A-Rod

Quantitative Methods II Case Study On A-Rod: Signing the best player in baseball Executive Summary In the late 1990s, America saw the birth of a new baseball star in the form of Alex Rodriguez, popularly known as A-Rod. A-Rod was a unique combination of world-class offense and defense and in no time had become one of the game’s best players. Apart from his sporting talents, A-Rod became a significant name in the world of baseball business when he became a free agent in the Major League Baseball. This case looks into how Texas Rangers which is one of the American League teams is facing a long-term investment decision regarding the hiring of A-Rod. Background The Major League Basketball consisted of 30 teams, governed by the Major league Agreement, whose revenue was derived from three primary sources: * Local revenues –ticket sales, local television, radio and cable rights, ballpark concessions, parking, and team sponsorships. * Central Fund revenues – Receipt and disbursements from national television contract and licensing arrangements (Shared equally by the teams) * Revenue sharing – Transfer of Local Revenues from high-revenue to low-revenue teams, as a part of Collective Bargaining Agreement The local revenues generated the maximum share of the revenue stream for all the teams. Also, the local revenues varied a lot from team to team since the local broadcasting rights were sold to individual teams which depended on the size of the city and population. The major costs to the teams were salary expenses (more than 50% of the total) and operating expenses (fixed costs and same across teams). The salaries varied a lot across teams since it depended on the star-value of the players as it directly impacted the local revenues. The Texas Rangers, founded in 1971, had a stadium capacity of 49,200 with occupancy of around 71%. In 1998, when Southwest Sports Group took over, the agenda of the club was to upgrade the quality of the team by hiring quality players which would eventually drive the revenue stream for the club. This is where hiring of A-Rod fits in the picture. In the pursuit of building a strong team, Texas Rangers also wanted to capitalize on the stardom of A-Rod to further contribute to the team’s brand image, thereby attracting a bigger fan base worldwide. Signing A-Rod Tom Hick, the Chairman of Southwest Sports Group, was focused to sign on A-Rod in the interest of the future of Texas Rangers. The negotiating team had to analyze whether the annuity of tangible benefit over the contractual period would exceed the opportunity cost of signing Rodriguez on a long term contract. Rodriguez’s rare talents would ensure increased attendance and eight additional wins in favor of the club. Since the current capacity utilization of the stadium was 71%, there was room for additional fans. The tangible benefits resulted from parking and concessions fee of $2.50; merchandise generating $1.80; and ticket prices averaging $18. Additionally, with the inclusion of A-Rod, the club would have high probability of making it to the playoffs. Reaching American League Championship series could add about $10 million and reaching the seventh game of the World Series could account for $20 million incremental revenue. Rodriguez entry would also be instrumental in generating sponsorship revenue that account for 7% to 10% of total revenue. Overall, this would take Rangers to highest local income revenue generator, enabling it to be the major contributor in revenue sharing agreement. The expected intangible benefits included a commitment to winning and being the first class organization thereby improving young talent players’ retention and franchise visibility that would facilitate project funding in the long run. The initial pitch of $252 million would break new grounds for its size. But the benefits commensurate by signing Rodriguez were more than the costs incurred, provided Rodriguez was young and his long haul would lead to increased loyalty and enthusiasm among fans. The contract amount was divided into base salary and a signing bonus that amounts to $10million, which had to be paid evenly over the first five years. The contract called for a portion of each year’s compensation to be deferred for 10 years at 3% Interest rate. To counter this issue, the members planned to purchase contract insurance of this magnitude that required a premium each year of 10%of that year’s contract value. Recommendations The pre-tax value of the incremental costs of signing A-Rod ($ 164 million) is higher than the incremental benefits of signing him ($ 111 million). However, the applied regression model used is a highly conservative one and does not account for many potential sources of increased revenue. The model also does not take into account the intangible benefits as well as the fact that A-Rod is a young star with a huge potential to turn into a bigger match winner. Also the after tax difference in costs and benefits would be lesser than the present estimate of $ 53 million. Keeping these in mind, we recommend the Rangers to sign Alex Rodriguez. Some of the measures Rangers could adopt to break even are: 1. Increase the ticket price: With marquee signings like Alex Rodriguez, the Rangers fans would be willing to spend more on tickets to watch the matches. The Rangers can therefore adopt a two step increase in ticket prices. In the first step, they should increase the ticket price to $24. In the second step (2004), they should increase the ticket price to $31. This will increase the average revenue per match per spectator to around $38. 2. Work out better sponsorship deals to increase revenue from this stream: A-Rod is a highly marketable name in the world of sports. The Rangers should leverage his brand value to improve sponsorship deals (kit sponsorship, stadium sponsorship etc) 3. Rigorous measures to increase the revenues through selling merchandise: The rangers should also use A-Rod’s appeal amongst fans to sell more club merchandise. This could result in a significant increase in revenues as the current average revenue per spectator is only $144 ($1.8 per game) for an entire season. Problem Statement The Texas Rangers are evaluating a contract offer for Alex Rodriguez, arguably the best young player in baseball who will become a free agent in December 2000. The Rangers want to offer a long term contract for a period of ten years that would be accepted but at a price that is financially justified. The proposed contract consists of an annual base salary and a signing bonus of $ 2 million per year for the first 5 years. The team revenues are primarily derived from three sources: * Local Revenues * Central Fund revenues * Revenue sharing Signing Alex Rodriguez will result in increased revenues for the franchise in the following ways: * Increased attendance at the home games- the current capacity utilization of the Rangers stadium is only about 71% which leaves scope for further increase in ticket sales. Further the extra ordinary skills of A-Rod would also increase the Rangers probability of making the pay-offs. This could result in additional revenue of $ 10 million if the Rangers reach the American League Championship Series and $ 20 million if they reach the World Series. * The wide appeal of Rodriguez would also make the Rangers more attractive to potential sponsors. Sponsorship revenue could account up to 10% of the total local revenue. * Rodriguez’s presence may also increase the team’s television and radio audience. However due to long term fixed fee deals with local broadcasters, Rangers might not directly benefit from this. It should also be noted that some part of the increases revenue through signing Rodriguez would go to the common pool as part of the Revenue Sharing agreement between the franchises. Now the Rangers have to decide whether signing on Alex Rodriguez is a wise investment. For this we need to compare the present value of the cost associated with signing A-Rod to the incremental revenues obtained through the channels described above. We can break down the larger problem into the following sub-steps: * Calculate the Present value of cost associated with the proposed contract * Estimate the increase in attendance through signing A-Rod and subsequent increase in revenues * Revised probability of qualifying for the American League Championship Series and the World Series and the expected incremental revenues from the same * The revised value of the Franchise in 2010 if they sign Alex Rodriguez * Is the pre-tax incremental revenue higher than the pre-tax incremental costs'