January 22, 2015

Valuating NBA Teams

I read a very interesting article on Forbes listing the NBA's most valuable franchises. The article in itself is an interesting read, not just because it lists the rankings from highest (LA Lakers at $2.6 billion) to lowest (Milwaukee Bucks at $600 million) but also because it gives casual fans an insight into how these valuations are actual computed.

What I've learned in my accounting and finances classes at IE Business School is that valuations are always partly subjective. Merely taking the value of the assets for each team will barely even give you a fraction of what these teams are being valuated at, even for teams that own their own arenas (most of them don't).

There is a large chunk of these valuations that fall under what is called goodwill, or the gap between the actual value of the assets and the actual valuation being given. Probably the most obvious source of goodwill is that there is a finite number of NBA franchises (only 30) and this helps prop up the value of teams.

One reason why the values of NBA teams have spiked in the past year, based on the valuations conducted by Forbes, is the new national TV deal worth $24 billion. The current collective bargaining agreement of the NBA gives owners 50% of this revenue and you can expect that players will push to have their share increased as soon as they get the chance. There is no league if there are no players after all. So you can expect that some of the revenue being projected will go down in the future, unless the NBA is able to monetize other aspects of the current business (like sponsorship of jerseys for instance).

The NBA is probably the most "global" of all the major American sports leagues, but its popularity is still a far cry from the global popularity of European football's EPL or La Liga. With this sort of growth potential, it's not surprising that the values of these NBA franchises are increasing at such a fast rate.

However, all these points to a large gap in intrinsic and extrinsic value of NBA franchises which ultimately makes any investment of this magnitude a big risk. Many people who want to join the owners circle may look to increasing franchise values, instead of future cash flows, as the main means to make their investment back. So far, this has worked out nicely for current owners, but it may not be the case in the future. 

As such, it is more likely that future owners are looking to buy into the NBA circle more for the prestige of owning something that is rare and for their passion and love of the sport. And at these valuations, future owners are very well likely able to afford having this kind of luxurious asset in their portfolios. This bodes well for the potential profile of future owners as they are more likely to be like Steve Baller and Mark Cuban: passionate, deep-pocketed, and serious about building a winning team for the community than Donald Sterling who was more concerned about turning his NBA team into a profit center.

Link here to the rankings by Forbes