Friday, February 04, 2005

The Value of an Asset

What is the value of an asset? Whenever I ask that question, I get responses ranging from "the discounted value of future cash flows" to "whatever the price is."

Well, someone should have asked Jim Hendry that question before the events that unfolded on the last day of the season. Had he realized the precise and only answer to the above question, the Cubs could have avoided the unnecessary trade of Sammy Sosa for Hairston, Jr and 2 minor leaguers.

The value of an asset is exactly what the market deems. Sometimes the market seems overvalued, sometimes it seems undervalued. And while that might be true in retrospect, the value of an asset at the precise moment it changes hands is exactly the exchange price. Simple example – what was the value of all those internet stocks back in 1998? Well, the short answer to that is in 1998 the value was much higher than in 2001. But, that doesn’t mean the stocks were necessarily overvalued in 1998. It just means that, for numerous reasons, the market decided to value those stocks at a much higher price in 1998 than in 2001. The onus falls upon the seller of an asset to maintain and even increase the value of his asset, and the buyer of an asset to perform the proper due diligence and determine the appropriate price, given market conditions.

How does this relate to Jim Hendry, Sammy Sosa, and the Chicago Cubs? Until recently, Sammy Sosa was an asset of the Chicago Cubs. At some point, after the last game of the season, the Cubs’ brass decided to shed itself of that asset. This happens all the time in the business world – a person sells some stock from his portfolio to diversify, a corporation divests a unit for strategic or financial reasons, a homeowner sells a rental property, etc. In all of those cases, the entity selling the asset has to ensure that he does not destroy the value of his asset. This is especially important in inefficient markets like the one the Cubs are dealing with, and less important in efficient markets like the stock market. For instance, the person wanting to sell his stocks can continuously “bad-mouth” those stocks and still sell them at the market price because the market is efficient (numerous buyers and sellers). Whereas, the rental property owner wanting to divest will significantly reduce the value of his property by indicating it needs extensive plumbing work and the tenants are malcontents. The real estate market, for numerous reasons, including liquidity, is not as efficient as the stock market.

The baseball market is even less efficient than the real estate market. There are only a total of 30 buyers and sellers at any given time. So, any destruction of value is amplified in this very inefficient market. This severely hinders a team like the Cubs that very publicly and continuously destroyed the value of its asset throughout the off-season. First, they announced to the public (including other major league baseball teams) that their asset walked out in a very unprofessional manner. Then, they released videotape indicating his dishonesty. That followed by the destruction of Sosa’s personal property (the boom box) indicated that his co-workers wanted nothing to do with him. Finally, given a chance to recoup some value in the off-season, their leaders (specifically, Dusty Baker) continuously lambasted the asset and ensured there was no way he could comfortably come back and work for the team. Add those devaluing factors to the fact that the Cubs were openly shopping Sammy Sosa and one can easily understand why they received Hairston, Jr and 2 minor leaguers. Why would the market pay anything more than necessary when it knew that seller was desperate to rid itself of the asset? In fact, a strong argument can be made that the Orioles overpaid for the asset given how much the Cubs devalued Sosa.

How should the Cubs have handled the situation? Start by not releasing videotape indicating he is a liar. Smart buyer teams know that Sosa had lost significant value on his own (corked bat, decreased head size). They don’t need the help of the seller to figure that out. The Cubs should, as an organization, study how effectively Scott Boras sells his clients and continuously obtains the optimal price no matter the circumstances. Did anybody think that Alex Rodriguez would get $252 MM? Or more recently, how about $64MM for a 3rd baseman with one good year (Beltre)? Or $55MM for an outfielder with one full non-injury major league season (Drew). Or a reported $55 MM for an outfielder with 2 knee surgeries (Ordonez)? Or $119 MM for an outfielder with, arguably, 1 good postseason under his belt (Beltran)? Boras is a case study on extracting maximum seller value.

Fine, Boras is an agent and the situation does not exactly correlate with the Cubs and Sammy Sosa. Let’s contrast Hendry’s actions with the Master at extracting value, Billy Beane. Beane shed the A’s of his two best pitchers, 2 guys he knew he had no chance of signing, and received substantial return value. Every GM in baseball knows, or should know, that the A’s could not afford those two pitchers on the verge of free-agency. Beane did not make a public announcement that there was a fire sale for the pitchers, but he did discreetly create a market. Next thing you know, he had traded his two best pitchers, pitchers he had to sell, for a boatload of cheaper, younger, and possibly better prospects. Textbook. Subtly, he determined the value of his assets without announcing his intent to sell and then he sold at maximum value. Beane did not highlight the fact that Tim Hudson had given the A’s until March 1 to sign him, or he would file for free agency at the end of the year (effectively, eliminating any chance for the A’s to sign him). He did not accentuate the fact that Mulder has not been the same since his hip injury. He quietly created a market and obtained the best return despite the fact that, as a GM of a small-market team, he HAD to sell. Contrast that with how the Cubs handled Sammy Sosa. Or for further insight, how the Diamondbacks destroyed the value of Randy Johnson and had to, essentially, sell him to the Yankees at under optimal value.

The Cubs, as an organization, made the decision to sell Sammy Sosa. No harm in that. But, the only possible way they could have destroyed his value any more was by holding a press conference and announcing, “We will rid our team of Sammy Sosa at all costs, no matter what, so make an offer.” It’s no coincidence that the Cubs have not won a championship since 1908. It is due to continual business decisions like the Sosa debacle that highlight their futility. By the way, for sale: 28 year old head case with a 100mph fastball, any and all offers will be accepted.