NBA Ownership: The Money Is in Cashing Out, Right?

Emile AvanessianCorrespondent IJuly 17, 2010

Early yesterday afternoon, CNBC reported that Joe Lacob, managing partner at venture capital firm Kleiner Perkins (early investors in Google in addition to over 150 companies that have gone public), and Peter Guber, chairman of Mandalay Entertainment, will purchase the Golden State Warriors for an NBA-record $450 million—the previous mark was the $401 million paid by Robert Sarver paid for the Phoenix Suns in 2004—despite reportedly being outbid by Oracle CEO, billionaire Larry Ellison.

Although, it should be pointed out that Ellison’s final bid was submitted after the deadline for bids had passed.

The Warriors franchise was bought by Chris Cohan in January 1995 for $119 million, and valued at “just” $315 million by Forbes in December 2009, but apparently the Warriors' monopoly on the NBA in the Bay area, along with a rabid, non-fairweather fan base, played a role in the franchise’s premium valuation.

Now, one might be compelled to ask why, in a sluggish economic recovery following the worst recession in more than half a century, a pair of presumably intelligent and wealthy businessmen would shell out more money than anyone in history for a franchise in a corporation that claims to be on the heels of a year drenched in red ink. 

One would be hard-pressed to come up with a reasonable answer. Toss in the fact that with the notable exception of their playoff upset of Dallas Mavericks in 2007,  the Warriors had the NBA’s second worst record—after the Los Angeles Clippers—in the 16 years that Cohan owned the team. Suddenly, a price tag approaching half a billion dollars begins to look a bit crazy.

Commissioner David Stern has already estimated that NBA teams will lose $370 million from the past season, and the league may be staring down the barrel of its second work stoppage in roughly a dozen years after next season.

Now, I’m by no means saying that those with the means and the desire to purchase a team shouldn't do so, but given the current economic climate in the NBA, but it might be more prudent to engage in a bit of bargain-hunting, a la Mikhail Prokhorov, who purchased his 80% stake in the New Jersey Nets at a valuation of around $270 million. And last I checked the Nets aren’t terribly far from a good-sized metropolitan area, one capable of supporting two teams in a given sport, to which they will be relocating in a couple of years.

This figure took a bit of a hit in the aftermath of LeBron James’ “Decision," falling in value from a reported $269 million to $250 million, but remains a virtual lock to eclipse $300 million, provided sales of premium seating and sponsorships at the team’s forthcoming Brooklyn arena are strong, according to Forbes.

An interesting note, according to the same report from Forbes, the value of the Miami Heat increased by 12.6% on LeBron’s decision, rising from $364 million to $410 million, with potential to go much higher in the coming years, should LeBron and Wade begin stockpiling championships.

It should be noted, however, that the team and owner Micky Arison, Chairman & CEO of Carnival Cruise Lines, still have a great deal of corporate (about $9 billion in debt for Carnival) and arena debt (undisclosed, but said to be considerable) to repay. Meanwhile, jilted LeBron lover—and Cleveland Cavaliers owner—Dan Gilbert, lost nearly a fifth of their value (yeah, I’d slam a few tequila shots and send a venomous email too), plunging from $476 million to $390 million.

For years, we’ve heard owner after owner whine about losing money year in and year out, only to ultimately watch these guys cash out a decade or two later, and book a nine-figure gain.

However, if we delve a bit deeper into Chris Cohan’s windfall, we see that, yes, he did nearly quadruple his initial investment in 16 years, but some basic math show that his investment only compounded at a rate of 8.67%, roughly ¾ of 1% more than he would have received had he simply purchased 30-year U.S. Treasury bonds at the start of 1995.

However, these returns simply will not fly in the world of venture capital, where Lacob’s firm has raised and invested billions and billions of dollars. In this world of illiquid investments—not unlike an NBA team—the required rate of return for most investors never dips below 20%, and commonly approaches 30%, with each winning deal making up for a dozen or more losers.

The success of all investing comes in buying the right asset at the right price, and where it looks as though Mikhail Prokhorov has exemplified this with the Nets, Lacob and Gruber aggressively paid up for a subpar team in a premium region.