Monday, October 29, 2012

Revenue, Profit, and the Winnipeg Experiment

I think that at this point you have to be pretty pessimistic about a season. There's a lot of hard feelings among the fan base towards the owners, and this is understandable. The players are the ones we pay to see, the ones we talk about at the water cooler, the ones that were our heroes growing up. It's easy to cast the owners and Mr. Bettman as the bad guys. Is that really the case?

Personally, I'm not sure they're actually malevolent. I don't think Mr. Bettman hates the game. Say what you want about him, but league revenues have grown from around $400 million when he started as commissioner in 1993 to the whopping $3.3 billion figure we see quoted daily in the papers. That is truly an amazing feat, and I believe that it owes a great deal to Mr. Bettman's aggressive efforts to expand the league into new markets and establish a stronger television presence in the US. This makes it all the harder for us to accept Mr. Bettman's point that revenues do not necessarily reflect profit. It's hard to believe that owners today aren't making 8 times as much money today as they did in 1993.

The reason is more evident when we start thinking about teams like Phoenix that lose money hand over fist. When the league has to support teams that never make money, then obviously profits take a hit. You're paying money to keep teams in these markets.

The rational explanation, if there is one, might be the hope of keeping a team in place for a long period to try to develop a fan base over time. Maybe you would project bad numbers for the first couple of years while your team gained a presence in the city and established a community. The goal would be to establish hockey markets in places where there were large populations and potential for growth, and eventually enjoy large profits where there wasn't even a market before.

If this is the case, among my first questions as an investor would be "How long before we see a profit, and how long do we wait before we call it a loss and move on?" The answer in Atlanta was about 10 to 11 years. The one time I went to Atlanta in 2006, I could tune into a televised high school football game from my hotel, but I couldn't get the Thrashers game. The owners and the league eventually accepted it as a loss and moved the team to Winnipeg, where they expected to have to battle for fans like they did in the US. Instead, they sold out every game and the team turned a tidy profit, probably for the first time in its existence.

For NHL owners, teams are first and foremost businesses. Each one has an owner, and Mr. Bettman is a bit like a CEO that oversees 30 distinct, separable, self-contained divisions of the huge business that is the NHL. Which makes the current state of the league all the more confusing. I've been thinking about it for months, and I can't come up with a single example of any business in the history of anything, ever, that has kept a discrete, self-contained division losing money like the Thrashers have without shutting it down, moving it, or drastically restructuring it. Not only this, but this CEO has been fighting actively to keep the division in the position where it's been losing money for over a decade. I don't think it's ever happened.

This is where I find the argument about profits breaks down. The owners can say that the massive increases in revenue don't lead to increased profits, and they are being perfectly truthful. However, at least one reason that revenues haven't gone up has to be because of this support for unprofitable teams, and for this, they have no one to blame but themselves.

The new-found financial success of what used to be the Thrashers franchise would have had significant impact on overall league profits. Teams are privately owned, and so don't have to release their financial information the same way a publicly owned company has to. Still, the formula is simple: 2 years ago, the Thrashers lost a lot of money. Last year, the Jets made a lot of money. The result is that there's more profit that goes into the revenue-sharing pool, and all the owners end up with more in their pockets.

The success of the Jets, or what I call the Winnipeg Experiment, is good news for Canadian hockey. We've been saying for years that we can support more teams north of the border and keep them profitable. The Jets proved that a larger population doesn't necessarily equate to a larger hockey market, which is the logic that drove many expansions into the States, and likely lies behind rumours of teams moving to such unlikely cities as Las Vegas, Seattle, or Houston.

Frankly, if the owners want to make more money, they should look into picking up teams that are ruining their profit margins and moving them to places where they'll make money. It worked for Winnipeg, and it can work in other places. Pick up Nashville and send it somewhere just west of Toronto. Shut down the massive financial hemorrhage that is Phoenix and move it to Quebec City. Hell, it would probably be more successful in Yellowknife than in Phoenix.

The argument that revenue increases do not necessarily reflect profit increases holds water. However, it follows that their losses have been steadily increasing every year. As long as the league fights tooth and nail to keep these financial dead weights alive and losing more and more money, I can't sympathize with their complaint that profits haven't been going up at the same rate as revenue. Higher profits aren't just about increasing revenue. Decreasing losses has the same effect, and the Winnipeg Experiment should show the owners that moving teams around can make for a better bottom line for all of them, without having to resort to labour stoppages that guarantee everyone loses money on the season. And hopefully brings more hockey north of the border.

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