Friday, May 30, 2014

The Price of the Bragging Rights for an NBA team just went through the roof!

“I can teach you how to bottle fame, brew glory, even put a stopper on death.” 
― J.K. RowlingHarry Potter and the Sorcerer's Stone

Steve Ballmer is paying $2 billion for the Los Angeles Clippers.  The business today has annual operating income of about $15 million.

A “normal” business with no bragging rights tends to be valued at about 5 times annual income.  Based on this crude metric, the value the Clippers’ underlying cash flow is about $75 million.

The difference between the pending sale price of $2 billion and the $75 million value of the cash flows is what we call the “Pride-of-Ownership Premium”.

The price of the Clippers is an extreme example.  Many times, an asset might have a Pride-of-Ownership Premium that is 25-50% of the value of the underlying cash flows.  But in this Clippers’ sale, the Pride-of-Ownership Premium is about 25 times the value of the underlying cash flows.


My thesis is that it’s easier to make money in the garbage business than owning an NBA team. Of course Donald Sterling totally contradicts this general rule.

Let’s consider the Pride-Of-Ownership Premium differences between two assets. They both might have the same underlying cash flows (say $15 million per year), but in the garbage business, the cost of buying the business is $75 million, while the NBA team (in the case of the Los Angeles Clippers) is going to cost Steve Ballmer $2 billion.

If the Pride-Of-Ownership Premium increases dramatically, like it has since Donald Sterling bought the team in 1981 for $12.5 million, then the NBA owner has made up for the small cash flows. Absent that boost, the NBA owner will not do as well financially.

Few prices go up forever (even in these less tangible dimensions) so what if, for unforeseen reasons, the Pride-Of-Ownership Premium for an NBA franchise actually drops? Suppose the NBA loses popularity to other sports (say they start losing more of their audience to the X Games) or the league is the object of nasty player strikes and the union leaders consistently talk about the rich NBA owners’ exploitation of the workers? Then the differences in the relative returns would be even more dramatic.

Once you have made your fortune, you can afford to “invest” in these bragging rights.  But until then you better realize that the Pride-of-Ownership Premium can drop just as easily as it can increase – just like everything else in life.

Make sure and download a copy of Lucky and Good: Risk, Decisions and Bets for
Investors, Traders and Entrepreneurs

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