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The Corrections

14 Oct

After re-reading my posts from two weeks ago on the Collective Bargaining Agreement and salaries, and discussing the CBA with people, like Tyler Dellow, who understand it much better than I do, I’ve come to realize that I’ve written poorly about the issue of non-Hockey Related Revenues, to the point of being erroneous. I’d like to take a moment to correct myself, in particular for this statement: “Non-HRR cannot be used by the owners to run their teams.”

Non-Hockey Related Revenues can be used to operate an NHL hockey team. When I said that they couldn’t, I meant (and wrote) that at a team level, additional revenues couldn’t help the Oilers ice a more competitive club because they’re not allowed to spend beyond the salary cap, and they’ve already been spending at or near the limit. Additional revenues of any kind will simply improve the owner’s economic return.

At a league-level, the salary cap itself is tied entirely to league-wide Hockey Related Revenues, which guarantees the players a fixed share of HRR. The other point I was trying to make is that the owners (collectively) would rather earn a whole dollar of non-HRR rather than just a portion of HRR. It therefore makes sense for them to make deals where they get all the non-HRR revenue, where there are more luxury suites and concessions, and where the city they operate in foots the bill on arena construction.

Where this explanation got muddy is that I made the CBA’s revenue definitions (which govern the salary cap system) sound like rules that restricted the spending and investment activities of individual clubs. They don’t, and I apologize for the error.

I stand by my view that the Oilers need to be transparent and open their books to prove they are in fact losing money. I also stand by my view that if they are losing money, it is because they are spending too much, spending unwisely, and putting in place a management group that isn’t getting them to the playoffs.

In the two posts I mentioned above, I will keep the current text, along with an asterisk that will lead people to this post. I don’t feel that it’s appropriate to erase my mistakes and pretend like they never happened. Over the past four years I have worked very hard to be a credible source on the arena issue, and have tried my best to bring to light facts and opinions about it that I felt were being ignored by the mainstream media. In particular, I have been very critical of some local publications and journalists for providing what I considered to be one-sided and sloppy reporting on this issue. Well, I did a really sloppy job. It’s my time to eat some humble pie.

Waste Not, Want Not

30 Sep

“The fans want to get to the other (fiscal) side. That’s what I get in my e-mails, about 99 per cent in favour of a new system. They tell us to fix the NHL, so we’re going to try and do it.” —Patrick LaForge, President & CEO, Edmonton Oilers, September 17, 2004

“Today, our board of governors gave its unanimous approval to a collective-bargaining agreement that signals a new era for our league, an era of economic stability for our franchises, an era of heightened competitive balance for our players, an era of unparalleled excitement and entertainment for our fans.” —Gary Bettman, NHL Commissioner, July 22, 2005

“In the hockey business, expenses are somewhat similar across all teams, given that the single largest component of expense are player salaries, which are bound by a cap and floor, calculated based on league wide Hockey Related Revenues.

As a result, hockey is a business where the operator does not have much discretion over its most significant cost item.”Paul Marcaccio, EVP & CFO, Katz Group, July 21, 2010

———–

Well, that story has certainly changed over the past five years. It didn’t take long to go from “we need cost-certainty or we’ll die!” to “we have cost-certainty!” to “cost-certainty is killing is!” As Matt noted, it’s pretty galling to have an NHL owner complain about the restraints of the Collective Bargaining Agreement, the salary cap and revenue sharing after they locked the players out for a year in order to achieve that exact goal. Cost-certainty was the endgame that fans were told would save the game of hockey. Now we have an owner saying it’s not enough, and that he needs non-Hockey Related Revenues, which can’t even be used to operate the team*, to survive. We’ve gone through the looking glass, down the rabbit hole, and drunk every bottle in sight.

