Given the 2012 lockout, it should come as no surprise that I’ve spent some time thinking and writing about profitability in hockey over this past year. As various contracts are signed and new developments emerge, I occasionally referred back to those old posts, and it occurred to me that August—the dead of hockey winter—is the perfect time to try and consolidate all of my thinking on this subject into one big post. It’s something I’ve wanted to do for some time; but given recent news around the Minnesota Wild, I finally found myself inspired enough to do some typing.

So, without further ado, I present to you: an English major trying to write about hockey economics. Enjoy!

The cost of doing business v. underlying value

Last week, the Minnesota Wild reported a loss of $30 million during the 2012-2013 season. This figure seemingly verifies predictions made during the 2012 lockout, especially by ownership hawks like Wild owner Craig Leipold, who sought cost certainty even if it would come at the expense of half a season of hockey.

That $30 million number, at a glance, is alarming; the Wild play in an established hockey market, they made the playoffs last year, and they have an intriguing mix of veteran stars and terrific prospects. If even they, in those conditions, can incur such a loss, then were the hardliner owners right to be so gloomy?

But we should be cautious when speaking about snapshot reports, because those reports—looked at in isolation, often released at strategically opportune times, and only presenting a few of the many factors that describe a franchise’s ability to produce value—are, and have long been, the ammunition NHL owners use to negotiate for increasingly favorable terms.

It’s important not to speak only of short term losses without also looking at the underlying value of the investment. To say that a hockey team is only losing money is not unlike buying stock and treating it as a loss because the money is no longer in your bank account. Unless the value of the stock is decreasing too, nobody would refer to your investments as a loss. But it’s become routine for NHL owners to do just that—reporting exclusively on operational costs without also talking about the health of their investment. Perhaps more troubling, some in the media breathlessly report these losses without providing additional context, creating cognitive dissonance with Commissioner Gary Bettman’s own triumphant announcements of soaring league revenues.

While we don’t have access to ownership’s valuations, Forbes does release their own estimates of the value of each NHL franchise. If you remove the outliers from the list—the top and bottom five franchises, which either gained an exorbitant amount of value, saw no growth, or saw losses—your middle 20 franchises increased in value between 1%-16%, or an average of just over 7% on an average value of $235 million. So even if your franchise experiences moderate growth of about 5%, the underlying value of your franchise is increasing by about $12 million year-over-year. As anyone with a sad little RRSP will tell you, a 5% annual return on an investment is nothing to scoff at, and if you can keep your operational costs under that annual return more often than not, you’re not “losing money.”

Which isn’t to say that it isn’t challenging to maintain liquidity. Most businesses with operating costs in the tens of millions are heavily leveraged—which is to say, their owners borrow money to fund costs and bide their time while underlying value builds. And we did just go through an international financial liquidity crisis where no one was able to raise capital. Appreciative value—or the lack thereof—sunk the housing market in 2008. (Though then again, most mortgage owners didn’t go into the transaction knowing that they’d have to cover operational losses through ups and downs, and the bubble that burst was a pretty big one.) It’s a challenge, to be sure—but again, to paint NHL franchise ownership strictly as a money-losing endeavor is to only look at one small aspect of the transaction. That NHL owners were willing to suffer through not one, but two lockouts, should imply that they’re more than willing to take the long view on their investment.

Hockey related revenue v. everything else

So far, we’ve only talked about the cost of owning a franchise contrasted with the value of the franchise itself. But what about other investments that aren’t necessarily hockey related, but are only possible because you own a hockey franchise?

Hockey related revenue became a bit of a dirty word during the lockout, precisely because nobody was able to agree on what it was. Those who own NHL teams are fond of presenting strict operating costs-to-hockey revenue calculations in order to demonstrate how tepid their balance sheets are. The players, rightfully, wanted to look at all of the tangentially related revenue streams in order to understand just how much money the league was making. The owners spent much of the lockout playing a shell game—changing their definitions, or just generally burying figures in mountains of boxes of paperwork.

Think of owning an NHL team as a portfolio of investments. Sure, you own a team, and as a result you can sell tickets, and jerseys and foam fingers, and hot dogs and beer, and you sign a local television deal, or maybe partner up with other businesses for endorsements. All of those things together may not, actually, come close to paying player and staff salaries, operating an arena, chartering flights and paying jet fuel. If you strictly compare the costs of operating a hockey team to the revenue generated, then yes: you might come up with a loss.

