Friday, June 05, 2009

NHL to Hamilton conference call, part III: Does Canada make a difference?

Continuing in the vein of my first and second posts on this week's conference call about the official application to relocate the Phoenix Coyotes to Hamilton, I figured it would be worth taking a look at some of the other aspects of the situation. One element that's particularly interested me is if it makes any difference that the proposed new site would be in Canada, so that's the focus of today's post.

Obviously, there are some major differences to be found in operating a professional sports franchise in the United States or in Canada. The biggest one is the currency. One of the main reasons that the Winnipeg Jets (who became the Coyotes) and Quebec Nordiques (who became the Colorado Avalanche) left for the U.S. in the 1990s was thanks to a slump in the Canadian economy and a correlated decline in the Canadian dollar. There were other issues in both cities, including arena capacity and capabilities, corporate support and television cash, but the dollar's weakness did factor into it. In a league like the NHL, one of your biggest expenses is payroll, and that's in American dollars regardless of where your franchise is located. If you're operating an American franchise, your revenue from seat sales, corporate sponsorships, advertising and television deals all comes in in American dollars as well; if your team's in Canada, your revenues are in Canadian dollars but some of your biggest costs still have to be paid out in American dollars. Thus, while the Canadian dollar was extremely weak against American currency in the 1990s, it put a lot of pressure on Canadian franchises. Winnipeg and Quebec moved, and there were rumours that Calgary and Edmonton would follow suit.

Since then, the Canadian dollar's done much better against the U.S. greenback. That change in the relative values of the currencies, combined with a huge upswing in demand for hockey north of the 49th parallel since the lockout from both average fans and corporate sponsors (allowing for massive price increases in many markets) and a corresponding downturn in many U.S. hockey markets, meant that all of a sudden, it was the Canadian teams supporting the league and many of the American teams in trouble. Kevin McGran of the Toronto Star reported in February 2007 that the six Canadian teams (representing 20 per cent of the league's 30 franchises) were bringing in a disproportionate 33 per cent of the profits. Since then, the situation appears to have perhaps shifted even further in favour of Canada; all six Canadian franchises were in the top 10 in Forbes' year-end list of NHL franchises sorted by annual operating income.

That list is quite interesting. If you add all 30 franchises' operating incomes (earnings before interest, taxes, depreciation and amortization, calculated by subtracting operating expenses from operating revenues), you wind up with a net operating income of $141.5 million U.S. for the entire league. Conversely, if you add just the six Canadian teams' operating incomes (ranked #1, 2, 4, 7, 8 and 10 overall), you get $149.1 million U.S.. Thus, despite the strong performances of American markets like New York, Dallas and Detroit (#3, 5 and 6), the Canadian clubs alone are more profitable than the league as a whole. That doesn't mean that a six-team Canadian league would be more profitable, as it would be much harder to sell advertisers and television networks on. However, it does show how much of the league's income is coming from Canada.

Moreover, much of that income is coming out of the Toronto area, the proposed site for Balsillie's relocated team. The Maple Leafs recorded an operating income of $66.4 million U.S. in 2008, $26.8 million above the second-place Montreal Canadiens. Obviously, a second team in the Toronto area wouldn't put up quite the same numbers given the Maple Leafs' extensive history and massive fanbase. Still, if a new team makes two-thirds as much operating income as the Leafs, they'd be the second-most profitable team in the league. If they make half as much as the Leafs, they'd be the third-most profitable team in the league. Thus, a second team in the Toronto area in one way or another would appear to be a surefire bet from a pure business standpoint.

One thing to keep in mind is the aforementioned currency effects, though. At the moment, the Canadian dollar is hovering right around 90 cents U.S. If it dropped to, say, 60 cents U.S., all of a sudden (not far below the exchange rate in parts of the 1990s), it costs the Canadian franchises an extra 30 cents on every dollar to pay their players. Because their revenues are in Canadian dollars, their expenses shoot up but their incoming cash flow remains largely the same, hurting their profit margins significantly. Meeting payroll costs them 1.5 times as much as it did before if no salaries change.

Now, a second team in the Toronto area would still probably do quite well even under these circumstances. From those Forbes numbers, the Leafs took in $160 million U.S. in operating revenue and recorded an operating income of $66 million, thus making their operating expenses $94 million. We'll assume a second Toronto team would have similar operating expenses. I don't know how many of those expenses are in American dollars and how many are in Canadian currency; payroll, one of the biggest expenses for any professional sports team, is paid out in greenbacks, but many of the other expenses can probably be paid in Canadian currency. However, even if all $94 million is in American currency and the dollar drops to 60 cents U.S. (likely a worst-case scenario), that would raise their expenses to $141 million Canadian. Even if we assume that all of their incoming revenue is in the lower Canadian dollars (which likely isn't the case), the Leafs would still make an operating income of $19 million under this worst-case scenario. If we go by my previous idea that a second team could make two-thirds of the Leafs' income, that would be $106.6 million in revenue. This would lead to a significant loss under the worst-case scenario, but we don't know how much of that income would be in the more valuable American currency and how much would be in Canadian cash, and we also don't know what percentage of the expenses would be in U.S. dollars. Under more realistic assumptions than the worst-case scenario above (which assumes all revenue in $CDN and all expenses in $US), the team could still make a profit even in an economic crisis.