During the presentation to Edmonton’s City Council on July 21, Mr. Marcaccio claimed that “Daryl Katz has had to subsidize the team by several million dollars in each of the past two years in order for the team to break even,” and that “sustainability can only be addressed by a new arena….” Having already examined the NHL’s Collective Bargaining Agreement, we can move past the question of how exactly one can aid the Oilers on-ice product by getting more non-Hockey Related Revenue (you can’t), and instead focus on the ways the Oilers might lose money that have nothing to do with getting revenues from a Coldplay concert. I don’t actually believe that the Oilers are losing money, at least not in a way that is anything other than fancy accounting, but since they refuse to be transparent and open up their books, I thought I’d take a look at ways in which their own mismanagement may be affecting their bottom line.

Spending Too Much

The NHL has a salary cap and salary floor. In the CBA, they are called the “Upper Limit of the Payroll Range” and the “Lower Limit of the Payroll Range.” Teams are required to spend above the salary floor, but below the salary cap. There are almost no exceptions to this, which makes the NHL’s a “hard” cap system.

Looking at the charts below, one can see that over the past five years, since the end of the NHL lockout, the Oilers have spent over 90% of their cap limit in every single year. Over the past three years, it’s been over 97%, making them the 6th, 13th and 7th highest spending teams in the league in those years. Last year the team spent $58,855,000, which actually exceeded the salary cap (they were allowed to do so because of long term injuries to players on the team). They didn’t need to spend that much money. They could have spent $5 or $6 million less without anyone complaining. In fact, considering the results, they probably should have done just that.

Year Cap Max. (Millions) Floor (Millions) Oilers Payroll
2005-2006 $39 $21.5 $35,604,891
2006-2007 $44 $28 $40,929,194
2007-2008 $50.3 $34.3 $49,747,000
2008-2009 $56.7 $40.7 $55,208,000
2009-2010 $56.8 $40.8 $58,855,000
Year % of Cap Used Payroll Ranking NHL Standings
2005-2006 91.3% 16th 14th
2006-2007 93% 22nd 25th
2007-2008 98.9% 6th 19th
2008-2009 97.4% 13th 21st
2009-2010 104% 7th 30th

Not Making The Playoffs

Looking at those same charts, one sees that the Oilers have only made the playoffs once since the lockout. That was the first year after the lockout, when they went to the Stanley Cup Finals. Every other year they’ve missed the playoffs, often by a wide margin. In fact, last year they spent $58.86 million dollars on the worst team in the NHL. So while they’ve been investing an enormous amount of money in player salaries, they are not getting any return in terms of additional playoff revenues.

Spending Poorly

In the chart below, I’ve listed a few examples of expensive contracts the Oilers have signed, extended or attempted to sign since the lockout. This is not an exhaustive list, and not all of the contracts on it have been bad decisions hockey-wise, but it’s a list that reinforces how little a team that claims to be broke has worried about being frugal. And this list only shows the overall contract value, which averaged out over the length of term would indicate the cap hit the team must take on the contract. It doesn’t show how the individual contracts are structured, and how that may affect the bottom line from one year to the next. Shawn Horcoff’s cap hit is $5.5 million a year, for example, but he doesn’t get paid that much every year. The Oilers paid him $7 million in 09/10, and will pay him $3 million in the last year of his contract (14/15). Structuring his contract that way may make sense hockey-wise, but it’s easy to see how frontloading that contract may negatively affect the bottom line of the 09/10 Oilers.

Player Year Term/$
Michael Nylander 2007 ≈ 4 years/$22 million
Thomas Vanek 2007 7 years/$50 million
Dustin Penner 2007 5 years/$21.25 million
Sheldon Souray 2007 5 years/$27 million
Lubomir Visnovsky 2008 5 years/$28 million
Marian Hossa 2008 ≈ 9 years/$80 million
Shawn Horcoff 2008 6 years/$33 million
Dany Heatley 2009 5 years on 6 year/$45 million
Nikolai Khabibulin 2009 4 years/$15 million

One response to all of these examples is going to be that Daryl Katz has not owned the team for the entire post-lockout period. This is true. The Edmonton Investors Group (EIG) owned the Oilers until the spring of 2008. But the argument isn’t just about the Daryl Katz-led Oilers being financially viable. It’s about the Oilers being financially viable in the Edmonton market. Furthermore, in the time Mr. Katz has owned the team, the team payroll has continued to rise (right now the Oilers payroll for 10/11 is $54.4 million, or about 91.6% of the cap limit), he’s tried to sign players like Marian Hossa to huge, expensive contracts, and his team has won 65 of 164 hockey games. Rather than sending out his CFO to make the claim that the team is losing money, and that only a new arena will make professional hockey sustainable in Edmonton, Mr. Katz should probably consider spending less, spending smarter, and putting in place managers, coaches and players who can take his team to the NHL playoffs.

