impact of a RSN on a baseball team:

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.

The range of RSN asset values could account for most, if not all, of the difference between the Forbes value and the Astros' sales price. We have talked about the pros and cons of the Astros RSN at TCB in the past, and not everyone thinks it is a good idea. But, in terms of the sale price, the critical issue is what Crane's group thinks they can get out of the RSN. In a corporate takeover, the acquistion group tries to identify activities which they believe they can operate more efficiently or profitably than the current business. The Astros' RSN provides a mechanism for the new owners to increase revenues if they can boost fan interest in the team.

The Astros' RSN involves some risk, but higher rewards usually require higher risk. Some small market teams (Twins and Royals) which attempted to create RSNs were unsuccessful and retreated to the conventional Fox broadcast contract. In the case of the Twins, the team's RSN was unable to secure sufficient distribution rights from cable and satellite systems in Minnesota--the kind of "worst case" that concerned some Astros' fans. However, Crane's group probably looks at the RSN as an opportunity for success if they can improve the level of fan interest.

This has some interesting implications for the possible strategies that Crane's baseball operations personnel may pursue. The HT article estimates that the value of a win (i.e., adding 1 win to the team's W/L record) could increase by 50% due to the existence of a team owned RSN. The RSN provides a more direct and immediate connection between a team's win-loss record and profits. The existence of the RSN creates a significant incentive for management to improve the team's win-loss record. Also, the article notes that "RSNs are a team marketer’s dream, as they provide a unique vehicle for marketing the team and building its brand."

Wait and See

I know that some fans have wondered whether the high price that the Crane group paid for the Astros will leave the owners strapped to come up with increased funds to improve the team. That's a fair question. And I don't know the answer. However, I have to assume that the new owners have prepared detailed studies which leads them to believe that they will have adequate resources to build a winning team. Crane said that at his press conference. We can only wait and see.

Another issue to watch is the amount of debt that Crane's group will require to finance the purchase. The author of the Forbes' valuations recently expressed concern over the possibility that the Astros' purchase will be financed by $300 million of debt. He urged MLB to examine the issue closely before approving the sale. Given the recent financial problems associated with Hicks' Rangers, the Wilpon's Mets, and the McCourt's Dodgers, keep an eye on this issue. Right now we don't have enough information to reach any conclusions.