Commentary

Is the NBA really losing money?

Are the league's stated losses merely an accounting fiction? Here's a closer look

Updated: July 12, 2011, 12:39 AM ET
By Larry Coon | Special to ESPN.com

The NBA's collective bargaining agreement will expire at 12:01 a.m. on Friday. If a new agreement is not in place by then the league effectively will shut down, ceasing all business with the players until the labor dispute is resolved.

With the season over and CBA's crunch time now here, the two sides briefly picked up the pace on the negotiations. But the chasm remains wide and deep. Despite some movement on both sides, a work stoppage seems inevitable. One last face-to-face meeting remains scheduled before the agreement expires, and while NBA commissioner David Stern insists that there's always time to make a deal, the conclusion now appears to be foregone.

The league contends that 22 of the 30 teams are losing money, to the tune of about $370 million per season collectively. The individual team owners are seeking a complete overhaul of the league's financial model, and have submitted proposals to the players that feature a $45 million hard cap and rollbacks to existing salaries (reductions in existing contracts of 15 percent to 25 percent, based on the players' starting salary) -- a proposal the players association termed "a non-starter." They have also discussed an alternative in which salaries are pegged near their present levels, so the players' share of revenues declines over time as revenues increase over the next 10 years.

"Their demand is gargantuan, and we just can't meet it," National Basketball Players Association executive director Billy Hunter told reporters.

The players association paints a different picture of the league's health. "Our belief," Hunter told ESPN.com's Henry Abbott, "is that a small number of teams are suffering, and their problems can be addressed through revenue sharing."

Union president Derek Fisher placed the blame squarely on the teams' front offices. "We've run into situations where teams have either mismanaged spending, overpaid staff, or made decisions on rosters and personnel that weren't in their best interest -- things that we're now being asked to take the hit for," Fisher said in October.

The league says it has provided full financial data to the players association to substantiate its losses. "We've given [them] our certified financial statements," Stern said. "We've provided access to our tax returns, and if there's more needed, they'll get more."

"We're very comfortable because we've given the players association more financial information than has ever been done in the history of sport," he said.

But the union disagrees with the story the numbers tell.

"There has been ongoing debate and disagreement regarding the numbers, and we do not agree that the stated loss figures reflect an accurate portrayal of the financial health of the league," Hunter said in a statement released during the All-Star break.

The players association contends that a significant portion of the losses is merely an accounting artifact, and doesn't reflect an actual operating loss.

"There might not be any losses at all. It depends on what accounting procedure is used," Hunter said. "If you decide you don't count interest and depreciation, you already lop off 250 [million] of the 370 million dollars."

Billy Hunter
Robert Sullivan/AFP/Getty ImagesWhen looking at the financial numbers, Billy Hunter and the union disagree with the league's claims.

Hunter was referring to the accounting practice of amortizing certain assets related to the purchase of the teams themselves. These show up in the balance sheet, but there is little or no economic substance to the amortization. It does not represent actual money that is going out the door.

Are the league's stated losses merely an accounting fiction? Financial statements for the New Orleans Hornets were leaked to the public late last year, and Deadspin recently obtained similar documents for the New Jersey Nets. ESPN.com assembled a group of financial experts to review these documents and help determine whether these teams are actually losing money.

These statements give us a glimpse behind the curtain -- some insight into the inner workings of the NBA -- but it would be a mistake to infer too much from them. They represent just two franchises out of 30. They also are not current -- the Nets' documents are from 2005-06, the first year under the current CBA. The Hornets' documents are more recent -- 2008-09 to be exact -- but are nevertheless nearly two years old.

They also represent two franchises that were recently sold, and in the Hornets' case, reeling from the effects of poor management in Charlotte, relocation to New Orleans, and the devastation of Hurricane Katrina. Since most teams were not recently sold, and few teams have withstood the ordeals of the Hornets, these teams can be viewed as anything but typical.

But that's not to say that having information from these specific teams doesn't give us insight. The players association claims that the league is overstating its losses by mixing in costs associated with the purchase of teams with the profit and loss associated with the operation of those teams. In order to examine this claim, we need statements from teams that have recently been sold. Fortunately, we have them.

So while we can't extrapolate from these financial statements to draw firm conclusions about the league as a whole, we can still use them to inform ourselves about some of the arguments used in the ongoing labor dispute, and perhaps gain some insight into which side is on more solid footing.