***Cap numbers taken from NHL Numbers and Cap Geek.***

*Note* Please read this link for errors I made in the writing of this post.

The CBA

29 Sep

Edmonton’s arena debate – more particularly, the financing aspects of the debate – is not going on in a vacuum. Rather, it’s being influenced by the economic incentives built into the National Hockey League’s Collective Bargaining Agreement, or CBA. The CBA is an important document to consider when discussing the proposed plan for a downtown arena, yet it hasn’t yet appeared on the radar of local media, politicians and the general public. Here, then, is a breakdown of that agreement, and how it affects the ongoing arena discussion here in Edmonton:

1) The CBA is the labour agreement between NHL owners and the NHL Players Association (NHLPA). It covers everything from the length of the NHL season to the NHL salary cap. The current version was agreed upon following the lockout of 2004-2005, and will expire in September of 2012.

2) The NHL is not a normal, competitive market. It’s more like a socialist utopia: by signing the CBA, the players and owners have agreed to a “fair share” of league-wide, Hockey Related Revenue (HRR). That fair share is fixed, depending on the amount of revenue the league brings in. It’s described perfectly here:

In most competitive markets, having your business generate “big-city revenues” while other competitors have lower revenues would give you relatively more money to invest in your enterprise, or more money to flow to the bottom line. But the NHL is not a normal market.

The market is distorted by the player’s fixed share of hockey-related revenues, and by the revenue sharing system.

Under the CBA the biggest cost – player salaries – is a fixed-proportion of league-wide revenue. Earn more revenue and you’ll ultimately pay more in salaries and more in transfers through the sharing system. Earn insufficient revenue, and your shortfall will be made up by revenue sharing.

3) Here is how the league-wide revenue is divided: for every dollar that’s labeled “Hockey Related Revenue” (HRR), the owners have to pay 56 cents to the players. With the remaining 44 cents they pay their expenses and make their profits. HRR is the operating revenue that owners use to run their teams.

4) The definition of HRR is outlined in Section 50.1 (a) of the CBA, and it is comprehensive. From sweaters to seats, television to Internet, almost any way a club can earn money is considered HRR. In addition, if anyone invents a new stream of revenue (i.e. the next Internet), that’s included in HRR, too.

5) There are some exceptions built into the agreement – revenue sources that aren’t called HRR, and where the owner gets to keep 100% of the cash (found in Sections 50.1 (a) and 50.1 (b)). These are the non-Hockey Related Revenues (non-HRR). Non-HRR cannot be used by the owners to run their teams.*

6) By far the largest exemption is for the financial benefits public authorities can create through arena building and renovation. To use two contrasting examples:

  • If a public authority pays a team $10 million a year to locate or stay in a community, all of the $10 million is counted as HRR. The owner keeps just $4.4 million, while the players get the rest.
  • But if a public authority builds an arena for $100 million, or creates a financial structure that produces the same result, the owner gets to keep 100% of the benefit from that wealth transfer. The CBA takes a broad, even eager, view of all the ways a public authority can structure the transaction to get around the HRR definition. It exempts:

“Any thing of value received in connection with the design or construction of a new or renovated arena or other Club facility including, without limitation, receipt of title to or a leasehold interest in real property or improvements, reimbursements of expenses related to any such project, benefits from project-related infrastructure improvements, or tax credits or abatements, so long as such things of value or other revenues are not reimbursements for any operating expenses of the Club.”

If the Katz Group gets the City of Edmonton to finance an arena, then, all benefits of that wealth transfer go to Daryl Katz. That includes a much higher team valuation, which will surely occur with a new arena and all of its new, Katz-controlled revenues.

