Friday, April 15, 2011

Cutting Spending

The Cubs need to maximize attendance, and also the value of the brand, is more than just a simple profit proposition. In acquiring the Cubs, the Ricketts took on a massive amount of debt, in the order of $674 million. Our good friend and former 1060 West blogger Gaius Marius provided a link to this summary of the Cubs debt picture. In short, the debt includes:

$250 million in private placement notes due in staggered maturities through January 2022
$175 million in bank debt due October 2013
$249 million in subordinated debt, of which at least $175 million is owned by the Ricketts

The first two pieces have all the Cubs assets, including Wrigley Field, pledged as collateral for the loan.

While it’s impossible to know exactly what the annual costs are for these loans, we can make a reasonable guess. Interest rates are probably somewhere near 5% for the bank debt, 65 to 7% for the private placement debt, and even higher for the subordinated debt.

Since the Ricketts own the bulk of the sub debt, the payments related to this are really irrelevant. If the Chicago National League Ball Club, Inc. has to cut a check every year to the Ricketts Family Trust, the Ricketts can turn that money right around and put it back into the Cubs.

The private placement notes are trickier. The amortization schedules over the 13 year time period could be very irregular. But, we do know they need to be paid in full by the end of 13 years. We can also guess that none of them mature for at least 5 years. If you figure that the notes are interest only for the first 5 years, then begin to paydown evenly over the next 9 years, we can estimate the private placement debt service like this:

Year Interest Principal Total
2010 $15,000,000.00 $- $15,000,000.00
2011 $15,000,000.00 $- $15,000,000.00
2012 $15,000,000.00 $- $15,000,000.00
2013 $15,000,000.00 $- $15,000,000.00
2014 $15,000,000.00 $27,777,777.78 $42,777,777.78
2015 $13,333,333.33 $27,777,777.78 $41,111,111.11
2016 $11,666,666.67 $27,777,777.78 $39,444,444.44
2017 $10,000,000.00 $27,777,777.78 $37,777,777.78
2018 $8,333,333.33 $27,777,777.78 $36,111,111.11
2019 $6,666,666.67 $27,777,777.78 $34,444,444.44
2020 $5,000,000.00 $27,777,777.78 $32,777,777.78
2021 $3,333,333.33 $27,777,777.78 $31,111,111.11
2022 $1,666,666.67 $27,777,777.78 $29,444,444.44

The line of credit that is due in 2013 is probably interest only which adds another $8,750,000 in annual debt service. It is possible that there are currently some principal reductions required, but not likely given that the banks were already paid down via the private placement notes. All in, it appears the Cubs annual debt service is close to $24 million per year with a major refinance need in 2013. Furthermore, when that debt is refinanced, it will likely be required to start to amortize beginning in 2014. That could escalate the debt service required beginning in 2014 to over $60 million per year, up from $24 million now.

To sum up, while the Cubs can certainly afford the cost of their debt today, the cash flow requirement is going to escalate dramatically beyond 2013. The key risk to the Ricketts is the bank debt that will need to be refinanced. The terms of that refinancing will be dictated by the cash flows available for debt service. The more cash available after paying for operations, the less risk to a lender. The less risk, the better the terms.

So, how do the Cubs improve cash flows if the seats are empty? There are a few ways. The easiest one is also the most obvious. Cut payroll.

Per Cot's Contracts, the Cubs 2011 payroll is $134,004,000. That drops radically over the next two seasons, which happen to be just before the debt needs to be refinanced. Let's see what goes away::

Aramis Ramirez - $14,800,000
Kosuke Fukudome - $14,500,000
Carlos Pena - $10,000,000
John Grabow - $4,800,000
Jeff Samarzdija - $3,300,000
Kerry Wood - $1,500,000
Reed Johnson - $900,000
Carlos Silva - $9,250,000
Total: $59,050,000

Carlos Zambrano - $19,000,000
Ryan Dempster - $14,000,000
Marlon Byrd - $6,500,000
Sean Marshall - $3,100,000
Total: $42,600,000

Grand Total: $101,650,000

That’s a lot of free cash flow. Now, clearly the Cubs won’t just replace those 12 guys with guys salaried at the major league minimum (total cost of about $6 million). Some will go to raises for other players (like Geovany Soto and Carlos Marmol). Some of that money will go to replacements, a few of which might get good sized dollars. As you can see, an Albert Pujols level contract is certainly affordable if payroll is kept flat.

But if evil bankers tell the Ricketts that they need to see more earnings before interest and taxes, payroll could easily be cut. If payroll goes down, minor league development is paramount to keep the team competitive on the field. Unfortunately, Jim Hendry's track record in player development is spotty at best.

Now, payroll is only the easiest way to free up cash flow. Another is to raise revenue. The solution here could raise more bitching than discussion of raising taxes does.

The Wood deal is apparently $1.5 million per year as long as he wants to keep pitching or until his arm falls off (June). If they can get other players to accept huge discounts out of loyalty the Cubs could have a payroll of $37 million in 2016, and they'll go 0-162. But think of the profits!

Really appreciate your response on the last thread and think you are right on with your analysis--smart businessmen, not so smart baseball men. I agree they will try to avoid putting in additional equity, and maybe the best way to do this is to diversify revenue streams.

I am curious as to what you see as potential ways to generate more revenue (and I'm guessing that's the subject of your next post).

I see substantial unrealized revenues in sponsorships, advertising, and real estate. While some of the sponsorship and advertising dollars might be controversial to a segment of the fan base, perhaps if they're sold to that crowd as a way of financing improvements to Wrigley Field (or Bank of America presents Wrigley Field), they might go over better.
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