In general, financial statements provide a snapshot of a company's performance during a given time period. These statements communicate to the reader (in this case the league office, creditors, potential investors, and now the players association) information about what the company owns, what they owe, what revenue came in and where it all went. These statements are prepared by the company's accountants and audited by an independent firm to ensure the dollar amounts are reasonably accurate and the generally accepted accounting practices were followed.

The Hornets' financial statements paint a picture of a franchise in trouble. These were the team's first two years back in New Orleans after Katrina. The team was a slightly below average revenue earner, and right at average in terms of player salaries. From an operational standpoint it was living within its means, but with very little margin for error. The crippling problem was their debt -- they likely built an enormous debt in Charlotte, forcing previous owner George Shinn to either shut down, sell the team or move it elsewhere. He chose the latter, but this added another $30 million in relocation fees to the problem. From there the team walked right into a devastating hurricane, and in the end the team was saddled with an accumulated debt of more than $120 million in 2009.

The Nets were another weak franchise, which helps explain their upcoming move to Brooklyn. During the time period covered by these financial statements they were in the bottom half in attendance, had one of the league's highest payrolls, and were operating in a high-cost environment. Under these circumstances you would expect the team to lose a lot of money, and it did -- it claimed losses of $49 million in 2005 and $57.4 million in 2006.

But these statements also illustrate the accounting practices to which Hunter and the players association take issue. Brooklyn Basketball (the Nets' parent company) paid $361 million for the team. In order for the balance sheet to balance, it had to show assets in that amount. Some of these are real, physical assets; accounts receivable; and the like. Other parts are "intangible" assets, which represent the amount the buyer paid above the value of the tangible assets. These assets (but not the franchise itself) are amortized over their "useful lives," with a portion of their value (a total of $200 million for the Nets) counted as an operating expense each year. For the Nets this expense added up to $41.5 million in 2005 and $40.2 million in 2006.

In other words, $41.5 million of the Nets' $49 million operating loss in 2005, and $40.2 million of its $57.4 million in 2006, is there simply to make the books balance. It is part of the purchase price of the team, being expensed each year. This doesn't mean they cooked their books, or that they tried to pull a fast one on the players. It is part of the generally accepted accounting practice to transfer expenses from the acquisition to the profit and loss over a certain time period. However, it's an argument that doesn't hold water in a discussion with Hunter and the players association, who would claim that the Nets didn't really "lose" a combined $106.4 million in those two years, but rather that they lost $7.5 million and $17.2 million, respectively.

The Hornets' statements show that despite their hardships, the team would have turned a reasonable operating profit in 2009 had it not been for the interest expense on their crushing debt. Despite operating on such a thin margin, the team loaned Shinn and his company $35 million at a low interest rate -- while at the same time borrowing $100 million at higher interest rates. While there is no reason to suspect it wasn't for legitimate reasons, the loan still contributed to the team's cash flow issues. Here the players would argue that it isn't their responsibility when teams mismanage their franchises, nor for the portion of debt that is unrelated to the actual basketball operations of the teams.

In either case their argument is the same: some issues simply aren't the players' problem. Unless the players can share in the profit when a team is sold, they don't want to be burdened with the costs associated with buying the team in the first place. And if they don't have a say in the team's management decisions, they don't want to pay the cost when those decisions go awry.

When applied to the league as a whole, these numbers add up fast. Seven teams were sold since the CBA took effect in 2005. Teams assign different amounts to these intangible assets and the amortization changes on a yearly basis, so we really can't predict exactly how much is being amortized in a given year. If we assume seven teams deduct an average of $30 million each, then the league would show an operating loss of $210 million per year due to franchise sales alone. In addition, many owners are likely paying many millions of dollars per year in interest related to financing some portion of their team's purchase. While these are real obligations and represent real cash going out the door, they relate to team ownership, in which the players do not share.

To repeat, we can't extrapolate from just two franchises to draw any firm conclusions about the league as a whole. But Hunter is privy to current documents for all 30 teams and claims that at least $250 million of the league's $370 million loss comes from these sorts of accounting quirks. Based on what we've seen from these two teams, he indeed may have a point.

From the owners' perspective, accounting quirks or not, the league still loses money each season. They insist that the whole financial model of the league is broken, and that much more is required beyond better team management and increased revenue sharing.

"Revenue sharing doesn't solve the problem if there are losses," Stern said, "because you can't revenue share your way to a profit as a league."

