We’ve all seen the reports regarding the Ricketts’ reluctance to spend money this offseason, so I’m going to get down to brass tacks very quickly: the Cubs can afford any free agent they want this offseason. They could sign Bryce Harper or Manny Machado, add to their shaky bullpen, and nab a veteran backup catcher, all while still making a profit.
Several outlets have pegged the Cubs’ current Competitive Balance Tax (CBT) payroll—which does differ from their absolute 2019 payroll—around $225 million after picking up the $20 million option on Cole Hamels and trading Drew Smyly to the Rangers for $5 million in CBT relief. What does that number mean in the context of the luxury tax?
BE WARNED: This piece will deal with a lot of hypothetical payroll numbers, and feature words like “threshold,” “surcharge,” and “operating income.” It’s painfully boring, but you can blame the Ricketts for that. We here at BP Wrigleyville much prefer to do actual analysis in the offseason. I’ve done my best to keep it punchy.
There are two overlapping CBT structures to take into account. First is the rising percentage of dollars taxed as a team goes over the CBT mark their first time, second time, and third-plus times. Then, there is a surcharge assessed if a team goes into the second ($20 million over the CBT mark) and third ($40 million over) tiers, which gets a little confusing. This table shows the changes in the three tiers over the next three years, with the percent surcharge in parentheses:
|First Tier (0%)||$206 million||$208 million||$210 million|
|Second Tier (12%)||$226 million||$228 million||$230 million|
|Third Tier (42.5%*)||$246 million||$248 million||$250 million|
*Note: the third tier surcharge of 42.5 percent only applies to teams whose payrolls are in excess of $40 million above the CBT line for the first time. If a team enters the third tier for a second consecutive season, that surcharge moves up slightly to 45 percent and remains for all subsequent seasons in the third tier.
The Cubs’ player payroll for CBT purposes, as currently constructed, lands right around $206 million. Including player benefits, international signing bonuses, and draft bonuses, they’re right at the cusp of the second tier of $226 million. With necessary free agent additions, they are almost guaranteed to add $10-20 million and butt up against the top tier. If the Cubs enter 2019 with a payroll of $245 million (for example), they would expect to pay 20 percent tax on $29 million; they would also be subject to a 12 percent surcharge, meaning the $29 million would be taxed at 32 percent, total. With no significant additions besides some bullpen and relief help, and a desire to stay out of the third tier, the Cubs will pay no more than $9.3 million in overages. Total payroll and tax penalties would be $254 million.
So, let’s get saucy. What if the Cubs sign Bryce Harper at $35 million average annual value (AAV), and add $16 million AAV in relief help and a backup catcher? That pushes the Cubs from their current $225 million payroll to $276 million, and into the top tier. The quick math: $70 million taxed at 20 percent (regular CBT tax for first-time payors) plus 42.5 percent (surcharge for first-time entry into the third tier)—penalties that amount to 62.5 percent of $70 million, or $43.75 million. That’s $276 million, plus $43.75 million, for a total payroll and tax penalty of $320 million. Adding Harper would effectively “cost” the Cubs’ owners $79 million or so, of which $35 million would be Harper’s salary.
Now, that number means very little to you and me (unless you are Tom Ricketts, in which case: hello, go tell Theo to get Bryce already, dammit). What’s $80 million between friends?
For the Cubs, though, it is reportedly very important. To find out why, we need to weigh that $320 million number against the team’s annual revenue, and their annual operating income (i.e. profit). We’ll use Forbes’ annual calculations of these figures for 2018, since they are the most easily accessible source and have calculated these for over two decades. Keep in mind, however, that Forbes is a financial publication, and therefore likely estimates rather conservatively.
Forbes’ estimate for 2018 put the franchise’s value at $2.9 billion, third among all teams. Their revenue (all money “made” before expenses) came in at $457 million, and their operating income (revenue minus expenses) landed at $102 million, tops among all teams by $11 million. A back-of-the-napkin calculation, subtracting the Cubs’ $197 million payroll from their $457 million in revenue, gives us a remainder of $260 million. That means there were about $160 million in additional expenses directly related to the team, bringing their operating income down to $102 million.
This lays the groundwork for a prospective 2019 calculation, which we can do at a few different payroll totals in order to see how well the Ricketts would make out. Some other factors to consider: the team’s revenue jumped $20 million from 2017 to 2018, and I think we can safely assume the same will happen for 2019. Expecting an increase of almost $100 million, like the team experienced in 2017 following their World Series win, is unreasonable, but their revenue has gone up significantly each year since 2014. Their “other expenses” beyond player payroll were virtually the same in 2018 as in 2017, at $160 million. Also, a reminder: payroll for CBT purposes (using AAV instead of that year’s actual player salary) and actual payroll are not identical, and the Cubs’ real 2019 payroll plus CBT penalties yields a slightly different number. If the Ricketts back-load any contracts, they could sport better margins for 2019-2021 than the CBT calculations indicate.
