When NBA owners locked out the players four years ago, it didn’t come as a surprise. For months before the league shut down in July 2011, both sides engaged in all sorts of public posturing meant to increase their negotiating leverage and convince the public of their righteousness. Some of it worked.
In an April press conference that proved surprisingly effective at setting the terms of the debate, then-deputy commissioner Adam Silver claimed that the league was $300 million in the red, and that 22 of the 30 teams were unprofitable. By the time the National Basketball Players Association got around to filing a National Labor Relations Board complaint, later withdrawn, alleging that the league was “failing and refusing to provide relevant financial information,” the public had already sided with the owners.
Before this season, the league was still pushing that same message, with now-commissioner Silver asserting that “roughly a third” of teams were losing money. The difference this time lay largely with new union director Michele Roberts, who responded, “the NBA’s cries of poverty will not work this time.” And looking at the evidence, Roberts is clearly correct. No one actually believes that the NBA is in anything other than excellent financial health.
In October, the league signed a new national television contract that will nearly triple the amount of money paid to each owner annually, from roughly $15.5 million to $44.4 million. Just before the playoffs began, the league announced that the 2014-15 regular season set a new attendance record. And, of course, franchise-selling prices are increasing exponentially. Silver, notably, made no mention of teams losing money at his February state of the league address.
Roberts’s response to Silver was one of the many combative statements she has made since being elected executive director 10 months ago. Given a chance to back her words with action at the All-Star break, the union unanimously rejected the league’s “cap-smoothing” proposal. Now the NBPA has decided to once again undertake an action sure to displease the league’s owners, telling Deadspin that it plans to exercise its option to audit the books of up to five teams later this summer. The union has held this right since at least 1995, but has rarely, if ever, utilized it.
The collective bargaining agreement, or CBA, that governs the league doesn’t expire until 2021, but either side may give notice by Dec. 15 of next year that it plans to opt out after the 2017 season. Roberts herself has said that it is a “pretty good bet” that the union will opt out, and independent experts don’t think she’s bluffing.
After speaking with sports economists, lawyers, and sports business reporters, as well as reviewing league documents, court documents, and SEC filings, it is apparent that the players have a strong argument that they are currently being screwed out of money that is rightfully theirs. Under the CBA, the money allocated to players comes from a pool of what is known as basketball-related income, or BRI. Players get half of this revenue, which was almost $4.5 billion last season, and the definition of it under the terms of the CBA is woefully out-of-date—to the detriment of the players. Their strongest argument, simplified, is that the owners are putting money in both their left and right pockets and saying, “Well, we only agreed to split the money in my left pocket.”
The 2011 NBA lockout was a fight between the owners and players over who got a bigger slice of the league’s revenue pie. The coming strike will be a fight over what goes into the making of that pie in the first place.
Owners Can Cut Deals With Themselves to Hide Money From Players
When the most recent lockout finally ended, just in time for an abbreviated 66-game season, the owners were clearly victorious. Among dozens of comparatively minor changes to the CBA, the key modification was an enormous reduction in the percentage of basketball-related income that went to the players, from 57 to 50 percent. (Technically, the players’ share of BRI can fluctuate between 49 and 51 percent. Two seasons ago they received 49.96%, and last season they got 50.09%.) Based on the future revenue forecasted in the CBA—and this was grossly underestimated, as it didn’t anticipate the new national television deal—this change amounted to a $3.5 billion loss for the players over the agreement’s 10-year lifespan.
The BRI section of the CBA outlines exactly how much of which revenue streams the players are entitled to. This includes obvious sources like local and national television deals and tickets sales, and also more obscure founts of money like fixed arena signage and mascot appearances. But the BRI section of the 2011 CBA looks remarkably similar to the BRI section of the 1995 CBA, with the main changes being additions to the list of things excluded from BRI. This can only be described as an enormous oversight by the union during the bargaining sessions in 1999, 2005, and 2011, all of which were overseen by then-director Billy Hunter.