But owning a pro sports franchise is not opening a lemonade stand, where you might compare lemons purchased to glasses of lemonade sold. (The lemon in this case is Alex Kovalev.) Does ownership also own neighboring real estate? Once the fixed costs of operating an arena are eaten up by hockey related revenue, what other events are taking place that drive profit? (A cursory look at the Xcel Energy Center’s website shows upcoming concerts by Taylor Swift, Mumford & Sons, Justin Timberlake, Michael Bublé and Blake Shelton.) What sort of tax incentives or public contributions does the team extract from city council? If you own your building you can sell naming rights. My god: parking. Let’s not even talk about what’s happening in Brooklyn.

As you can probably tell, arena ownership is a major factor here. Some NHL owners also own their building; others receive a fee from the city for “operating” the arena (and then sometimes farm that responsibility out to a third party); still others simply pay the owner rent and try to subsist on hockey related revenue alone. (R.I.P. Atlanta Thrashers.)

But the possibilities really are myriad, and not always clear to us. The Maple Leafs (along with the Marlies, Raptors, and Toronto FC) were purchased by two telecommunications and broadcasting giants who now not only own the infrastructure and delivery devices for their services, but the content. It’s possible that if you want to watch Tyler Bozak and David Clarkson hoist the Stanley Cup, you’re going to have to pay Bell and Rogers about five different ways to get it. Therefore, it’s naïve to think that the value of the Maple Leafs should be calculated on the basis of how many tickets they sell and what they charge for beer at the Air Canada Centre.

We have no way of knowing the true value of a portfolio without the owners really opening up their books. But we should remain skeptical when a team talks about operating losses, because the portfolio itself is only made possible through ownership of a pro team. Sometimes that portfolio will lose value because, say, the economy of Arizona is based on real estate and the real estate economy just collapsed. But in most cases, we might assume that a diverse portfolio of interconnected investments is well worth the operating costs of a hockey team.

So…are the Minnesota Wild really losing money?

After all that, the answer is…probably, yeah. The Forbes valuations shows middling growth in 2012 (2%); the amount of debt the Wild are carrying as a percentage of underlying value is ninth highest in the league at 52%; the Xcel Energy Center isn’t owned by the Wild, but by the city of St. Paul (though the Wild do “manage” the space); and the value of the franchise, at least by Forbes’ estimate, is down to $218 million from the $225 million Craig Leipold paid back in 2008. All in all, the team doesn’t seem to have been a terribly solid investment, but then we did just go through a protracted financial crisis which saw the value of boutique investments like sports franchises impacted. Viewed on a 10-20 year timeline, Leipold may yet recoup his investment, assuming of course that he can stomach the operational costs in the meantime. And, of course, we don’t know the other ways Leipold might be leveraging his ownership of the Wild to make money. When I see $30 million in losses, I think either Leipold is inept, or isn’t telling us the whole story.

All of which puts yet another question mark next to the decision to sign not one, but two marquee free agents. Ownership committed to paying obscene bonuses to Ryan Suter and Zach Parise—tens of millions in up-front dollars that couldn’t be prorated in the event of a lockout. Part of the Wild’s losses is bad luck; part is questionable decisions by management, or an inability to leverage their investment in a hockey-mad market. But surely it can’t all be blamed on a broken economic system or player salaries.

How do we solve this?

One could argue that there’s really nothing to solve. Pro sports franchises are long-term investments in which most value isn’t derived until the point of sale. Snapshot reports of operational losses never tell the whole story unless they’re at least presented in relation to changes in underlying value. Malcolm Gladwell has argued that franchise ownership is always a bad business, certainly relative to the other ways you might invest your money, and that billionaire owners should be content to simply enjoy the privilege of owning a pro sports team. Maybe there’s really nothing for us to do but to notice when owners get hysterical about losses and be alert as to what’s happening with the public purse.

