Friday, July 06, 2007

The collective bargaining agreement
How high will the cap go?

That first year postlockout, with the Canadian dollar up to about 84 cents (U.S.), the cap was set at $39-million (U.S.). Then two things happened: the Canadian teams rode a wave of pent-up demand for their product, filling their buildings, maxing out their revenues, and the Canadian dollar began to climb toward parity.

That swing was enough to push overall league revenues up, even as American television money dipped, and many U.S.-based franchises were struggling to reclaim even the modest fan bases they had maintained before the lockout.

This year, with the Canadian dollar closing in on 95 cents — up more than 27 per cent over the spring of 2004 — the new cap number is $50.3-million.
It's true: The steadily rising Canadian dollar has helped push NHL revenues higher, along with the salary cap's floor and ceiling. What we don't know, precisely anyway, is just how much of a factor that boost has played.

Given the details regarding what the players' percentage of total revenues will be this season (a figure that has risen from 54 per cent to 55.5 for 2007-08), we do know that league revenues have topped $2.3-billion. It will take an additional $200-million boost for that percentage to escalate further to the next tier outlined in the agreement: 56.3333 per cent.

A brief look at the relevant section of the CBA, 50.4, which is entitled 'League-wide Player Compensation, Players' Share, Escrow Account':
For the 2005-06 League Year, the Players' Share shall be fifty-four (54) percent of Actual HRR.
Actual HRR for a League Year is $2.3 billion; the Players' Share for such League Year will be 55.5 percent of Actual HRR.

Actual HRR for a League Year is $2.5 billion; the Players' Share for such League Year will be 56.33333 percent of Actual HRR.

Actual HRR for a League Year is $2.6 billion; the Players' Share for such League Year will be 56.66667 percent of Actual HRR.
For any League Year (other than the 2005-06 League Year) for which Actual HRR is equal to or exceeds $2.7 billion, the Players' Share shall be fifty-seven (57) percent of Actual HRR.
How close we get to that $2.7-billion, 57-per-cent high-watermark, however, is still anyone's guess.

The six Canadian NHL clubs are said to generate one-third of league revenues, meaning that even a 10-per-cent boost in the strength of the dollar would augment that $2.3-billion figure to some point in the neighbourhood of an additional $80-million. Another favourable bump from a rebound in key American markets such as Los Angeles, Chicago and Boston could push that increase up further, as could things such as inflation and, hey, how about that elusive U.S. network television contract?

I'm kidding.

Let's be kind, and for argument's sake imagine a wondrous, $200-million jump for league revenues this coming season. Where would a $2.5-billion NHL put the league's salary cap?

The CBA's cap calculation works by determining a midpoint for what's termed a salary range, which is essentially a $16-million span from the floor to ceiling. This coming season, for instance, with a cap of $50.3-million, the midpoint falls at $42.3-million and the floor another $8-million lower at $34.3-million.

That $16-million figure is a constant, regardless of how high the cap goes.

To find that midpoint takes some minor arithmetic: Multiply the players' percentage of revenues (56.333%) by league revenues ($2.5-billion), minus what are termed "preliminary benefits" (which we'll assume remain the same as in 2006-07 at around $90-million). Divide that figure by the number of clubs in the NHL, and we have our midpoint.

(56.333 x $2.5-billion) - $90-million
30 NHL teams


The $2.5-billion NHL's salary cap
Cap midpoint: $43.9-million
Floor: $35.9-million
Ceiling: $51.9-million

That doesn't seem all that bad: After all, the ceiling has risen just $1.6-million from where it will sit this season. But what's not taken into account is the 5-per-cent bump which comes at the discretion of the NHLPA, something likely to come into play (as it did this year) and that would put the $2.5-billion NHL's cap at roughly $54.5-million.

All that said, I think $2.5-billion is a generous estimate — but I'm no economist (surprising, I know). It's certainly reasonable — downright guaranteed, really — that the league will hit this target by the following year, and that revenues will continue to rise and push the cap further north.

Using a little bit of algebra, the salary-cap ceiling would reach $60-million at roughly $3.17-billion in revenue, or $865-million (38 per cent) higher than last season. It's taken roughly seven years for the league to grow to that extent, at least based on a crude apples-to-oranges comparison using NHLPA-provided revenue data from the last 12 seasons.