So, our working figures are $477 million in revenue and $160 million in other expenses, leaving us $317 million before player payroll is debited. And—what do you know!—subtracting the current estimated payroll of $226 million, plus CBT penalties of $6.4 million, leaves the team with $84 million in operating income. Subtracting an expected payroll of $245 million, plus CBT penalties of $10 million, leaves $62 million in operating income.
And, finally, subtracting a Bryce Harper-fueled payroll of $275 million, plus CBT penalties of $44 million, leaves the team within a couple million of their estimated profit line. That’s before considering the family’s unimaginable wealth from other sources (including the new Hotel Zachary across the street from Wrigley Field), or the money the family rakes in from MLB revenue sharing, or the $50 million they received earlier this year from the sale of MLBAM, or the hundreds of millions in profit they’ve made the past decade on the team alone. They have plenty of income that they can use to pay down their debt, outside of the team. After all, the Ricketts have said they would pump all money made by the Cubs back into the Cubs.
You might ask, “What of the team’s 2020 or 2021 outlook?” And I’ll tell you: it’s even rosier than the projected 2019 numbers.
Say the Cubs land at $276 million for 2018. What changes for 2019? Several contracts come off the books: Ben Zobrist, Cole Hamels, Pedro Strop, Steve Cishek, Brandon Kintzler, and Brian Duensing are all free agents. Brandon Morrow and José Quintana have club options. Assuming the Cubs pick up Quintana’s option but decline Morrow’s, the team is looking at $65.75 million coming off the books for luxury tax purposes.
Arbitration raises for Kris Bryant, Javier Báez, Willson Contreras, Kyle Schwarber, Albert Almora, Kyle Hendricks, Mike Montgomery, and Carl Edwards add, at the most aggressive assumptions, about $20 million to their projected 2019 totals. The Cubs will need to add relievers (hello, Strop!) and maybe a position player or two, but probably not at great cost. If we subtract the $65 million in departing free agents and add $35 million in arbitration raises and new free agents, the team’s payroll for CBT purposes dips from $276 million to $246 million.
With the 2020 third tier threshold at $248 million, the Cubs could conceivably drop into the second tier in 2020 even with a Harper signing. At $246 million, they would pay 30 percent tax for being a second-time payor, plus 12 percent surcharge for being in the second tier, on $38 million. That’s $246 million, plus $16 million, totaling $262 million. If they get frisky and add $45 million in arb raises and free agents instead of $35 million (which would put them in play for 2019-2020’s best free agents), they would pay $256 million, plus 30 percent, plus 45 percent, on $48 million—or, $292 million in payroll and penalties. Even if the team’s revenue is static, the Cubs make more money in 2020 than they would in 2019.
As they enter third-time payor territory in 2021, they subtract Quintana, Jon Lester, and Tyler Chatwood’s contracts (just under $50 million total for CBT purposes), likely evening out any arbitration raises and free agent spending. The tax penalty shoots up to 50 percent, and they would pay an additional 45 percent for being in the top tier, but the team’s overall payroll and penalties don’t become prohibitive (e.g. a $256 million payroll in 2021 would result in $44 million paid in CBT overages—a 95 percent tax on $46 million—for $300 million total, still below our profit line before projecting any revenue increases).
There you have it. The Cubs can certainly afford Bryce Harper and other additions for 2019 and beyond with the Ricketts still turning a profit. Of course, that’s dependent on other mid-season additions that the Cubs will surely make; however, it’s also dependent on several necessary assumptions and caveats:
1. The team’s revenue could grow by more than the $20 million I estimated above, giving them a bigger profit margin.
2. The Ricketts are certainly bringing in lots of Cubs-related money from projects around the ballpark that might not be included in the figures we have. This will eventually include a new TV deal, which might not be as lucrative as it would have been a few years ago, but it will likely still land more money in the Ricketts’ pockets.
3. Any publicly available numbers on the team’s revenue and operating income are likely to be very favorable to ownership, and could be off by tens of millions of dollars.
4. We don’t know what the team has done with the hundreds of millions in operating income they’ve raked in the past few years as the most profitable team in the league. The Ricketts might have used it to pay off interest on their debts, but that would be a very loose interpretation of their “all Cubs money goes back to the team” platitude.
The Ricketts have borrowed hundreds of millions of dollars to purchase the team and to fund construction of the various projects in and around Wrigley Field. They’ve also significantly refinanced their debt using Tom Ricketts’ expertise in debt markets, and the team’s debt as a percentage of total value has dropped significantly in recent years. With major construction coming to a close in 2019, and with some sort of new TV deal beginning in 2020, ownership should find themselves on increasingly firm financial footing, even as they pay off their debt.
Bring Bryce to the Cubs. They can afford it.
Lead photo courtesy Jerry Lai—USA Today Sports