SBJ/20100816/Opinion

How a team’s value can suffer when a star player departs

Every successful company goes to great lengths to protect its good will and implement risk management programs designed to protect against catastrophic loss to its major assets. They typically do this by maintaining adequate financial derivatives to protect against currency or commodity price fluctuation; by obtaining insurance against major damage to their key assets, product liability and the like; and by implementing vigorous procedures and standards to protect the good will associated with their businesses.

A business whose value is tied significantly to its good will or intellectual property, such as Microsoft or Pfizer, for example, spends millions of dollars on patent and trademark registrations and vigilantly policing infringements of the company’s intellectual property rights.

Franchises in the NBA and in other professional sports leagues cannot protect their businesses in these customary ways from the loss through free agency of their most valuable assets: their marquee players. That inability and potential loss can have an adverse impact on the brand that the franchise has built through its investment in its players.

The Cleveland Cavaliers will be an interesting case in point following LeBron James’ decision not to re-sign with the team.

Hark back to the pre-LeBron years and the struggles that the Cavs had in their home market. In the year prior to James’ arrival, the Cavs suffered through a 17-65 season. That earned them the right to select James with the first pick in the 2003 NBA draft. Their average attendance that year was 11,497. According to Forbes, in 2002, the Cavs were valued at $222 million.

In 2003, the year James played his first game with the Cavs, Forbes valued the Cavs at $258 million. Since then, the franchise has increased in value dramatically, to a reported $477 million in 2008-09 (sixth highest of all NBA franchises). Over that period, Forbes reports that the Cavs’ annual revenue has increased more than 100 percent, from $72 million to $159 million in 2008-09.

The Cavs and Raptors used sign-and-trade
options after losing James, left, and Bosh,
right, to Miami.

Dan Gilbert reportedly paid $375 million for the Cavs in 2005. One can only speculate how the value of the Cavs will decrease with James’ decision to leave for Miami. Will other free agents be attracted to the Cavs without him? Will team sponsors or other team partners place the same value on those sponsorships and relationships without James? Not likely in either case. The revenue drawn from season-ticket sales, suites, merchandise, television and radio deals can reasonably be expected to decrease, and perhaps dramatically.

SportsBusiness Journal recently reported that a deal involving the sale of David Katzman’s 15 percent minority interest in the Cavs to a Chinese investor had been languishing (June 21-27 issue). Is it possible that the delay was due to the uncertainty of where James would decide to play? It is entirely conceivable that the value of that 15 percent interest is worth considerably less now than it was before James decided to leave Cleveland.

What, if anything, could Gilbert and the Cavs have done to protect against the loss of a player such as James, the team’s greatest asset, and the potentially dramatic impact this may have on the Cavs’ value?

While an NBA team can and does buy insurance compensating the team against the loss of a valuable player due to injury, it can’t buy insurance against losing a player to free agency. The NBA’s collective-bargaining agreement, which allows teams to draft and protect players for a period of time, also rightfully permits players to move on after a point in time without any guaranteed compensation to his current team. An NBA team is entirely reliant on its internal player personnel management and the use of the collective-bargaining agreement to try to re-sign their own players, trade them before their contracts expire, or work “sign-and-trade” transactions to try to mitigate against the risk of losing a major player.

There is no question that a player should have the right to seek employment where he chooses, perhaps even sooner than six or seven years into his career. The more difficult task is to strike a balance in the CBA to try to compensate a team that loses players who are so key to its success both on the court and financially without creating impediments to the players’ ability to sign with other teams. The sign-and-trade provisions offer opportunities for a team to work some compensation for the loss of a player, but they are woefully inadequate in the case of a player such as James.

In Major League Baseball, teams can earn compensatory picks in the next annual player draft based on a departing free agent’s ranking by the Elias Sports Bureau over the player’s previous two years of playing, and against players of similar position.

In the case of James, or in the case of the Toronto Raptors also losing Chris Bosh to Miami, neither Cleveland nor Toronto had a built-in right in the CBA to receive compensation for losing the player. Both Cleveland and Toronto were fortunate to be able to use the CBA’s sign-and-trade provisions to notionally sign the player and then trade him to Miami, which enabled both players to receive more money and a year-extra term on their contracts. Both Cleveland and Toronto received draft picks and a large trade exception. In James’ case, that included two first-round picks between 2013 and 2017.

As a sophisticated multibillion-dollar business, the NBA can develop a better system to protect franchise values than its current CBA without creating any undue impediment on the players’ freedom to work in a city of their choosing. Nothing less should be expected given the dollars paid for franchises today and the risks involved in those investments.

Just ask Dan Gilbert and the Cleveland Cavaliers.

Jeffrey A. Citron (jcitron@goodmans.ca) is a corporate finance and sports lawyer in Toronto.

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