The Bulls signed Dwyane Wade for a two-year contract at the hefty price tag of $47 million. The Miami Heat refused to pay Wade over $40 million while the Denver Nuggets offered him approximately $50 million. While Bulls fans will be welcoming Wade back home, Heat fans will be mourning the loss of arguably the city’s all-time greatest athlete.
I created a Discounted Cash Flow model to evaluate the returns of such a deal. Due to the confidential nature of the NBA, it is difficult to obtain certain information, so some assumptions were necessary for completion.
The net present value of the Dwyane Wade deal yields a loss of approximately $6,876,134; however, the market value of the Bulls will increase by about $300 million compared to the previous year. According to Forbes, an NBA team’s valuation is a multiple of team revenue. The projected revenue increase from signing Dwyane Wade will be approximately $30 million. The loss in net income can be justified due to the net change in the team’s enterprise value because the Bulls have an EV/Revenue multiple of around 10 for the year 2016.
- The NBA needs a salary cap to balance out the league. Teams that have greater revenue than their competitors have higher revenue to team value multiples. Not only do two teams with the same multiple experience different values due to different company sizes, but these values are also exacerbated by greater multiples. This means that a company/team can incur annual losses (like the Nets) while increasing the team’s market cap, which can’t be done by smaller market teams. Without a salary cap, the more lucrative teams would be able to leverage these multiples and growth potential to outbid the rest of the teams in the NBA. Historically, this is why big market teams tend to be more successful.
- There is another issue that is a common business practice – it’s called the free cash flow agency problem. In these situations, companies will invest in cash flow negative projects in order to spend money that would otherwise go to another use. This is exactly what is happening with the Bulls. They would rather expand than be operationally efficient. If they didn’t pay Dwyane Wade, they would possibly not be able to reach the salary cap minimum. If this were to happen, they would have to redistribute the remaining money to the other players on the team. Thus, they would rather invest in Dwyane Wade even if it means losing money.