That's also not to predict a sudden massive setback in the Canadian economy relative to the American one. The Canadian economy actually looks reasonably strong compared to that of the U.S. at the moment, but relative currency strength is highly volatile and depends on a wide number of factors. Thus, the prospects of the Canadian economy make a significant difference to the revenue-generating prospects of another NHL team in Canada. Add that in to the laws, taxes, television deals and other such subjects that affect NHL teams and differ from the U.S. to Canada, and it's clear that operating teams in the two countries can be quite dissimilar.

Given those factors, you'd think that several, if not all, of those subjects would be covered in any application to relocate a team. However, that isn't the case. This was a topic I was rather interested in, so I asked application author Tom Wright on Tuesday if there were any parts in the application that addressed the differences between running a team in Canada and the U.S., and he was quite adamant that there were not. "There were no specific provisions that were asked for or provided," he said.

Wright added that the application was a standard one mandated by the NHL for any group that desired to move a franchise, not anything particular to the Phoenix to Hamilton situation.

"The questions are not specifically written for this instance," he said. "They're bylaws that must be considered when transferring a franchise."

At first glance, it seems incredibly foolhardy of the NHL not to include anything on the different regulations or economic circumstances that might be involved in this kind of a franchise transfer. Of course, the part of the application laying out the future business prospects for the team in Hamilton was extremely vague, as mentioned earlier. It didn't appear to ask for even a projected profit estimate, so perhaps country-specific regulations are less of an omission. Still, franchises in the two countries work under very different circumstances, and pretending that those differences don't exist or glossing over them appears to be a recipe for trouble.

However, there is one logical explanation as to why nothing on the subject is in the NHL bylaws that govern relocation procedures. It's a simple, but elegant one; they never expected it to come up. As mentioned above, when Winnipeg and Quebec fled south, hockey in Canada appeared to be struggling. Even in the much better economic climate at the moment, there still aren't any major Canadian cities that currently don't have a team and would be a guaranteed success if they did get a team. Winnipeg and Quebec are in better shape than they were, but both face significant hurdles with respect to arenas, corporate sponsorships and television deals. They might not even be successful at the moment, and a return to economic malaise would certainly hurt them substantially. That's not to say that they can't work; I actually think both cities would be better for the NHL than some of the current money-draining franchises. Neither is a surefire sensation in pretty good times, though, so it's fair to say that the NHL certainly never envisioned going back during the darker times.

The one absolutely can't-miss spot to put a new NHL team is in Southern Ontario. As mentioned above, a new Southern Ontario team would likely be in the top two or three franchises in the league in terms of profitability at the moment. Even in a more dire economic situation, the team could still be profitable. Thus, it would be logical to think that the NHL would consider that this situation would come up at some point and include some sort of guidelines in their standard bylaws that would take Canadian circumstances into account. However, the league doesn't appear to have done that, suggesting that they didn't expect another team to pop up in the Toronto area at all, and certainly not through relocation.

Why is that? It's not driven by business interests, and I don't buy the nationalistic explanation that it's all due to Gary Bettman's hatred for Canada. Part of it is due to a genuine desire to grow the game in the States and gain a substantial television contract, but that still doesn't tell the whole picture. No, the real answer lies with the Toronto Maple Leafs and Buffalo Sabres, and their supposed "territorial rights" over Southern Ontario. As Jim Kelley pointed out in a Sports Illustrated column Thursday, the Leafs in particular are the real eminence griese behind this situation. It's been made quite clear that they aren't going to give up their lucrative monopoly in Southern Ontario without a fight, and their financial standing gives them considerable influence with the league's other clubs.

Moreover, keeping Balsillie out preserves not just the Leafs' monopoly, but also monopolies for all of the other NHL clubs in solid markets and monopolies for NFL, NBA and MLB clubs. Those leagues aren't supporting the NHL in this one out of any love for Bettman or any high ideals of solidarity; they're doing so because it supports their business model. This is why Balsillie likely felt he couldn't try and go in through the league's front door again, and instead had to gamble on a risky all-or-nothing play in bankruptcy court. There's more to it than just this one omission in a set of bylaws governing relocation procedures, but it's indicative of the league's general attitude. For the NHL, Canada is apparently a place to leave, not a place to contemplate moving struggling franchises. That isn't a productive attitude at this moment in time, and they may need to rethink it as more and more of their teams begin to run into trouble.

1 comment:

  1. Maybe Maple Leaf Sports Entertainment can operate its second NHL team in Hamilton. The Toronto Maple Leafs can be the CTV/TSN team while Hamilton can become the A-Channel team.