In other words, we should have a ways to go before a $44-million salary floor is the norm.

My apologies if this was either too complicated and/or elementary an approach at this business; I plan on coming back to it again as more revenue-related information becomes available.

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16 Comments:

At 8:36 AM, July 06, 2007, Blogger FAUXRUMORS said...

1) What happens if/when the Canadian dollar resumes its traditional value against the US dollar from 95% to 80%?
2) Add to that, both countries have experienced relative economic prosperity the last few years. History shows us that an adjustment(recession) is not an unlikely possibility. Therefore its not a guarantee that the cap will continue to rise every year.

 
At 9:45 AM, July 06, 2007, Blogger BlackCapricorn said...

Also, without a true tv deal in the US, the cap can't go much higher because this is such a gate driven business and the Canadian Dollar can only do so much against the USD. I think the cap will be capped in the next year or 2.

 
At 10:06 AM, July 06, 2007, Anonymous Anonymous said...

James, regarding the seeming ongoing mystery among commentators as to the impact of the exchange rate on NHL revenues (a mystery which baffles me, as I have solved it using grade eight level math), I have posted at length on this topic recently on HF Boards. Here is my post, reproduced for your readers:

[The assumption that the exchange rate has had a significant impact] is based on a rather misleading (unintentional I assume) miscalculation. It is not relevant to take a number that is the low point in a given year and compare it to the high point in another year.

The CBA provides (quite sensibly so) that the exchange rate for purposes of revenue calculation is based on the average excahnge rate for the League Year (a defined term in the CBA that runs from July 1 of a year to June 30 of the subsequent calendar year). That is how revenues are calculated, so that is what we use to compare the relative impact of exchange rates.

Using that measure, the exchange rate has been as follows:

2004-05 (strike year) - CDN$1 = US$0.8002

2005-06 - CDN$1 = US$0.8602

2006-07 - CDN$1 = US$0.8831

Now - what Canadian denominated revenues shall we plug in? . . . I have substantial doubts about whether Canadian teams make up one third of NHL revenues, as reported by TSN a number of months ago. My own view is that Canadian teams make up one third of gate revenues, and it was simply lost in translation from player agents to hockey reporters.

HOWEVER, for purposes, I would accept that figure and use one third of revenues as an approximation. Accordingly, I will use US$750 million as a plug number for the calculation (to the extent that this number is too high, as I suspect, the impact of the exchange rate will be less).

Moving along, here are the calculations:

2005-06 - assume US$750 million in Canadian revenues (approximately one third of NHL revenues that year). Assuming all Canadian team revenues are in Canadian dollars (which is not correct, resulting in a further overstatement, but I will give it the benefit of the doubt), this equates to CDN$871.890 million ($750 million divided by .8602).

2006-07 - this same CDN$871.890 million, based on an exchange rate of .8831, is US$769.97 million.

The year-over-year impact is $19.97 million.

(Note: if Canadian revenues are US$700 million, the impact is only $18 million and change).

Note as well that this assumes (incorrectly) that all Canadian team revenues are received in Canadian dollars which must be exchanged. Given that Versus revenues are denominated in US$, this is incorrect for that reason alone. However, it may be that the Canadian national TV contracts are denominated in CDN$ (although that is far from a given) and that would require a counter-adjustment. I would expect that this would work out to a null effect, as Canadian TV revenues that are spread out league wide would be offset by certain revenues that Canadian teams would get in US$ (US TV revenue, certain sponsor contracts from US companies, etc.). Either way, as you can see, with an overall difference of two cents year over year, such differences are in all likelihood immaterial, as I have given Canadian revenues the benefit of the higher assumption as stated above.

I hope this helps. Comments are welcomed as always.


In a further post, I pointed out that, no matter which number you use for Canadian revneue, the difference in the exchange rates is such that the rate differential has only a US$200k impact for every additional CDN$10 million in revenue. At the end of the day, the difference in exchange rates for 2005/06 and 2006/07 is only 2.29 cents. That is all.

Cheers,
Gerald

 
At 10:31 AM, July 06, 2007, Anonymous David Johnson said...