In a recent profile in The Atlantic, Roberts was characteristically blunt about her predecessor’s performance. “The formula has been: after a few months when the checks don’t come, the players cave,” she said. “I can’t say with certainty what Hunter did wrong. But he clearly failed.”
Michele Roberts testifies before the Senate, 2014. Photo via Getty
The most obvious failure was in agreeing to that seven-percentage point drop in the players’ share of revenues. The less obvious but perhaps even more damaging one was never significantly renegotiating the definition of basketball-related income. Not having kept up with trends in sports ownership, the obsolete language fails to properly account for the increased entanglement of NBA teams and related businesses. Ten team owners, for example, also own the arena their team plays in, and five have an equity stake in the regional sports network, or RSN, that broadcasts the majority of their games. But the CBA has little to say about these issues.
As written, the deal between players and owners essentially assumes that an NBA owner doesn’t own any related businesses. Since players receive half of BRI, they have a strong preference for owners to negotiate the most lucrative possible deals with third parties like arenas and television networks. Most of the time NBA owners share this preference, and everything is fine. But when an NBA owner also owns a related business, suddenly their incentives aren’t necessarily aligned with those of the players.
Assume for a moment that the same person owns both an NBA team and the network that holds its local broadcast rights. If the owner’s media company pays the owner’s NBA team $15 million to broadcast the games, the players receive $7.5 million of that. But if the owner pays himself a dollar to broadcast the games, the players only receive 50 cents. To the owner, it’s all just a matter of accounting and shifting money from one ledger to another. To the players, it matters dearly.
Such situations are regulated by the CBA’s related party section, which is as dated as its BRI definitions. In fact, the 2011 CBA simply refers to the 1995 CBA for the definition of a related party, and that definition isn’t particularly clear. A related party is considered to be a third party “owned or controlled, directly or indirectly, by the persons or entities owning or controlling the NBA Team.” Proceeds received from related parties that fall under the BRI definition are considered BRI, and there is also a procedure for utilizing independent accountants in the cases where “such net proceeds cannot reasonably be determined for transactions entered into with an entity related to an NBA Team.”
To an extent, the related party clause protects players, and they want it in place. In Brooklyn, for example, Russian billionaire Mikhail Prokhorov owns 80% of the Nets, while real estate developer Bruce Ratner owns 20%. Meanwhile, Ratner owns 55% of the Barclays Center, where the Nets play, and Prokhorov owns 45%. While both entities are entirely owned by the same two men, by the NBA’s definition, the Nets and Barclays Center are not related parties. If they were to engage in any revenue-shifting shenanigans, the players would be helpless to collect their money. They would prefer the Nets and Barclays Center to be considered related parties.
But back in 2000, sports economist Andrew Zimbalist explained how arena deals can be massaged to benefit owners. In an article in the journal The Economics of Sports, he wrote this in regards to arena signage:
Suppose you are an owner negotiating an arena lease and are given a choice: pay $2 million in rent and receive 50 percent of a projected $4 million in signage income or pay no rent and receive no signage. It might seem that this is a choice between equals, but since the CBA gives 40 percent of signage income to the players, the owner would do better with the second option of no rent/no signage. Lease agreements offer manifold opportunities for such juggling, especially when the arena and team are owned by the same person or entity.
While the related party clause can protect players, it can also be used to harm them, and nowhere is this a bigger concern than with the New York Knicks.
The Knicks Are Headed for a Showdown With the Union
The Madison Square Garden Company owns the Knicks, Madison Square Garden, and the MSG Network. This presents a host of problems in the abstract, but since at least 1995 the league and players have dealt with them in a relatively elegant way. For local media rights, the value of the Knicks’ deal is assumed to be the same as the Lakers’. From the 2011 CBA:
BRI for the Knicks for each NBA Season covered by this Agreement shall include an amount equal to the net proceeds included in BRI attributable to the Los Angeles Lakers’ sale, license or other conveyance of all local media rights (including, but not limited to, broadcast and cable television and radio) for such NBA season.
