Let's Make a Deal! Ohtani Restructures His Pay

With some Taxing Tuesday Lessons, with some risk considerations...and how much is it worth?

I think I’m collecting a portfolio of long-term baseball contracts here. I see they are on the list of largest sports contracts, so maybe they are worthwhile analyzing.

To add to Bobby Bonilla’s great deal, which reminds us of the value of annuities (and also reminds us about Bernie Madoff). Evidently, Bruce Sutter got the best deal from a total return perspective.

But while the percentage return for these two have been fabulous, the deal just agreed upon by the Dodgers and Shohei Ohtani have eye-popping numbers involved:

Yahoo Sports: Report: Shohei Ohtani to defer all but $20M of his $700M Dodgers contract until after its completion in 2034

When Shohei Ohtani agreed to his record-breaking, 10-year, $700 million contract with the Los Angeles Dodgers on Saturday, the deal reportedly came with "unprecedented deferrals."

On Monday, we learned what those deferrals entail. Per The Athletic's Fabian Ardaya, Ohtani is deferring all but $2 million per year of his $70 million average annual salary until the contract's conclusion in 2034. That means he won't see $680 million of the salary for more than a decade.

Per the report, the deferred portion of the contract will be paid to Ohtani without interest from 2034 to 2043. The deferrals were reportedly Ohtani's idea. The Dodgers officially announced the signing on Monday, but not the terms.

The payment deferrals will free the Dodgers to spend more around Ohtani as they seek to build a perennial championship contender with the two-way superstar. Per the report, the contract with the deferrals will count for roughly $46 million annually for competitive balance tax (CBT) purposes. The CBT — like the NBA's luxury tax — is a financial penalty for teams that spend above an agreed upon ceiling in any given season. It wasn't immediately clear how that $46 million figure was reached.

How much is this contract actually worth?

So, unlike the Bobby Bonilla deal, where we was getting bought out of his contract by deferring payments until later, but he locked in an 8% accruing interest guarantee, there is no interest accruing for Ohtani.

And, as Dirty Texas Hedge is saying - this is pretty Japanese, in that Japan has negative real rates and even negative nominal interest rates (though very short term and very minimal):

The Bank of Japan (BoJ) kept its key short-term interest rate unchanged at -0.1% and that of 10-year bond yields at around 0% in its October [2023] meeting, as widely expected. At the same time, the central bank redefined 1.0% as a loose "upper bound" rather than a rigid cap and scrapped a pledge to guard the level. Since July, the long-term interest rate has been capped at 1%, an increase over the previous cap of 0.5%. In a quarterly outlook report, the BoJ revised higher inflation forecasts for FY 2023 and 2024 to 2.8% from 1.3% and 1.2%, respectively, exceeding its 2% target.source: Bank of Japan

But Ohtani is living in the U.S. (for at least 10 years… at least during baseball season), and while some of his expenditures may be back in his home nation of Japan (and thus currency exchange risk and interest rates could bite), I assume for the period during which he has signed on to play for the Dodgers, he will be spending U.S. dollars in the U.S.

So many people did bring up the inflation issue in the contract — not asking for accrued interest?!

How noble! or… What a sucker!

But, also - let’s be real here — you get to have a headline contract number:

MOST EXPENSIVE SPORTS CONTRACT EVER!

BIGGER THAN MESSI!

So that gets PR for the Dodgers and Ohtani…

But then you start reducing the actual present value of the contract by deferring payments, not requiring accrued interest, etc.

The actual present value of the contract is less than the headline $700 million, eh?

I have put a very simple spreadsheet together, and I’ll get back to that potential present value in a moment.

Ohtani: the team player

So, here are a couple of things - we’ve got the headline numbers that get a lot of PR for the team and for Ohtani…

…But then Ohtani carves down the amount the Dodgers pay him while he’s active to a very reasonable $2 million/year, so that they have more flexibility with filling out the rest of the roster. That’s for actual cash flow.

Then, supposedly, the deferrals carve down the “luxury tax” the baseball league will charge the Dodgers (used to keep the “big spending” teams like the Yankees and Dodgers from just buying championships every year.)

So it makes Ohtani look good… but let’s look at his possible downsides and upsides from a financial perspective.

Risk profile of the deal for Ohtani

This isn’t about a quantitative analysis per se, but considering the main aspects Ohtani needs to look at.

Inflation has been mentioned: but this is also assuming that non-deferred amounts were on the table. I’m not assuming that’s true.

By not including any inflation/interest rates, they can quote the contract at the full amount for headline purposes. So let us ignore that “risk”. Yeah, inflation does exist and would eat into the value of future cash flows, just like anybody. But that is assuming that was a lever.

Credit risk: this is the risk that payments will not be paid — or will be deferred.

Originally, I misread the terms of the deal, and thought the deferred amounts were a balloon payment of $680 million after the 10 years were over — that would have been a real credit risk. Instead, the plan is after the initial ten years of $2 million/year is $68 million /year.

Now, that should be coverable, however, I can definitely foresee potential scenarios where not only the Dodgers run into financial trouble in 10 years, but baseball in general. Credit risk is a possibility. But then, taking $70 million/year for ten years also has a similar problem.

Present value calculations of the contract, simplified

Okay, I’m going to keep this very simple.

Years 1 - 10, at the end of each year, $2 million.

Years 11 - 20, at the end of each year, $68 million.

Discount to time 0 for present value, using a constant interest rate, regular compounding.

An example - 0% will get you $700 million as present value, as one expects.

3% interest rate will get you $449 million as present value.

Ooooh.

Here’s a graph. [No, I’m not sharing this spreadsheet, this is too simple. I leave it as an exercise for the reader. I used the XNPV function in Excel.]

Something to note: if the valuation interest rate should be 7% to 8%, the contract's present value would be cut by more than 50%.

Think about that in the context of pensions.

The real value: tax and flexibility

Many of the sources point out that Ohtani has income on the order of $50 million/year currently (various ad endorsements), so he can afford to defer $68 million/year (no kidding).

But another thing to think about: Ohtani may not be living in California once he stops playing for the Dodgers.

To be sure, he may return to Japan. He could go almost anywhere (that’s the beauty of being a really rich person). At that point, he may be an American citizen (if he wants to be).

He may move to Texas or Florida… and not pay income taxes at all.

And now we may start to see why he may want to defer the bulk of his earnings to post-income-earning years.

And maybe we can see some of the foolishness of millionaire-income taxes in various states.

I am giving away very few secrets by mentioning there are entire industries centered on optimizing finances based on multiple dimensions, and taxes are certainly part of that calculation.

Any agent worth representing the best baseball player in the biz has got to include the very big hit taxes may have.

Those of us in the tax-avoidance biz (-cough- LEGAL -cough-), we highly appreciate the politicians who attempt to make taxes as difficult as possible. It makes our services more valuable. You guys are awesome! I know you love our lobbying groups, especially when backed by the estate tax-loving types. WOO HOO!

But it does make the present value calculation a bit more complicated… and I’m not about to fold in all the potential tax impacts.

So, congrats to Ohtani! May your throwing (and batting) arm stay good!