The problem is the salary cap is based on projected revenues, not past revenues. What we don't know is what exchange rate the league used to project what next years revenues will be? Were the conservative and used $0.91 or were they aggressive and used $0.94. Similarly we don't know what they used last summer to come up with $44 million. What if they used $0.86 and this year they used $0.94. That is a 9.3% increase in the exchange rate. On $700 million that is $65.1 million. Spread that over 30 teams and the impact is a bit over $2 million in the salary cap.

So, in my opinion the worst case scenario is that the exchange rate increased the salary cap by $2 million over last year.

 
At 10:35 AM, July 06, 2007, Anonymous David Johnson said...

Actually, I forgot to multiply by the players share so if the players are to get 56% then the $65.1 million becomes $36.5 million resulting in $1.2 million being the maximum impact on the salary cap due to the exchange rate.

 
At 11:05 AM, July 06, 2007, Blogger FAUXRUMORS said...

1) So if the exchange rate really is a red herring with regard to revenues, then why all the hoopla 10 or so years ago when the non-Toronto Canadian franchises were given compensation for the currency disparity back then?
2) Is it just a coincidence that since the exchange rate has become much more favourable that the teams up north are much more profitable?

 
At 11:19 AM, July 06, 2007, Blogger Vic Ferrari said...

Excellent post James. A question though, how did you arrive at the 90 million USD figure for Benefits? That seems about 20 million high to me, granted I haven't dug into it.

Worth noting also that there is not a "5% growth trigger" or some such. Not now that the hockey related revenues have exceeded 2,100 million USD. This multiplier can be any number that the NHLPA and NHL agree upon. Though as Tim Wharnsby reported, 1.05 does seem to be the multiplier that the NHL and leaderless PA agreed to this season, after using a 1.00 multiplier one year ago.

 
At 11:28 AM, July 06, 2007, Anonymous David Johnson said...

That is because back then the Canadian dollar was sitting around $0.65 but the dollar rose to about $0.85 by the time hockey returned from the lockout. That's the equivalent of raising your ticket prices 30%. The increase hasn't been quite as dramatic the past year or two (at least on a percentage basis).

 
At 11:36 AM, July 06, 2007, Anonymous snafu said...

The time frame is all wrong. The question is what impact have currency fluctuations had on NHL revenues over a time period greater than 1-2 years?

League revenues were $1.76 billion once all 30 teams were installed. Even that is misleading because the league uses a new formula to disclose what NHL HRR is post-lockout, however they are now $2.33 billion. Coincidentally, nested within this time frame is the period when the loonie was trading at the 0.6-0.65 to the USD range.

What is "known" is teams gate receipts for the Canadian teams, translated to the USD at 0.88, for the latest season. If you isolate that, and work backwards to the various years, you can figure out the exchange rate effect. One may borrow from Levitt and estimate that in-arena sales comprise 40-50% of the revenues from gate receipts. The rest would have to come from media deals which probably can be found for Canadian teams.

If I have time, I'll do the exercise in HF, however making grand, sweeping statements about the league as a whole doesn't work in an environment where US-based teams have lowered and raised ticket prices, and where some have suffered at the gate as well. On the Canadian side, any ticket price increases not only increase revenues due to price hikes, but there's a multiplier effect if the local currency is increasing relative to the reporting currency.

There may be huge individual variances, but these really can be masked when you throw it all into one pot.

 
At 12:08 PM, July 06, 2007, Blogger Vic Ferrari said...

Gerald:

Seems like sound reasoning to me. What is your nickname on HF?

I'd take it further as well, because many teams hedge currency. Obviously the lowest cost means of accomplishing this is selling advertising in USD, but by conventional means as well I'm sure. Depending on their personal situation of course.

Also, a strengthening of the CAD relative to the USD weakens the equity position of Canadian ownership. Though the plainly bizarre sequence of events surrounding Jim Balsillie may or may not have done something to remedy that. Depending upon the level of cynicism of the valuators I suppose. I dunno, haven't been following it closely enough, just going by smell on that issue for now.

I'm not sure that you're being overly conservative in your calculations of CDN team shares of revenue though. Television and new media are huge sources of revenue for the NHL. And like all non-NFL sporting leagues ... the vast majority of that revenue comes from local audiences.