Even still, there are genuinely challenged groups: a team like the Islanders, in an aging arena and questionable location, unable to get new real estate development approved and with ownership that can’t bankroll a cap floor team let alone a cap ceiling one, is guaranteed to see stagnation. (See again: Brooklyn.) There are teams who derived no revenues from non-hockey related events because they didn’t own their arenas or weren’t paid to manage the facilities. Obviously Phoenix is a mess. Non-traditional markets like Carolina, Florida, Tampa Bay, and Nashville remain not so much long term investments as looooooooong term investments, more on the order of affecting culture change than anything else.

However, the teams at the top of the revenue list—Toronto (the first NHL team to be valued at $1 billion), New York, Montreal, Vancouver, Detroit, Chicago—are generating such staggering value that even marginal increases in revenue sharing can buoy the bottom five teams.

How should owners conduct themselves?

I’m an Ottawa Senators fan, and my relationship with Eugene Melnyk is a complicated one. He rescued the team in a pre-cap, pre-revenue sharing world, when the team was in bankruptcy and facing a very real, existential threat. He brought some semblance of stability and, for a number of years, kept Ottawa competitive in the salary department.

He also has a tendency to go on sports radio and talk about how desperate the franchise is for money right before season tickets are about to go on sale, or compare Canada to an Eastern European country when he’s pressuring city council to approve the construction of a casino near his land. In Ottawa, many are familiar with his oft-repeated assertion that the Senators need to make it to the second round of the playoffs just to break even. It begs the question: if a team is top ten in attendance (6th overall in 2012-2013) and sets ticket prices right in the middle of the pack (15th in 2011-2012), and still can’t break even without consistently being one of the best eight teams in the league…then who can?

On the one hand, I’m sensitive to the fact that it’s difficult to cover operating expenses in the millions, or tens of millions, especially when it’s difficult to borrow money. On the other, when an owner cries poor, these reports are often, and quite transparently, designed to squeeze more out of a fan base or local politicians. Darryl Katz’s scaremongering exploits in Edmonton are well documented, and have resulted in Edmonton city council committing to cover $542 million (in a city of about 800,000) to construct an arena and surrounding complexes. In bankrupt Detroit, whose urban center is slowly descending into The Road-like conditions, valuable franchises like the Red Wings and Tigers also get public funding for new arenas at a time when public schools are closing and paramedics are asking for used car donations so they can continue to pick up patients.

[Update 7/8/2013: thanks to an anonymous commenter on this post, who provided the following:

“I recommend this article:

http://www.wingingitinmotown.com/2013/7/29/4554706/broke-detroits-bankruptcy-and-its-new-arena-complex for more information on the funding for the Red Wings new arena. The funding for the new arena is not taking away money from public schools or paramedics, and the project should be hugely beneficial to Detroit’s economy in the long run.”

Upon reading further, anonymous is right. The arena is being funded, in part, by Michigan state bonds, and in part by Wings’ ownership’s developer. The money does not come strictly from the city, nor from the public school or health infrastructure funds.

The argument might still be made that this amounts to state-facilitated funding to construct sports and entertainment infrastructure, and one could also argue that if you’re going to put shovel-ready projects on the ground to create jobs that other systems are more deserving, but no one can imply that the Detroit Red Wings’ organization is simply getting a pay-out from money otherwise earmarked for schools or paramedics. That’s too direct a connection to make, and one I should have been careful not to imply in the previous paragraph.

But there’s still a lot of murkiness, both around the numbers and ethically. I think my key takeaway from the article is the following:

“It should be noted that the overall financial picture is still extremely fuzzy. Some outlets report two-thirds public funding, while others report that Ilitch is paying the majority of the cost. The Detroit Downtown Development Authority, according to the Associated Press, has long been allowed to pay Detroit’s general obligation bonds with $12.8 million that otherwise would have gone to schools throughout the state of Michigan. The general picture of the finances that seems to be surfacing is that roughly 44 percent of the funding will be public, and the rest will be paid for by Olympia Entertainment Incorporated, the developer owned by Mike Ilitch.”]

…none of which is really ownership’s fault. They present us with only some of the facts, and it’s up to us—the readers and writers, who care about hockey, and about the cities we live in—to ask questions and spread the word. I have no doubt that some owners are, in fact, losing money. At this moment, Craig Leipold may be one of them. But until we get a little bit of honesty and transparency going—especially after two soul-crushing lockouts—it will be up to us, the fans, to demand the whole story.