Friday, January 11, 2008

Ragenomics: The Ovechkin Deal

The following is a guest post by Japers' Rink commentor/financial analyst Rage. If you like it, he might get another spot in the future. If you don't, it's back to the Commentors Bin with the rest of you.

First things first: the Caps just got a hell of a deal. They stole a bunch of money from Alex Ovechkin (or, alternatively, Ovechkin, in his limitless good will, saved Ted Leonsis a bunch of money). If the deal truly was six years for $54 million and then an additional seven years for $70 million, Leonsis et. al. is the greatest negotiating team of all time.

Think about it this way: with conservative inflation assumptions (around 1.77%), Ovie will be earning the exact same amount in present value dollars in Year Seven as he is in Year One (and less in each subsequent year). How many of you would be completely comfortable going 13 years without a raise? That’s a win for Ted.

Which brings up the question of whether the cost in Year 1 is a "fair" price to pay. That, of course, is much fuzzier. Yes, Alex will earn $300K more than Sidney Crosby [ed. note: actually, they'll earn the same amount - $9 million - but Sid's contract is structured so that the cap hit will be $8.7m while Alex's will be just over $9.5m based on the average annual salary over the course of the deal]. However, if you consider the long-term gains, the short-term costs are justified. In terms of strict inflationary dollars (assuming 2% inflation), Ovy has left nearly $14m in 2008 dollars on the table, and anyone who thinks that Crosby won't be capable of earning more than $10m when his new deal runs out in five-plus years is crazy.

It's also interesting to note, that no player on a team can earn more than 20% of the total team outlays in salary, incentives and bonuses. This means that for next year, the Caps must spend more on the team around Alex (up to $48m) than they currently are paying (just over $40m). That’s a pretty big jump (even if Mike Green gets $6m per year on his new deal).

Now let's turn our attention to some of the stuff we've seen floating around the blogs and papers today (summarized, as many have been posted by more than blog/paper):
  • Claim: The contract will eat up tons of cap space every year.
    • Currently, the cap is just over $50m. Let’s assume that the present value of the cap stays at this value (this would mean the NHL’s revenue is just keeping pace with inflation, which we'll estimate again at 2%). As a percentage of the cap, Ovie’s salary would start at 18.59% and drop to 14.66% by the end of the contract. That is the WORST case scenario. If there are any large revenue jumps (as there have been the past two years), Ovie’s percentage would fall lower and lower. [ed note: the real beauty here is that not only will the Caps be getting great value as the contract passes its midpoint, but they'll be getting a break on the cap too when they're paying a player $10m per year but only taking a $9.5m cap hit!]
  • Claim: The Caps should be afraid of a repeat of Jaromir Jagr Contract Hell.
    • This is probably the biggest risk of the deal. Let’s enumerate the risks demonstrated by the Jagr deals and other long-term marriages:
      • Ovie will lose his zeal for the game, and stop being worth the money.
      • Ovie will get traded and the Caps will have to pay for him after he's gone
      • Ovie plays such a rugged game that he will get injured and have to end his career early.
    • All of these risks are 100% legitimate. However, we have some mitigants:
      • Ovie has shown zero likelihood of bailing on even a single game, no matter how relatively insignificant the game may same.
      • Under the new CBA, teams aren't allowed to pick up a portion of a traded player's salary. Besides, as we’ve covered, Ovie’s salary becomes more palatable over time, not less. And his salary should be getting lower as a percentage of the cap over time, not higher.
      • The Caps are insured in case of an injury (we assume).
  • Claim: Crosby and Ovechkin both left gobs of money on the table.
    • Crosby signed a big deal - but could have signed for more - and will cash in (likely to the tune of $11m-plus in present value dollars if revenues continue to grow) again in five years.
    • Ovie signed a huge deal - but could have signed for more - and will cash in again (maybe) in 13 years. While his cap hit is $838,461.53 (approximately one Brent Johnson) more than Crosby's for the next five years, Ovie left a ton of money on the table over the course of his career. Whether that’s because he is so good natured, or dumb, or a team player, or whatever, others can decide, but what is 99% certain is that in six years, Alex's cap hit will be less than the cap hit Sid will be inflicting on his team (whoever it might be).
  • Claim: The Caps are taking some of a cap hit now for immense relief later.
    • Exactly. This contract is essentially a forward bet on the success of the NHL or, at very least, its ability to keep pace with inflation. There are many young players in the system who will be making minimum salaries in the next five years, but when they need to be resigned, the cap will have moved and Ovie’s contract will have stayed the same.
  • Claim: This deal means that Ovie is worth nearly as much as the 10 NHL teams that are valued around $160m or less.
    • This is an absurd statement. If I receive an annuity (with seemingly no expiration) payment of $15 a year, and you receive 13 lump sum payments of $9, who is going to make more money? Ovie is worth a whole lot, but if you want to compare apples to apples, compare the $160m to the $9m he’ll make next year.
  • Claim: The whole lockout and lost year were for nothing, as this deal shows.
Conclusion: As with any deal of this magnitude, there are huge risks involved - the length, injury, enthusiasm, revenue shrinkage, etc. But there are also enormous benefits, even in a conservative projection of the market. This deal could (and should) work out very well in the Caps favor. And with $124m headed into his bank account, it ain't too bad for Number Eight either.