The CBA also has a specific workaround to determine the value of the Madison Square Garden signage:
BRI for the Knicks for the 1999-2000 NBA Season shall include $3,750,000 for signage. In each subsequent Season covered by this Agreement, this amount shall be increased (or decreased, as the case may be) by the League-wide percentage increase (or decrease) in signage as determined in accordance with Section 1(a)(1)(v) and (a)(1)(vi) above.
While these are adequate solutions to address a complicated problem, they’re not perfect. The NBPA could, and probably has in the past, argued that in both cases the players are losing money from these workarounds.
According to the latest Nielsen estimates, there are 7.44 million television homes in the New York market, and only 5.52 million in the Los Angeles market. Other factors, like media market competition and the strength of each team, are similarly unaccounted for in the workaround. It’s quite possible, perhaps probable, that the Knicks’ broadcast rights are more valuable than the Lakers’, yet they’re assumed to be of equal value. And until the recent signing of a huge local broadcast deal with Time Warner, the Lakers were locked into a surprisingly below-market deal. The players were thus doubly screwed by the poor Lakers deal.
There is an interesting catch in this arrangement. If and when the Knicks are no longer “related parties” with Madison Square Garden or the MSG Network, the CBA stipulates that the workarounds will be thrown out the window:
At such time as the MSG Network and/or the Madison Square Garden Arena are no longer Related Parties, BRI for the New York Knicks in the categories described in Section 1(a)(7)(iii)(A) and/or (B) above, as the case may be, shall not be determined in accordance with the foregoing and will instead be determined by the applicable provisions of Section 1(a)(1) and (a)(7)(ii) above.
In March, the Madison Square Garden Company announced in a Securities and Exchange Commission filing that sometime before the end of 2015 it will spin off its sports and entertainment properties—the Knicks, Rangers, Madison Square Garden itself, and so on—into their own company. These holdings will thus be separate from its media properties, like the MSG Network.
New York Knicks owner James Dolan, 2014. Photo via Getty
But whether the Knicks—which according to the SEC filing will be owned by a new company called MSG Spinco—and the MSG Network will still be considered “related parties” is a very complicated question to answer. MSG Spinco’s SEC filing says that “Charles F. Dolan, members of his family and related family entities will elect up to 75% of the new company’s Board of Directors.” This is the same group that owns the majority of the Knicks, and they will clearly have more than half-control the new company. For the NBA’s purposes, it would seem, these two new companies will be considered related parties, keeping the Knicks’s specific BRI workarounds in place.
According to a corporate governance lawyer I had review the CBA and SEC filings, it’s not so cut and dried. The CBA’s definition of related parties, for instance, doesn’t actually define what “owned or controlled, directly or indirectly” means. Does a person or corporation have to own or control the corporation’s votes, or value, or ability to name directors, or something else?
The practical importance of this vagueness is that while the two companies will probably still be considered related parties, if the NBPA and its lawyers wanted to challenge that, they’d have the basis for an argument. And since there is a credible argument that the players are losing money because of this related party arrangement, they probably will. (When asked whether the Knicks and MSG Network will still be related parties after the spin-off, an NBA spokesperson tells me “we are still reviewing the specifics of the deal and how, if at all, it will impact the Collective Bargaining Agreement.”)
If the Knicks and MSG Network will soon be owned by separate but connected companies, what will happen to the Knicks’ local media rights? According to the SEC filing, as part of the spin-off, the two companies will immediately sign a new agreement:
In connection with the Distribution, we will enter into media rights agreements with MSG that will provide our fans with the ability to watch locally televised home and away games of the Knicks and Rangers, as well as other programming related to our teams, on MSG’s award-winning regional sports networks. The media rights agreements will have terms of [—] years.
This is the point at which the union will begin to suspect ill intentions, and at which their lawyers will demand every single document relating to this already agreed upon deal—especially since there have been numerous reports (here’s one) suggesting that the real purpose of the spin-off is to facilitate a sale of the MSG Network.