The owners want a system in which all 30 teams are sustainable and competitive, which would require an overhaul. "In certain markets," Stern said, "even if they do everything right, given the size of the market and the available income, they still won't be profitable."

The league's proposed solution is a system that includes both robust revenue sharing and better player cost containment. It's a one-two punch of first ensuring the league as a whole is in the black, and then spreading the money around so that the big markets are on a level playing field with the small markets.

"It's about coming up with a system, if you think about it, where every team has the same amount of chips," Stern said.

The players are in favor of robust revenue sharing among the teams, but the league's proposal for cost containment is something they find hard to swallow. The biggest blow would be the proposed hard cap. The NBA currently utilizes a "soft" cap -- one that teams can exceed under certain circumstances, such as when re-signing their own players. Because teams are not required to keep their payrolls within a soft cap, few teams ever operate within its constraints. In 2009-10 salaries totaled $2.1 billion, and the CBA includes a system to ensure that players receive 57 percent of the league's gross revenues.

A $45 million hard cap would lower league-wide salaries to $1.35 billion, a 36 percent decrease. This would represent a staggering $760 million drop in salaries from this season to next.

"If we had to choose between this [proposal] and a lockout, we'd welcome a lockout," Hunter said.

Based on the $370 million loss figure, it's about double what the league needs to cut in order to break even. Of course, the league's goal is to do more than just break even.

"It's about getting the percentage down so our teams and our league are profitable," Stern said.

The league later offered to guarantee the players at least $2 billion in each season of a 10-year deal, but hold the salaries relatively steady over the lifetime of the agreement while revenues continue to increase over time. This would achieve the same cost reductions the owners seek -- reducing salaries from 57 percent of revenues to around 40 percent over 10 years -- but phase those reductions in slowly, rather than asking the players to take a massive pay cut at the start of the agreement.

The offer (it doesn't appear to have risen to the level of a formal proposal) also included what the owners call a "flex cap." This is a hybrid between a soft cap and a hard cap, with a soft cap at $62 million and a hard cap set at some unspecified level above the soft cap. But Fisher said he views the distinction between a flex cap and a hard cap as semantic at best.

"We view that as just a total distortion of reality," Fisher said. "It's not a flexible cap, it's a hard cap."

It is also interesting to note that the league considers collective bargaining and revenue sharing to be two separate, parallel discussions, while the players included revenue sharing as an integral part of their proposal. The owners contend that if they can use cost containment (such as a hard cap) to get the league in the black, then revenue sharing can take care of the rest. But a hard cap set at $45 million goes much further than the middle ground -- it aims to ensure that even the weakest franchises can turn a profit, before revenue sharing enters into the picture. The owners could be promoting revenue sharing to assuage the players' arguments about revenue inequity, while at the same time leveraging an agreement that is based on the worst aspects of that inequity. Or it could be that they are just doing what any good negotiator does -- leaving room for movement. Their subsequent offer to reduce the portion of revenues that go to salaries over the lifetime of a 10-year deal appears to suggest the latter.

So there you have the labor dispute in a nutshell. The owners want to turn a profit and increase the value of their investments, just like any business owner. The players want to protect their earning power as well as their job security, just like any employee. The sides disagree on the nature and scale of the problem, and what it would take to fix it. And both sides want their narrative to be seen as the right one.

In the end, it won't come down to whether the correct interpretation of the league's losses is $370 million, $120 million, or no losses at all. It also won't matter whether the sides ever agree on how much money the players should be able to earn, or how much profit the teams should be entitled to make. But agreement on those issues certainly would hasten a solution.

The players have indicated they are willing to share in a legitimate burden, but so far have insisted on an optimistic interpretation of the state of the league, while denying culpability in factors about which they have no say. The owners are fixed on a pessimistic interpretation of the league's health, and a more drastic response to the problem. And the two sides now have had two years to dig in their heels and refine their rhetoric.

As these financial documents show, the truth likely lies somewhere in the middle. And so, sooner or later, will the solution.

The real questions are how long it will take to get there, and how bloody it will be.

Update: The NBA has clarified that while the New Jersey Nets financial statements examined by ESPN.com do include amortization of assets related to the team purchase, this amortization is removed from the statements that are shared with the players association, and the league's stated loss figures do not include these amounts.

Larry Coon is the author of the NBA Salary Cap FAQ. Follow him on Twitter.

Larry Coon is the author of the NBA Salary Cap FAQ.