Anonymous said...

I'm not sure where I saw it, but if the cap number goes DOWN, all player salaries also go down, commensurate with the drop.

Anonymous said...

The cap won't go down. Gary will institute a mandatory "all games outside" edict to keep revenues up (because if it worked once, the results achieved there can be expected everywhere).

prcizmadia said...

Hell yes. Superb commentary. More of the same would be entirely awesome. Keep up the good work!

Anonymous said...

Excellent analysis! Perfectly sensible. (Bravo, Rage!) The only future risk that you didn't mention is that Ovie reads this analysis and gets so disgruntled and perturbed that he refuses to play. Let's hope not.

Anonymous said...

Outstanding post, thank you.

Hooks Orpik said...

Great article but I wanted to let you know there is an inaccuracy: The Caps do not have to inflate their budget in order to make sure Ovechkin makes only 20% of their payroll.

From the website you quoted:
"No player may be eligible to contract for or receive in excess of 20% of the Club's upper limit in total annual compensation (NHL salary plus signing, roster, reporting and all performance bonuses)."

"the Club's upper limit" is not their payroll or budget, but the salary cap. So, aside from meeting the lower limit (aka the salary floor) the Caps do not have to make sure Ovechkin only makes 20% of their payroll.

It just means he can't make more than 20% of the entire salary cap.

Also JP's second editor note is correct, under this CBA teams are not allowed to pickup salary on a traded players, so situations like the Jagr fiasco can not happen. Sometimes the owners have to protect them from themselves.

Hooks Orpik said...

"How many of you would be completely comfortable going 13 years without a raise?"

By the way, if you only made me work 82 days for about 25 minutes a day and paid me about $110,000 a night for my services and guaranteed it for 13 years I guarantee you'd get my signature on paper too! ;)

A fine piece of writing rage, I enjoyed it.

Have a good weekend everyone. I'm actually going to be in attendence for Sunday's game. I bought a Pack The House 6 Pack in section 114 for the Penguins games, and true to my word, I'm not going to resell to Philly or New York fans. The seat will, of course, be occupied by a visting fan March 9th though.

Abhinav said...

Thanks, everyone, for the kind words.

"No player may be eligible to contract for or receive in excess of 20% of the Club's upper limit in total annual compensation (NHL salary plus signing, roster, reporting and all performance bonuses)."

I've read that over and over and over, and I don't think I'm wrong. I understand "NHL Salary" to mean a specific team's NHL Salary. If it relates to a league-wide salary cap, I don't really understand how anyone could be under the cap when including all signing, reporting, and performance bonuses. Maybe someone more enlightened than me can explain it.

Abhinav said...

"I don't really understand how anyone could be under the cap when including all signing, reporting, and performance bonuses."

Er, I meant "how anyone could be OVER the cap".

bradley said...

It couldn't be referencing the club's actual cap number with the words "club's upper limit", because there's no upper or lower limit to be thought of there, there is only one number. The club's upper limit, 99% of the time, is the league-wide cap. The only time it would change is, if in the previous year, the club had gone over the cap (I believe they're allowed to go over by a small amount due to contract bonuses, I'm not sure of the details but there is a certain allowance), then their cap number is lowered by that same amount the next season. The Caps most certainly are not required to raise their total cap hit to 5 times OV's contract.

Hooks Orpik said...

This site is done from a very smart person who posts at HFboards and pays very close attention to contracts and the business of hockey.


I think we can definitely agree that it is not worded very well, at least for lay people to understand what they meant.