In an admittedly far-fetched scenario, assume that the Dolan family and Fox Sports have already struck a deal. When MSG Spinco sells the Knicks’ local media rights to the MSG Network, it will do so for $1. Then Fox Sports buys MSG Network, doing so for an inflated cash price because it holds the Knicks’ broadcast rights for just $1. The Dolan family would be receiving a higher sale price for the MSG Network but only a $1 annual rights payment from Fox, instead of receiving a lower sale price for the MSG Network but getting millions of dollars a year in annual rights payments. To the Dolan family it is just a matter of accounting and choosing which pocket the money goes into. The money that goes into one of those pockets counts as basketball-related income, though, which entitles players to half of it. The other doesn’t.
NBA commissioner Adam Silver at an innovation conference, 2015. Photo via Getty
You don’t have to be a conspiracy theorist to see why the Players Association will object to MSG Spinco’s stated plans. The New York sports media market is one of the most vibrant in the country, with the MSG Network, YES Network, and SportsNet New York all owning sports broadcast rights. But instead of soliciting bids from these wealthy media conglomerates for the right to broadcast Knicks games—for possibly more money than the Lakers are getting—MSG Spinco has already announced that they will “sell” them to the MSG Network.
Not selling the rights on the open market almost assures that MSG Spinco will sell them for a below-market price. And as long as MSG Spinco and the MSG Network are considered related parties by the NBA, that’s okay—the actual selling price for the rights is merely an accounting trick as far as the Players Association is concerned. What happens in a year or two, though, if the MSG Network is indeed sold by the Dolan family? The Knicks and the presumably renamed MSG Network will no longer be related parties, and thus the players—instead of receiving half of the revenue from a deal valued the same as the Lakers’s—will begin receiving half of the below-market deal the Knicks signed.
Large sums of money are involved here. A few years ago, Time Warner purchased 20 years of Lakers local media rights for $4 billion. Assuming that the deal the Knicks could get on the open market would be roughly comparable or better, either of the disaster scenarios described above means the players would be out hundreds of millions of dollars.
When asked to comment on the SEC filing, as well as related party transactions more generally, the NBPA provided an interesting statement:
The union predicted the potential for many scenarios, and closed the loopholes over the years in CBA negotiations and we’re prepared to address any new ventures from owners that would otherwise drain revenue from our shared pool.
We feel confident that any assets or relationships that could generate revenues for owners or the League, and should belong in BRI, will be calculated in in the BRI, per the current CBA.
For many years, the CBA has also included a provision that allows the union to engage its own independent firm to audit five teams of its choosing. This audit process can be initiated following the audit of the League and every franchise conducted at the end of every season by PwC. A similar protocol is followed in both hockey and football. To date, this option was used sparingly by the NBPA. Starting this year, the union will exercise this option and conduct the five-team audit annually.
The important part of this is the third paragraph, where the NBPA reveals that they will take advantage of the following provision in the CBA, allowing them to audit five teams:
The Players Association shall have the right as part of the annual review of BRI Reports to retain its own accountants (the “Players Association’s Accountants”), at its own expense, after the submission of each Audit Report under this Agreement (the “First Audit”), to audit the books and records of up to five (5) NBA teams (of its choosing)
Given that this is a right enshrined in the CBA, it is astounding that Billy Hunter never took advantage of it, and instead essentially said, “Well, I trust teams to report finances accurately” even while he was filing complaints about the NBA not turning over certain team financial documents. When asked which teams the union plans to audit, the union says, “We will not choose the five teams until after the BRI audit is completed.”
Even with the union demurring, you can bet that the Knicks will be one of the five, and that more generally the union will target teams that earn the most revenue and have a host of complicated related party issues. An informed guess would be that the Knicks, Nets, Mavericks, Nuggets, and Lakers will be audited, with the Rockets, Bulls, and Warriors candidates as well.
Broadcast Equity Deals Are Already Costing Players Money
As regional sports networks like the MSG Network grow in prominence, they’re increasingly paying for rights to broadcast NBA games in ways that screw the league’s players out of money. One workaround is including an equity stake in broadcast deals. For example, to purchase the right to broadcast Celtics games for 20 years, CSN New England reportedly paid somewhere in the neighborhood of $35 million annually, and also gave the team a 20% equity stake in the channel.
