A few days ago a commenter (and friend) wrote a response to the post regarding the $2 billion sale of the Los Angeles Clippers. Analyzing the sale, I felt that it may have been excessive, given that the Clippers revenues for the last year were $164.9 million. The $2 billion price tag was 12 times yearly revenues and no professional sports franchise had ever sold for more than six times yearly revenues before. Because of this, and other NBA franchise sales in recent years, I floated the notion that we may be seeing a bubble of some kind in the valuation of NBA franchises. The commenter (and friend) countered with the above chart, which shows that, for S&P 500 companies, a price-to-earnings ratio of 12-to-one is average, even low. In fact the current S&P ratio as I type is figured to be 19.17, far higher than 12. The implications of this are that, in comparison, the Clippers were not sold at an outrageously high price and the market rate for NBA franchises is more or less reasonable.
Before going any further, I should clarify what I meant in using the word bubble. In this case, I used it to refer to an asset that the market temporarily overvalues, which, in time, will regress (it’s not a bubble if it doesn’t burst). Bubbles in the technology industry in the late 90s, and the housing market in the late 2000s are what many experts consider to be the primary causes of the last two recessions. What occurred in such situations was an aggressive buying of technology stocks and mortgages, people believed the value of both would rise and had no problem risking their finances on a product they thought would only make them rich. The crashes came when the market corrected itself, and suddenly all the assets everyone thought would be worth a lot turned out to be worth very little. They were insufficiently insured against this contingency and overexposed. While the primary effects were felt at the highest levels (big banks, big hedge funds), it created a ripple effect. Credit became much harder to get, holding up both small and big business in a variety of sectors, and ordinary investors exposed in the stock and real estate markets felt the pain as well. Houses were mortgaged upon, retirement accounts and college funds lost their value.
This is not at all to say that a bubble in the value of NBA franchises will have any of these consequences. The NBA is a relatively small market at $4.6 billion last year (per Forbes). A decline in the value of teams will not mean much for the broader economy. Owners, especially someone like Steve Ballmer who just shelled out so much for the Clippers, will get hurt, and players/league personnel will lose out some as well, but probably not enough to threaten the solvency of the league in a significant way. Overall, the league appears poised for, at least, moderate growth in the next five years. The forthcoming TV deal will be more lucrative than the last one and the sport enjoys growing primacy both internationally and in the U.S.
While the commenter was right to question the notion that a 12 price-to-earnings ratio is excessive, the S&P 500 P/E comparison doesn’t quite hold up. For perspective, the total value of S&P 500 companies is pegged at over $15 trillion (per CNBC more than one year ago). Comparing their P/E to the NBA’s is apples and oranges. While it’s significant that the market for the U.S.’s largest companies sits at this level, they are the largest companies for a reason. Many of them have demonstrated longevity and all of them are hugely valuable. Investors are more comfortable paying more for what’s established and/or endured over multiple generations. The NBA does not have this pedigree, in fact many teams lose money, even with revenue sharing.
But despite the numbers, Ballmer may have still made an excellent purchase, one that will bear a great deal of fruit for him in the coming years. Just 30 years ago, NBA revenues were $118 million (also via Forbes), so there is a precedent of huge growth in a pretty short time. With the growing power of Netflix, Hulu, and illegal streaming, content-based TV is being overwhelmed with cheaper viewing alternatives and cable faces an uncertain future. Live sports are one of the few programming options that has demonstrated itself to be immune to this trend. When people watch sports they want to see them as they’re happening, and thus far illegal/legal streaming services have not been able to provide this regularly enough. The new TV deal should rake in a lot for everyone across the league. This, combined with the fact that the Clippers are in one of the largest markets in the world, gives them the ability to project themselves to an international audience as well as domestic. Furthermore, they have a great team. The Lakers were awful last year and next year doesn’t look too much better. For the first time, the Clippers are really good. They have two studs in Chris Paul and Blake Griffin, an interesting young player in DeAndre Jordan, and a great coach in Doc Rivers. Last but not least, Donald Sterling’s ouster brought a lot of attention to the team, all of it bad on him, but with new ownership fans will be drawn to the group that fought through such real adversity. That’s a compelling narrative, especially since they have a real chance of winning a championship.
When I was commenting on the sale, more than anything I was intrigued by the fact that selling a team for 12 times its revenues was unprecedented in sports, double the ratio for any other team in recorded history (per Bank of America people). Perhaps it indicates a new paradigm in the NBA (and maybe other sports), perhaps it’s an overvaluation. Who knows? The tough thing about bubbles is they’re hard to spot until they burst.