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Baseball's Financial Reins Bringing Yankees to Heel
Rules Drawn in 2002 Beginning to Have Effect
By Dave Sheinin
Washington Post Staff Writer
Friday, February 4, 2005; Page D01
NEW YORK -- For months, it was almost universally accepted around baseball that Carlos Beltran, the immensely talented, 27-year-old center fielder who entered free agency this winter, would sign with the New York Yankees. The Yankees needed a center fielder to replace the aging Bernie Williams. They had the most money and, almost without fail, had made a habit in recent years of acquiring any player they wanted, no matter the cost.
But when Jan. 11 dawned, it was the crosstown New York Mets holding a news conference to announce the signing of Beltran to a seven-year, $119 million deal, with the Yankees not even making an offer. That same day, the Yankees introduced lefty Randy Johnson, their latest acquisition, in a separate news conference. In addition to not making an offer for Beltran, the Yankees say they also turned down a last-ditch pitch from agent Scott Boras that would have delivered Beltran to them for about $100 million over six years.
The Yankees' disinterest in Beltran, which team officials said was at least partly for economic reasons, sent shock waves throughout the game.
Rival teams and league officials noted with discreet satisfaction that, for the first time, the impact of economic rules written into the 2002 basic agreement between baseball owners and players appeared to have succeeded in reining in the Yankees' spending.
Yankees officials acknowledge that they were constrained by two of the changes adopted three years ago -- revenue-sharing and a penalty against high-spending clubs known as the luxury tax. "We had priorities this winter -- primarily, improving our starting pitching -- and we feel we met those priorities," Yankees President Randy Levine said. "We're like every other team, even though our revenues are larger than other teams'. We're conscious of revenue sharing and the luxury tax."
But others around the league say that another, lesser-known part of the 2002 agreement -- a measure called the debt service rule that limits the amount of debt a team can carry -- might be causing the Yankees, and several other teams, to more fundamentally rethink their free-spending ways.
"There's a real rude awakening coming for them," said one high-ranking official from another team, who like others interviewed for this story spoke on condition of anonymity. Referring to Yankees owner George Steinbrenner, the official said, "Starting in 2006 [when the debt service rule goes into full effect following a three-year grace period], he won't be able to fund these $200 million payrolls any more."
Leveling the Field
Reining in the Yankees' payroll spending and ridding the industry of its ballooning debt were two of baseball's primary goals when Commissioner Bud Selig and his lieutenants risked a debilitating work stoppage and pushed through a series of economic measures designed to improve the sport's financial picture and competitive balance.
Although the measures in the 2002 basic agreement stopped short of the egalitarian system championed by the NFL and NBA, baseball's increased revenue sharing and a more severe luxury tax bargained with the powerful players' association shifted more of the sport's resources from the richest teams to the poorest. Though the basic agreement never said so specifically, the new measures were designed largely to bring the Yankees -- whose revenues and payrolls increasingly dwarfed the competition's -- back to the pack.
While the two measures were aimed at increasing competitiveness, the debt service rule specifically targeted the industry's debts, mandating "fiscal responsibility," as league officials put it, among individual teams. The rule limited the amount of debt a team can carry by tying it to its cash flow.
However, whether intentional not, the debt service rule has had another effect: Since player payroll is by far a team's largest expense, many debt-ridden teams found the best way to get in compliance with the rule was to shed payroll and limit spending. Although Yankees officials say the team is not in violation of the debt service rule, many in the game are now connecting the Yankees' fiscal restraint this winter to potential concerns over the sanction.
In 2004, under the formula laid out in the basic agreement, the Yankees paid about $88 million for the right to earn and spend as much as they did that year -- $63 million in revenue-sharing payments spread among other teams, plus a $25 million luxury tax bill. That fee represented 30 percent of the Yankees' payroll spending above the league-wide threshold of $120.5 million.
Combined, the revenue sharing and luxury tax consumed more than a quarter of the Yankees' estimated revenues of $315 million.
In 2005, the Yankees, as a third-time luxury tax-payer, will see their luxury tax rate rise to 40 percent on payroll above the new threshold of $128 million -- a figure they long ago blew past. Their trade for Johnson last month shot their 2005 payroll above $200 million, making them the first team in history to exceed that figure.
What that means is, had the Yankees signed Beltran for $100 million (the price they say Boras offered), the real cost to them, including the luxury tax, would have been more like $140 million -- something the Yankees acknowledge factored into their decision.
"We just couldn't afford to get a deal done," Yankees General Manager Brian Cashman said. "We're paying an extra 40 cents on the dollar."
As things stand, the Yankees, with a payroll in excess of $200 million and almost certain to rise, already are staring at a luxury tax bill of nearly $30 million for 2005. Combined with their expected revenue sharing payments, the Yankees could be forking over $100 million to support poorer teams.
