How MLB could be causing the sports financing bubble

MLB has been at the center of skyrocketing values for sports organizations because of the money its franchises are commanding for their media rights. Since 2010, MLB and its teams have signed deals worth more than $28 billion. The Dodgers alone agreed to a 25-year, $8.35 billion deal with Time Warner Cable (TWC). The Texas Rangers, Los Angeles Angels, Houston Astros, and San Diego Padres have signed regional sport network (RSN) agreements worth at least $1 billion each.

With so much money for MLB media rights agreements, there are questions about whether broadcast and cable networks can make enough money to cover these payments without going bankrupt. More specifically, if networks are willing to pay $X for the media rights to sports properties then they need make at least $X + 1 dollars in revenue to make a profit. Is that likely to happen?

The Dodgers agreement shows how difficult this will be for many RSNs. TWC is asking for $4 per subscriber per month from cable and satellite providers to primarily carry Dodgers games on SportsNet LA to the 5 million pay-TV subscribers in the Los Angeles area. To provide context, ESPN receives $5.05 per subscriber per month for all of its content. Los Angeles pay-TV providers have not agreed to carry SportsNet LA at the $4 price point.

RSNs also make money from selling advertising for their programming. ESPN earns an estimated 38.2 percent of its revenue from television and mobile advertising. The lowest that TWC can charge per subscriber and still potentially break even if it can make 38.2 percent of its revenue from advertising is $3.44. Can TWC even reach this rate?

CSN Houston originally attempted to charge pay-TV providers $3.40 per subscriber to carry a channel with both the Houston Astros and Rockets. Its failure to secure distribution is the main reason the channel is now in Chapter 11 bankruptcy. It is now charging an estimated $3.03 and has less than 40 percent market penetration.

Not every contract, however, has the same tough parameters for RSNs as the Dodgers agreement. The Mid-Atlantic Sports Network (MASN) charged $2.28 per month per subscriber in the 6 million person pay-TV audience in the Washington and Baltimore metropolitan areas in 2013. Both the Washington Nationals and Baltimore Orioles each receive $0.40 per month per subscriber or $28.9 million per year enabling MASN to have a significant gross profit.

The current deal structure shows why MASN is the exception rather than rule in RSN deals. The Orioles became the majority owners of MASN as compensation for Nationals becoming a competitor in its market in 2005. The team has kept media rights fees for both Orioles and Nationals relatively low to generate higher profits MASN. The network’s profits do not count towards MLB’s revenue sharing meaning the Orioles keep more money from the network than from RSN fees. However, the teams are “on a collision course in court” because the Nationals believe it has not received its “fair market value” in compensation starting from the 2012 season. There is a strong possibility that Nationals’ rights fees will increase in the future making these deals significantly more expensive for MASN.

The economics of their MLB transactions suggest that RSNs are not going to make a profit. So why are they entering these agreements? The NPD Group found that the average pay-TV service rate nationally has increased by 6% per year since 2011 even as the number of pay-TV subscribers has started to decline. Many of the contracts, including the Dodgers agreement, are structured to have lower payments to sports teams at the beginning and increase over the time. RSNs are betting that they will command higher subscriber and advertising premiums over time given that sports is one of the last types of television programs that most viewers watch live.

If this logic sounds familiar, it is because it was used to justify both the Internet and real estate bubbles. Discounting known risks for risky future profits was at the heart of the rising asset valuations for companies and mortgage-backed securities.

Even if the RSN media rights bubble does burst, MLB and its franchises will still be winners. Franchises struck media rights agreements at a time when they could receive the maximum amount of revenue. At the same time, MLB’s investment in Major League Baseball Advanced Media (MLBAM) and its ability to consistently grow its overall attendance over the past decade means its teams will be in a strong position for future growth even if media rights deals need to be renegotiated.