Using a few hypothetical figures along with back of the envelope math illustrates why the union has a problem with these deals. Let’s assume that the Celtics are being paid $35 million annually for 20 years, for a total of $700 million. Let’s also assume that when the deal was signed, CSN New England was valued at $500 million, so that the Celtics’ 20% equity was worth another $100 million. In effect, the deal the two sides agreed upon valued the Celtics’ broadcast rights at $800 million over 20 years.
The players, though, are only entitled to half of the $700 million that was explicitly paid for the rights to broadcast games, meaning they lose out on $50 million. No matter what CSN New England’s actual valuation is, any amount of rights fees over $0 “paid” via equity is money the players never see. This gives teams a powerful incentive to take their payments in equity stakes and other assets that aren’t classified as basketball-related income. As we saw before, the team doesn’t particularly care which of two pockets revenue goes into—though of course there is a risk (or reward) in having an equity stake instead of cash—but the players do.
James Harden and Dwight Howard in happier days for CSN Houston. Photo via Getty
What’s especially perverse is that not only do players not share in the upside of equity stakes in RSNs, they’re actually subject to the downside. In October 2012, Comcast, the Rockets, and the Astros joined forces to launch CSN Houston. The network was valued at $700 million, of which the Rockets owned 31.5%. They also sold the network their long-term broadcast rights. But CSN Houston was a failure from the beginning, unable to work out deals with DirecTV, Dish Network, or AT&T U-Verse to carry the channel, and was thus available to only about 40% of customers in the Houston area. After fewer than two years of operation, CSN Houston declared bankruptcy. Today it no longer exists.
There were many reasons for the network’s failure, but one of the biggest was the Rockets’ and Astros’ equity stakes. Together they owned 78% of the network, meaning Comcast only owned 22%. Comcast put up $100 million in startup costs, but when that ran out, they decided not to throw good money after bad. According to David Barron, a Houston Chronicle reporter who has exhaustively written about the CSN Houston debacle, both the Rockets and Astros accepted larger equity stakes in exchange for lower rights fees. With no partner owning a supermajority of the network, and all three having different priorities and visions, the entire thing crumbled.
And how do the NBA’s players fit in here? First, they received less money than they otherwise could have from rights payments because the Rockets accepted more equity for less rights money. Further, with the CSN Houston mess still being hashed out in bankruptcy court, the Rockets haven’t been paid. Barron reports that the Rockets have unsecured claims of $101.3 million—primarily, but not entirely, from unpaid rights fees—against CSN Houston. The issue has yet to be resolved, but the players have already lost out. The BRI pool was smaller than it should have been last year because the Rockets were never paid their rights fee. If they ever are paid them, it will surely be less than the full amount.
A Strike Is Coming
It is clear that the league is nervous about the prospect of the players opting out of the CBA and reopening it for negotiation. Just last weekend, Adam Silver went on the radio and threatened that there are also CBA items that the owners want addressed. But when it comes to labor negotiations, Adam Silver isn’t on the side of the players. If he is warning them not to opt out, it probably means they should opt out.
If the NBPA were to strike in 2017 they would certainly be in a stronger negotiating position than 2011, but still likely would be unable to win a significant increase in the percentage of basketball-related income they receive. Everything else is negotiable to the league, but BRI is the hill the owners would die on. They give every sign of being willing to blow up an entire season to prevent giving back money.
Where the union might have success, though, is forcing new rules regarding related-party transactions and other things that constitute BRI. They may not be able to increase the size of their slice of the pie, in other words, but they may be able to cut into a larger one. Sports economist Andrew Zimbalist suggests that Roberts would likely argue for a broader definition of BRI, as well as arguing that teams receiving equity stakes in RSNs is a “capitalization of an income stream,” and therefore should count as BRI. If successful, the players would receive more money without having to fight over the topline BRI distribution.
Either side can opt out of this deal in a mere 19 months, and the fight begins in earnest now. The union is preparing their response to MSG Spinco’s plans, and that is going to spill over into general strike preparations. And they didn’t elect Michele Roberts as executive director to watch her sit on her thumbs while there is money out there they could be making.
Illustration by Jim Cooke