"No contract signed between July 1, 2007 and June 30, 2008 may contain a total salary and bonuses in any year which pays more than $10.06 million. This does not prevent a player from taking up more than 20% of his team's Upper Limit. The provision in (a) above applies only at the time the contract is signed. The CBA does not contain a provision prohibiting a player from taking up more than 20% of the Upper Limit in any year ... so on the event that the Upper Limit declines, a player could in fact take up more than 20% of the Upper Limit and could earn more than 20% of the Upper Limit."

JP said...

@ Bradley: There is an upper limit to be thought of there - if, for example, Nick Backstrom hits all of his incentives, the Caps payroll will be higher than if he doesn't.

Anonymous said...

Now why don't the hockey media guys right stuff like this over at THN or TSN, etc.? Is it because it could be close to the truth, or they're incapable of doing it, or deny its validity? Maybe they think the average hockey fan is an idiot, incapable of comprehending numbers and percentages.

At any rate, thanks Rage for the analysis (and JP for giving Rage the floor). Until we see someone capable of refuting it I'll keep it in mind. Makes more sense than the usual impending doom tone from the "professional" hockey media.

JP said...

It is poorly written, but I agree with Hooks on the interpretation - a club's upper limit is what everyone refers to as "the salary cap" (i.e. the $50.3m number).

Per the CBA:

For each League Year there shall be a "Lower Limit" and an "Upper Limit" at or between which each Club must have an Averaged Club Salary. The range between the Lower Limit and Upper Limit shall be
known as the "Team Payroll Range" (the "Payroll Range" or "Range").

Therefore, it's the $50.3m - and not a given team's payroll - that a player's salary needs to be equal to or less than 20% of.


JP said...

The illustration in Sec. 50.6(a) of the CBA makes it clearer (by not mentioning a team's payroll at all):

Illustration: Assume the Upper Limit is $40 million, and a Player signs a three-year SPC. The Player cannot receive more than $8 million in aggregate Player Salary and bonuses (twenty (20) percent of the Upper Limit) in any year of that SPC, even if the
Upper Limit in Year 2 or 3 actually exceeds $40 million, because any multi-year SPC providing the maximum allowable total aggregate Player Salary and Bonuses shall have the Upper Limit for the year in which the SPC is signed imputed across all years of
the SPC.

Anonymous said...

One minor point: I'm pretty sure only the first six years of the deal are insurable.

JP said...

Here's the deal. Insurance (at least in DiPi's case) is/was only available for six years at a time.

All that means is you buy a new policy when the first one runs out. It's really not a risk at all - I think Mirtle's off here.

bradley said...

Nope JP, the bonuses affect the cap number no matter what, met or not. Sure, they might not be met, but OV's current cap hit is ~3mil, not ~.7mil, regardless of whether he ends up earning those bonuses or not.

JP said...

You're right - my bad (brain fart). The team's payroll (which will vary based on incentives met and missed) is obviously different from their cap hit (which assumes all incentives are hit, etc.).

I do recall that players over a certain age on one-year deals with incentives (Shanahan comes to mind) are treated differently with respect to their cap hit and salaries, but I don't recall the specifics.

James Mirtle said...

All that means is you buy a new policy when the first one runs out. It's really not a risk at all - I think Mirtle's off here.

It might be difficult to insure the remaining $70-million of a contract for a player who can no longer play.

JP said...

And if he can't play, he retires. Like Bure (who was still scoring a goal every two games when he hung 'em up).

James Mirtle said...

He still receives the money in the event of a career-ending injury.

Anonymous said...

One other thing you have to remember about Ovie "leaving money on the table: he negotiated without an agent, so his $9M/year is the equivalent of an agent-represented player making $10M/year, with $1M (10%) going to the agent. By the second half, a player with an agent would need to make $11.1M/year to equal Ovie's $10M. -JW

JP said...

@ James: Right - but if he quits b/c of injury, the insurance co. and not the team is paying that sum.

@ JW Jr.: I could be wrong, but I believe that sports agents typically "only" take around a 4% cut on player contracts.

AO's Sunshine State Fan said...

Ragenomics makes my head spin! I'm just a VERY HAPPY Caps fan because Ov is a stand up guy who gave the Caps a chance. CANNOT wait until the game tomorrow to see if the trade rumor talk that he said was weighing on him will go away and he'll score a goal or two, or three, or ...! GO CAPS!!!

DMG said...

I guess I'm a little late on this one, but I'd like to mention that I too liked this post very much and I think it'd be great if Rage could post more stuff like this when pertinent.