7) In addition to the ‘build an arena’ exemption, there are other smaller features in the CBA that allow owners to insulate some of their revenue streams from being called HRR. These include:

  • Luxury Boxes: In an “affiliated arena” only 65% of box lease revenue (whether from hockey or other events), and only 65% of Club/Premium seat revenue counts towards HRR, rather than 100%. This means the owner ultimately keeps 63.6% of revenue from leases rather than 44%. Compare this to the treatment of gate receipts: 100% of the revenue from regular ticket sales count as HRR. All else being equal, an owner would rather build a luxury box which seats 10, instead of 10 new seats in the mezzanine. This is also why the sections designated as premium/club seats keep growing.
  • In Edmonton, for example, the plan is to increase the normal seat capacity from 16,839 to 18,000 seats. That’s an increase of 6.9%. Luxury seats will increase from 39 suites and 16 Skyboxes to 64 luxury suites, 12 bunker suites, 2 party suites, two restaurants, and a club lounge. The increase from 39 to 64 suites alone is an increase of 64%.
  • If the box lease or premium seat is only for non-hockey events, 0% of the revenue counts towards HRR. Parking and concession revenues on non-game days are also completely exempt from the HRR definition – owners can keep all of that revenue. This means that revenue from non-hockey events is especially valuable to owners (they keep all of it), but of no value to the team (none of the money is used to fund player salaries or hockey operations).
  • In addition, in an “affiliated arena” the club only counts 65% of fixed signage, naming rights sales and arena sponsorship revenue towards HRR. Again, it’s a case of the owner getting to keep 63.6% of the revenue rather than 44%.

8)  Last but not least, for parking and concession revenue the clubs get to deduct “direct costs” for these services, up to a limit. Obviously this creates an incentive to cram as many of their costs as possible into these categories, so they can pay for their costs with cheaper ‘pre-HRR-tax’ dollars rather than 44-cent ‘after-HRR-tax’ dollars.

  • 100% of parking revenues on NHL game nights count, but you can deduct direct costs up to 30% of the revenue (30% is a league-wide average; individual sites may vary).
  • 100% of concession revenues on NHL game nights count, but you can deduct direct costs up to 54% of revenues (again, a league-wide average).
  • By maximizing the costs you charge against parking and concession revenues on game nights, just 70% of parking revenue and 46% of concession revenue end up counting towards HRR.

The cumulative effect of the above is simple: it creates a strong economic incentive for owners to maximize financial benefits that don’t count towards, or only partially count towards, Hockey Related Revenue. These include arena financing, parking/concession revenues, and luxury box/club seat revenues. The lesson here is that not all revenue dollars are equal, and that not all are used for the same thing. Hockey Related Revenues are used to pay player salaries and redistribute wealth through revenue sharing. Non-Hockey Related Revenues, the revenues the Katz Group so badly desire, go directly into the owner’s pocket. There is no sharing with the players or other owners.

It is important for the City of Edmonton to understand this distinction, because it drives the Katz Group’s negotiating strategy. Citizens also need to understand this distinction, so that they’re not hoodwinked into thinking that the Oilers could ice a better team if only they received parking and concession revenues from concerts and rodeos.

More non-HRR for the Katz Group will not allow the Oilers to ice a more competitive hockey team. It will not allow them to offer a huge contract to a much sought-after free agent. It will not allow them to extend the contract of a beloved player on the current roster. Rather, that money becomes pure profit for Daryl Katz. There is nothing wrong with this in and of itself, obviously. Making money is the end goal of every business owner. But it’s a different story when that owner is making profits because the taxpayer is covering his costs. That’s corporate welfare, plain and simple.

 

*Note* Please read this link for errors I made in the writing of this post.

Bingo

23 Jul

My fellow blogger and friend Matt Fenwick beats me to the punch with an excellent post on the NHL Collective Bargaining Agreement (CBA), the difference between Hockey Related Revenue (HRR) and non-Hockey Related Revenue (non-HRR), and the absolute yarn spun by the Katz Group Wednesday afternoon at City Council.

*Update* A post in the same vein from fellow Oiler blogger Tyler Dellow.