Many US teams draw excellent local audiences, but several other US clubs pull minute ratings. So when a San Jose game pulls 30,000 viewers ... even though the PCMs are ineveitably going to be terrific, I'm pretty sure that this is negative HRR. Granted it appears they are buying airtime directly from FOX for some of the games, probably creating some synergy with their in-arena sponsors, shelling out a whack of comp tickets to said people. Just trying to grow the market in the Bay area, and probably not a bad ticket, surely the financial picture on the TV side is grim though.

Contrast that with the Canadian teams ... it's a license to print money.

 
At 12:10 PM, July 06, 2007, Anonymous Anonymous said...

The problem is the salary cap is based on projected revenues, not past revenues. What we don't know is what exchange rate the league used to project what next years revenues will be? Were the conservative and used $0.91 or were they aggressive and used $0.94. Similarly we don't know what they used last summer to come up with $44 million. What if they used $0.86 and this year they used $0.94. That is a 9.3% increase in the exchange rate. On $700 million that is $65.1 million. Spread that over 30 teams and the impact is a bit over $2 million in the salary cap.

David, the factors you reference do not come into play. The exchange rate plays no factor in determining projected revenues for purposes of the salary cap. The cap is determined by taking ACTUAL revenues already converted at the relevant year's exchange rate (that is, 2006-07 revenues using the 2006-07 exchange rate) and upping it by whatever multiplier is negotiated (or, in the absence of an agreed number, 5%). What the future echange rate is going to be does not enter into it, sorry. That being said, the NHLPA may internally consider it in the context of whether they think they are going to have to lose escrow dollars (i.e, if the CDN$ took a dive, they would be less likely to insist on a full multiplier, and vice versa), but that is not a part of the actual empirical calculation of the cap itself. I hope that clears that up for you.

As to your point regarding using .94, if next year the CDN$ stays at that level throughout so as to average that amount for the League Year, then certainly that would have an impact in future years. As noted, there was a 6 cent increase from 2004-05 to 2005-06, which certainly would have impacted the cap (had there been one in 2004-05, of course). Whether that happens remains to be seen. Keep in mind once again that it is the average throughout the year, not some point in time.

Gerald

 
At 12:31 PM, July 06, 2007, Anonymous Anonymous said...

Seems like sound reasoning to me. What is your nickname on HF?

My pleasure, Vic. My nick over there is gscarpenter2002. I post frequently on the Business of Hockey board (less frequently elsewhere).

 
At 12:54 PM, July 06, 2007, Blogger James Mirtle said...

Gerald - Just a heads up: You don't have to post as anonymous. You can enter any name under other and don't have to be a Blogger member to do so.

Thanks for the contributions; I guess what I would argue is that the Canadian dollar boost isn't as important to my post as trying to determine how high the cap will go. Even my estimate allows for only an $80-million boost from the changing dollar.

 
At 1:42 PM, July 06, 2007, Anonymous Gerald Carpenter said...

Thanks, James. The sign--in system made me a little unsure.

Point taken about the impact. I was merely pointing out that the assumed $80 million was way WAY high. I acknowledge the rest of your analysis. The braying of some of the more uninformed members of the media (present company excluded) is just that. I swear most of thme cannot do basic math.

 
At 2:47 AM, July 07, 2007, Anonymous David Johnson said...

David, the factors you reference do not come into play. The exchange rate plays no factor in determining projected revenues for purposes of the salary cap. The cap is determined by taking ACTUAL revenues already converted at the relevant year's exchange rate (that is, 2006-07 revenues using the 2006-07 exchange rate) and upping it by whatever multiplier is negotiated (or, in the absence of an agreed number, 5%).

You are correct in that revenue projections aren't directly used but it might be considered when determining whether to adjust the 5% growth factor multiplier. If the league or union believed revenue growth would be significantly above or below 5% (for whatever reason, including exchange rate projections) then they could adjust it accordingly. Ultimately they are going to try to set the cap based on reasonable projections of total revenue. By default that is 5% growth but they are in no way obligated to use that number if revenue projections differ greatly from that 5% growth.

 
At 9:00 AM, July 07, 2007, Anonymous Gerald Carpenter said...

Yup. I said that:

"That being said, the NHLPA may internally consider it in the context of whether they think they are going to have to lose escrow dollars (i.e, if the CDN$ took a dive, they would be less likely to insist on a full multiplier, and vice versa), "

 

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