Why the Yankees Will Continue to Pay the Luxury Tax

Derek Jeter embarks on his farewell tour in 2014, as Fox takes over the YES network. What does this mean for the future of the MLB's highest-valued franchise?

Mar 8, 2014 at 10:09AM
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Derek Jeter, the epitome of a New York Yankee not seen since Mantle or maybe even Gehrig, recently announced his plan to retire after the 2014 season.

His retirement signals not just a farewell tour for the heart and soul of the Yankees over the past 20 years, but also a new era for the franchise. Also gone are the days of Rivera and Cano. The likelihood of the return of A-Rod is also fairly slim, if the Yanks can figure out how to cut him and his contract loose.

So what's next for the MLB's highest-valued franchise?
Now that most of the big-name stars have moved or are nearing the exits, will the Daddy Warbucks of the MLB continue to thumb their nose at the luxury tax, or take on a new modus operandi?

So far they've spent a ton of money on free agents -- Ellsbury, McCann, Tanaka, and Beltran -- during the offseason. This after Yankees managing partner Hal Steinbrenner -- yes, George's little boy (obviously not cut from the same cloth) -- actually suggested that the Yanks wanted to get below the luxury tax trigger point of $189 million by the start of the 2014 season.

By doing this, the Bronx Bombers could save $50 million in luxury tax and receive significant rebates of the dollars they pay into the league's revenue-sharing pot.

In his 2012 statement, Steinbrenner described himself as "a finance geek" who "feels that if you do well on the player-development side and you have a good farm system, you don't need a $220 million payroll," according to a New York Times article.

Reality sets in
Well, guess what? Something happened on the way to $189 million. The Yankees had their worst record since 1992, the year Jeter was drafted. But, it still looked that Steinbrenner might make good on his promise when he let Cano, the Yanks best player, walk away. Cano signed with Seattle for 10 years and $240 million.

Then, like an addict who has one good day before jonesing and going on a bender, the Yankees shelled out $470 million. Tanaka, a Japanese pitching star, led the way with a $155 million contract, followed by centerfielder Ellsbury at $153 million, catcher McCann at $85 million, and Beltran for $45 million. New York also added reliever Matt Thornton ($7 million), infielder Kelley Johnson ($3 million), and second baseman Brian Roberts ($2 million).

Not having the luxury of no luxury tax
Here's the rub -- the Yankees don't have the luxury of shedding the luxury tax. After limping through the 2013 season at a respectable, but un-Yankee-like, 85-77, Steinbrenner may have seen the light ... or rather the numbers. The number of viewers tuning into the YES network plunged more than 30%. Around 111,000 Yankee watchers said farewell to the Yanks, a year before Jeter said he was saying goodbye. That left 244,000 die-hards manning the screens. Ballpark attendance also dropped about 3% from an average of 45,107 in 2012 to 43,733 in 2013.

Suddenly, the self-proclaimed "finance geek" turned into a riverboat gambler, spending $470 million to retool with players who are far from a Jeter-like sure thing.

Turnaround time
The Yankee's brass recently handed over more of YES Network to Twenty-First Century Fox (NASDAQ:FOX). Originally, News Corporation (NASDAQ:NWS), which has since split its television properties into Fox, purchased 49% with a deal to expand its share to 80%. Fox recently took over controlling ownership (80%) of the network, which broadcasts the Yankees games. Yankees Global Enterprises still owns 20% (down from 26%). Goldman Sachs (NYSE:GS) and other shareholders held most of the shares recently purchased by Fox.

The deal still leaves control of the Yankee content in the hands of the Yankees even at 20% ownership. Those have proven to be some capable hands, as YES has a value of around $3.8 billion.

The network currently has rights to Yankees games through 2042.

Money in the bank
When Fox agreed to the deal in 2012, the annual rights fee paid to the Yankees was about $85 million annually. It was set to increase around 4% yearly for a time, and then bounces to 5% to 7% down the road. The Yankee Global Enterprises, the Yankees holding company, reportedly received about $584 million at the time.

Now the rights payments are set to go higher, by some estimates up to $150 million a year.

The Yes deal and the new Yankee era
Fox had until the end of 2015 to close the deal, but choose to act now. One has to think Jeter's farewell tour had a little something to do with it. This year promises to be a banner year for YES viewership as Jeter makes a final lap around the baseball world and is greeted with standing O after standing O. Even the hated Red Sox will likely give him a rousing sendoff.

And, I bet the Yanks are hoping the new $210+ million lineup (sans Rodriguez) can contend for a championship and keep viewers tuning in long after the Jeter Era ends.

A fool's errand
And when it comes to the Yankees spending less to field a respectable, but nondramatic team versus a star-laden, glamorous, attention-getting, high-priced championship contender that's the face of the YES Network, the Bronx Bombers will always put their chips on the big number. They can't afford not to.

In the end, it's riskier to not spend big and lose games than to spend huge and get a few bad beats.

Call it the luxury of a market-leading brand with deep pockets.

Or, the cost of doing business the Yankee way. 

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Chris Brantley has no position in any stocks mentioned. The Motley Fool recommends Goldman Sachs. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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