NBA Franchise Valuations: The Business of Basketball

By Austin Tymins

As a result of the Donald Sterling controversy, the Los Angeles Clippers went up for sale in what quickly descended into a bidding war. Former Microsoft executive Steve Ballmer ended up with the highest bid for the team for a record-setting $2 billion. However, the most recent valuation done by Forbes magazine only had the Clippers listed at $575 million.

The price of NBA franchises in recent years skyrocketed, a phenomenon that can be attributed to two primary reasons. First, the new Collective Bargaining Agreement reached in the 2011 strike-shortened season has dramatically improved profit margins for teams (at the expense of players and the 2011 season). Second, local TV revenue has risen steeply as sporting events represent one of the few types of television programming still predominantly watched live—and therefore valuable to advertisers—and the Clippers current TV contract is up for renewal in 2016.

The owners of sports franchises often say they plan to run their teams “like a business”. However, as we can see from these graphs below, the NBA is particularly expensive business to be in. In the first graph I have plotted the 30 teams of the NBA with the 30 largest companies on the Dow Jones. As expected, the largest companies in the country dwarf the franchises of the NBA (shown on a log scale).

A commonly used metric in stock investing known as the price-earings ratio (or P/E ratio) can be applied to NBA franchises to measure relative value. A high P/E ratio is typical of a company that is expecting high earnings growth in the future, or one that is overvalued. In the histogram below, we see that the vast majority of NBA franchises have significantly higher P/E ratios than the companies of the Dow Jones. It is important to note that some NBA teams were excluded because of negative earnings while none of the Dow companies had negative earnings. The histogram below uses the Forbes Valuation for the price.

Forbes had the Clippers listed for $575 million before they were sold for $2 billion, or 3.478 times more than predicted. For the next histogram, I applied the Clippers’ valuation multiple to every team in the league to come up with a rough estimate of P/E ratios in the NBA. This is equivalent to multiplying every Forbes Value by 3.478, which is surely a vast over-approximation. This is what the new valuations and P/E ratios would look like.

Although NBA teams don’t typically publish their financial information, it is possible to use operating income as a starting point to estimate earnings. Looking just at estimated earnings, we see that NBA franchises are vastly overvalued. Below is a graph comparing the 30 NBA franchises’ P/E Ratio to that of the 30 largest firms on the DOW. The Clippers’ P/E ratio is 205.13, a number considerably higher than even a high growth stock like Netflix (NFLX). According to only relative valuation metrics, Ballmer’s purchase looks absurd. However, the team’s appreciation when Ballmer decides to sell the team could very well make the purchase profitable. Sterling bought the team in 1981 for $12.5 million, and since then its value has appreciated by 15,900%. This works out to a 17.8% compounded annual growth rate, far better than the 11.2% the S&P 500 grew over the same period. While this growth is certainly remarkable, it will likely slow down considerably well before we start to see $100 billion NBA franchises.