"If [the Yankees] didn't have to pay the luxury tax, it might have been a different story," said Boras, Beltran's agent. "As it was, for them to pay [Beltran] $17 million a year, it's actually more like $24 million. I would say it certainly was a parameter that created an issue in their pursuit of the player."
The Yankees' revenues (estimated by the league to be $315 million) and franchise value (estimated by Forbes Magazine as $832 million) dwarf those of any other baseball team. The Boston Red Sox, the Yankees' bitter rivals, are next, at $220 million in revenues and a franchise value of $533 million.
However, beginning late last fall, rumors began circulating within baseball that the Yankees' financial picture involved bigger concerns than the amounts of their revenue sharing and luxury tax payments. At last month's owners meetings in Phoenix, the rumors grew in strength. The Yankees, according to some owners, were carrying significant debt and were out of compliance with the debt service rule. Thus, like all offenders, they were subject to sanctions -- including, potentially, the loss of their share of a pool known as the central fund and exclusion from owners' votes -- if they did not get into compliance by the end of 2005.
Selig, in a telephone interview, would not speak specifically about the Yankees' financial situation. But he said, in general, about baseball's new economic system: "Do I think the changes have affected how teams have been run? Yes, I do."
However, an ownership source from another team said the Yankees "are clearly in violation" of the rule. "True, so are a lot of teams," the source said. "But they're the Yankees."
One source who attended the owners' meeting, where Selig gave a slide presentation detailing which teams were in and out of compliance, said the Yankees were in the category of teams currently out of compliance with the rule, but on track to be in compliance by the end of 2005.
Confronted with this claim, Levine said brusquely, "We're in compliance with the debt service rule," and declined to elaborate.
One source with knowledge of the Yankees' finances, who spoke on the condition of anonymity, downplayed the rumors, saying the Yankees' total debt was close to $100 million. "That's very little debt, relative to the value of the franchise," the source said, "and they could wipe it out by writing a check. People overestimate this issue."
A Push for Compliance
Even though Selig's powers to penalize teams that are out of compliance with the rule do not begin until after the 2005 fiscal year, league officials say he has been vigilant about forcing teams to be "on a trajectory," as one source put it, toward compliance.
That source said it would be logical to assume the Yankees were dissuaded from signing Beltran, in part, by the threat of the debt service rule -- in other words, that an extra $23.8 million in payroll commitment to Beltran in 2006 (his $17 million average annual salary plus the 40 percent luxury tax) would have pushed them out of compliance with the rule for that year.
The debt service rule, championed by San Diego Padres owner John Moores and modeled on similar rules in the loan industry, ties the amount of debt a team is allowed to carry to its cash flow, defined by the acronym EBITDA (earnings before interest, taxes, depreciation and amortization).
EBITDA is a commonly used financial formula that is calculated by subtracting a company's operating expenses such as payroll, administrative costs, travel and other items from gross revenues. Baseball's debt service rule limits a team's debt to 10 times its EBITDA, except in the cases of teams that are financing new stadiums, in which case the multiplier is 15.
Essentially, Selig has the power to force teams to prove they make enough money to fund their payrolls. A team with huge expenses, such as the Yankees, could be left with a low or even negative EBITDA, which would put its debt level in violation of league rules.
In April 2004, Forbes Magazine calculated the Yankees' EBITDA for fiscal 2003 as minus-$26.3 million -- an operating loss that was the second-highest in the game that year, behind the Texas Rangers'.
Although specific language in the basic agreement makes clear the rule was not designed to inhibit spending on payroll, Rob Manfred, baseball's executive vice president for labor relations, conceded it can have that effect.
"Everyone understood it could have an effect on payroll," Manfred said, "but that [the owners] wouldn't intentionally use the rule to drive payrolls down."
Although player compensation is not counted as part of a team's debt, it is a significant figure in calculating a team's EBITDA. So an out-of-compliance team could be inclined to lower its payroll as a way of improving its EBITDA figure and getting into compliance.
Baseball officials would not say how many teams are currently out of compliance with the debt service rule. However, Jonathan Mariner, baseball's chief financial officer, told CFO Magazine last year that 15 teams submitted financial plans to the commissioner's office that appeared to leave them out of compliance, and that, after revisions and pledges of additional equity, fewer than five teams remained out of compliance.
One high-ranking official from another team called the rule "a home run" for the owners that, in effect, acts as a "soft" salary cap. Although spending on free agents has risen throughout the industry this winter, total spending over the last three years, since the basic agreement went into effect, has dropped considerably from previous winters.
Another ownership source predicted that the union will fight to get rid of the rule when the basic agreement expires in 2006, but, the source said emphatically, "We're not changing it."
© 2005 The Washington Post Company
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