Tuesday, January 12, 2010

The Real Payroll Number

Today, we're going to try to explain why the Cubs didn't do a lot so far this off season in terms of payroll additions. Hopefully, this will explain to many of you why players like Rich Harden, Matt Capps, and Curtis Granderson are not here.

First, you need to draw a circle around the date of October 20, 2009. That's the date the Ricketts closed on the purchase of the Cubs. That's also the date the Cubs took on $425 million in bank debt.

All transactions that happened before then need to be viewed through the lens of a team that was still under the delusion that it could compete for a divisional title. That's why guys like Rich Harden and Tom Gorzelany were not traded. Jim Hendry was unwilling to White Flag the 2009 season. The decision to offer arbitration after the season to these players was tabled until the season was over. It had to be. You can't offer a player arbitration until the World Series is over. On October 30th, the Yankees and Phillies were still engaged.

On October 30, the Cubs became the proud owners of $425 million in floating rate bank debt with a maturity date 48 months later. In other words, the Cubs had to be out of debt BEFORE Alfonso Soriano's contract was over.

How does $425 million in band debt affect the Cubs? Look at it like this: Before the debt, the Cubs were free to spend all their available cash on operations, payroll included. The team was saddled with no debt. All of it was on the books of the parent company, the Chicago Tribune. Yes, the Tribune could have forced the Cubs to upstream cash to support parent operations. But remember the Cubs free cash flow was a pimple on the behemoth that the Tribune once was.

After the debt came on? Imagine this. October 29, 2009. The Cubs have a payroll for 2010 of $140 million. The next day? The Cubs have a payroll for 2010 of at least $161 million. What's that $21 million bump?

Interest expense (assumes $425 million at a rate of 5%).

And, unlike a player contract, that number wasn't fixed. If interest rates rise (as expected), the "payroll" goes up by another $4.25 million for every 1% rates rise.

If the Federal Reserve Bank normalizes interest rates, the Cubs could have a "payroll" of over $170 million.

But wait, there's more.

Crain's characterized the $425 million in bank debt as a "term loan." Most term loans are like mortgages. They require you to pay not only the interest, but the principal as well. How much principal?

If the banks were requiring principal reductions in the debt over the life of the loan (4 years)m that could have bumped the "payroll" up to, get this, as high as $260 million to $270 million.

You read that right.

Do you now see why the Cubs didn't offer arbitration to Rich Harden? Do you now see why the Cubs didn't go after Aroldis Chapman?

Do you now see why the refinance of the debt last week was such a big, positive development? The interest rates are now mostly fixed. The principle repayments are now over a much longer period of time.

The Cubs are now stable financially from a capital structure perspective.

Yes, the sale screwed up this offseason and, quite probably, the 2010 season.

I'll sacrifice 2010 if it means the Cubs can set themselves up for long term success.

Yes, this sounds like the "Keep the faith" crap you hear elsewhere. That's not what this is trying to say. What is being said is to give the new ownership some patience. There's plenty of time to decide if they really know what they are doing.

In fact, they've only made one mistake so far.

Comments:
Great info. Thanks for helping us understand the outlook. I'm just curious...what was the one mistake? Buying the team?
 
Seriously this sounds like a typical modern day scam being perpetrated by the Ricketts family. If the tribune company still owned the cubs their would be no doubt in my mind! Your post's are out of left field if you keep it up Cubs fans will no doubt begin to revolt because of this exact topic YOU CONTINUE TO BRING UP. Also, ricketts family whomever you are paying to provide damage control! fire them they are only creating damage NO control needed you only have to look to zambrano/soriano/fukudome to understand why you have no money 50million is going to average/below average talent.
 
Grabow has got to be a mistake. They not only overpaid him in general, they overpaid for the wins he'll provide. Save that money and the money they are apparently willing to give Ben Sheets, and give it to Harden.

Also, how can they be in the Ben Sheets running with an incentive-laden contract? Why spend $4 million that might be a bust or even spend upwards of $8 million (if incentives were given for starts) just to get a couple of extra wins.

This post makes it seem like wins are being punted from the front office in the interest of saving money. Signing Sheets and not thinking about Chapman (because he would provide future value way above his salary) just seem in congruent.

If you want wins and bang for your buck, you go after Harden and Chapman. If you want to save every penny possible, you don't go after sheets w/ an incentive-laden contract. At least in my opinion.
 
I believe the mistake is named Crane Kenney and his continued employment with the organization.
 
Keeping Crane and Hendry - or is that two mistakes?
 
This comment has been removed by a blog administrator.
 
Jimbo hires Mad Dog to take Ed Lynch's old gig. Smart move imo. We don't know what type of front office person Maddux will be but this will get his feet wet and he will get an idea of what it takes to be successful at the job and is something he wants to do long term.
 
great stuff chuck.
 
Payrolling isn't inexpensive. It is really imperative a business saves money when and where it could. In the event that payroll is performed in-house, organizations should pay to train payroll staff, in addition spending for the hardware and programs they applied.
 
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