When it was announced two months ago that Steve Ballmer, the former CEO of Microsoft, had agreed to pay $2 billion for the LA Clippers, it was no secret the price tag was steep. But what we didn't know was exactly how steep.
Now we do. Earlier this week, ESPN uncovered and published the bid book that Bank of America (NYSE:BAC) put together after it agreed to sell the team on behalf of Shelly and Donald Sterling. To say the figures cited by Bank of America are surprising would be an understatement.
What's behind the $2 billion price tag?
Take a look at the chart below. This illustrates the year and price paid in previous NBA acquisitions since 1998. See that dot in the upper-right-hand corner? That's the Clippers deal. It's nearly four times the size of the next biggest sale in NBA history, the $550 million acquisition of the Milwaukee Bucks by a group of hedge-fund billionaires earlier this year.
Why is Ballmer willing to pay so much? According to Bank of America, there are two reasons. First, it's situated in one of the most coveted and underserved sports markets in the world. Three years ago, the cross-town rival Lakers signed the richest local television-rights deal in the NBA. The 20-year agreement promises $4 billion in revenue, averaging out to $200 million a year.
Compare that to the Clippers, who get only $20 million a year. The catch is that the Clippers' agreement expires after the 2015-2016 season, at which point the team is expected to sign a deal with a significantly larger payout. If Bank of America's estimate is accurate, doing so could provide an additional $100 million in annual revenue. This would singlehandedly double the Clippers' annual revenue.
Adding to the appeal is the fact that Los Angeles is the most-underserved major market in the country with respect to professional sports teams. To give you some tangible figures, there are 2.9 million people per professional sports team in the city and its surrounding environs. That's nearly 1 million more than the average of the 15 largest metropolitan areas in the country. And it's roughly 800,000 more than New York City, the only metropolitan area in the United States bigger than Los Angeles.
The second reason Bank of America's presentation cites for Ballmer's willingness to pay up for the Clippers is because NBA franchise values are increasing. To illustrate this, the bank included the following chart (though the one below is my own rendition) -- which, for the record, is identical to the figure above minus the Clippers deal.
Seems convincing, right? Let's not get ahead of ourselves. If you project the trend line into the future, it would take roughly 70 years for the Clippers' price tag to fall within its orbit.
Indeed, Ballmer paid somewhere along the lines of 103.5 times EBITDA -- that is, earnings before interest, taxes, depreciation, and amortization. That's more than twice the multiples of the other two most recent NBA deals, and it's 10 times the multiple investors are willing to pay for the biggest and best publicly traded corporations in America. For instance, the price Ballmer has agreed to shell out for the Clippers is equivalent to paying $1,150 for a share of Wal-Mart, even though they currently trade for only $76.
Ballmer's not in it for the money
The point is that Ballmer didn't buy the Clippers to maximize his return on investment. He did so, first of all, because he enjoys basketball. "I love basketball," he said after the Clippers deal was announced. "And I intend to do everything in my power to ensure that the Clippers continue to win -- and win big -- in Los Angeles."
Furthermore, it can't be denied that owning a professional sports team is just a perk of being a billionaire. Ballmer's fellow Microsoft alum, Paul Allen, owns two: the Seattle Seahawks, and the Portland Trailblazers. And it's on this note that Bank of America's presentation hits the nail on the head. To a guy like Ballmer, the Clippers deal isn't about making money; it's about owning a "world class trophy property in the entertainment capital of the world."
John Maxfield has no position in any stocks mentioned. The Motley Fool recommends Bank of America. The Motley Fool owns shares of Bank of America. 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.