Why Did the Indians and SportsTime Ohio Fall Short?

As most fans are well aware of at this point, Fox Sports Ohio is close to finalizing an agreement to purchase Sports Time Ohio and, along with it, the right to televise the Cleveland Indians. As my fellow Wahoo’s on First staff writer Ed Carroll recently pointed out, the impending sale of the Indians’ flagship television network means a great deal to the financial and competitive future of the team, but to what degree? What can the team and the fans realistically expect from a rekindled relationship with Fox Sports Ohio? Is this much ado about nothing?

Perhaps the most intriguing question to come from all of this is: Was STO a failure?

David Richard-USA TODAY Sports

It’s important to note once again that while STO is considered the Cleveland Indians’ television network, it is not owned by the team. The Dolan family owns the controlling interest of the channel, and as such the Indians hold no financial interest and make no money directly off of its success. STO simply pays the Indians a rights fee to televise their games on their network of $30 million per year, and any and all profits generated by other programming, advertisements, and corporate partnerships go right back into the Dolans’ bank account.

One could argue the Dolans and the team are one and the same. The owner of the Indians also owns the team’s current broadcast network, so naturally the money that is being made off of the one is being put towards the other by said owner. But is that the case? Judging from the strict financial limitations in which the team operates it’s easy to think that this is not the case—STO pays its $30 million to the Indians each year and that’s it. It’s hard to say for sure because financials are not readily available to explain where all the money goes. But if that’s the case, then what was the point of setting it up?

When STO was created in late 2005 prior to the 2006 season, it was in an effort to boost the team’s finances so the Tribe could better compete with the likes of the Yankees, Red Sox, and other large-market teams with huge television deals. But, if the team is no better off now than it was in 2006 (one could argue the team is even worse off), doesn’t that make the entire STO venture a catastrophic failure? If STO were doing what it was intended and providing the Indians with better financial footing with which to compete, then why sell the network and the rights just a mere seven years later?

Because the game changed.

When the Dolans started STO, it was built on what was then the current model for MLB television rights and team networks along with aspirations that were never going to be met. Over the last seven years we have seen the price of MLB television rights skyrocket. The average yearly income from TV now reaches nine figures for some teams. Throw in the fact that the Indians are in the eighth-smallest market in all of Major League Baseball and demand for the network and its reach was never going to be on part with those of the Yankees, Red Sox, and Mets.

The MLB revenue sharing program further complicates how all of this plays out. All revenue generated from local television rights contracts is subject to revenue sharing under the current collective bargaining agreement. This income falls under the label of “Net Local Revenue” and is subject to what basically amounts to a 34 percent tax. Each team adds its 34 percent from Net Local Revenue into what becomes the “Base Revenue Sharing Pool,” which is subsequently divvied up amongst all 30 MLB teams. There is also a “Supplemental Revenue Sharing Pool” based on performance, but that doesn’t apply here. Here’s a handy flowchart to explain where the money goes: (click to embiggen)

I know what you’re thinking—Why don’t teams that own their own TV networks (or, in the case of the Indians, where the owner owns the TV network) undercut the rights fee in order to avoid paying as much out into the revenue sharing pool? Aren’t they just paying themselves? Well, Major League Baseball isn’t stupid. They’ve taken this into account, and as part of the collective bargaining agreement teams must negotiate a fair market value for their television rights. MLB does its own research in order to sign off on such agreements. However, the system isn’t without its flaws and this is where I believe the Indians and STO fell short.

While the income obtained from television rights is subject to the MLB’s revenue sharing program, income earned by the network is not. It’s not baseball operations income, so why should it be? Let’s take a look at the Red Sox as an example. The John Henry-led investment company, Fenway Sports Group, owns both the Red Sox and their broadcast network, NESN (80 percent control). The Red Sox earn $60 million per year in television rights from NESN under their current contract, which is subject to revenue sharing under the collective bargaining agreement. However, any additional income generated by NESN and used by the Red Sox is not deemed to be Net Local Income and therefore does not get factored into the revenue sharing equation.

That is where the true competitive advantage comes into play. The Red Sox Nation far surpasses the size and reach of the Indians’ fan base. The demand for NESN across the country is much greater than the demand for STO. NESN has a much broader reach and can contract with more cable providers and demand a higher price for on screen advertising time. Not to mention that while STO offers weekly Cleveland Browns coverage, Ohio high school and small-time Ohio college sports, NESN broadcasts the Boston Bruins, big-time college athletics, and other various local programming. All of that equates to income far exceeding that of STO.

From Photobucket, by Tony Lastoria

In its seven years of existence STO has done a great job with the Indians, its weekly coverage of the Browns is top notch, and its presentation of high school sporting events (most notably high school football) has been phenomenal. The problem is that STO never fully developed into the cash cow the Dolans had envisioned when they created it despite the fact it doubled the annual rights fees to broadcast Indians and provided a financial cushion to fall back on.

Now Fox Sports has presented a lucrative offer somewhere in the $200-$250 million range to purchase STO from the Dolans—and, along with it, the rights to broadcast all non-nationally televised Indians games. This may seem a bit shocking at first, but it further solidifies the notion that Fox is attempting an all-out domination when it comes to televising Major League Baseball.

Fox Sports West has reportedly been in negotiations with the Dodgers on a ridiculous 25-year $6 billion broadcasting rights contract. News Corp, the parent company of Fox Sports, recently agreed to purchase a 49% stake in YES, the Yankees’ broadcast network, for $3 billion. There were also grumblings that Fox Sports had initiated talks to purchase MASN, the television broadcast partner of the Nationals and Orioles. On top of that, Fox Sports regional networks are in the beginning years of lucrative multi-year contracts with the Angels, Rangers, and Padres and already hold broadcast rights to several other teams including the state rival Reds and the division rival Tigers, Royals, and Twins among others.

So it shouldn’t be a surprise that Fox Sports Ohio caame calling when the Dolans waived the white flag with STO. Fox Sports and its regional networks want to acquire as much Major League Baseball as possible and are willing to pay a premium to get it. The Dolans wanted out of the broadcasting game and could desperately use the influx of cash. It’s a perfect match, from a financial stand point it may be just what the Indians need.

It’s also a convenient time for the sale and renegotiation of broadcasting rights for the Tribe, as the model for televising baseball has once again changed. Prices are skyrocketing for larger-market teams and, as reported, the Indians could see an increase in their broadcasting rights from $30 million per year to $40 million per year. That kind of deal would put them on equal footing with the Tigers who entered into a 10-year, $400 million deal with Fox Sports Detroit back in 2008. It’s not the $100 million-plus paydays of the Red Sox and Yankees, but every little bit helps.

However, looking at recent deals put into place with Fox Sports by the Angels, Rangers, and Padres and by the Houston Astros with Comcast points to a new trend: Equity stake. In addition to coming to terms with their respective networks for typical broadcasting rights contracts, each of these teams also negotiated equity stakes in the networks as follows:

• Angels and Fox Sports West: 17 years/$2.5 billion ($147 million per year) with a 25% equity stake
• Rangers and Fox Sports Southwest: 20 years/$1.7 billion ($80 million per year) with a 10% equity stake
• *Astros with Comcast SportsNet Houston: 20 years/$3.2 billion ($80 million per year) with 45% equity stake
• Padres and Fox Sports San Diego: 20 years/$1.2 billion ($60 million per year) with a 20% equity stake

*The Astros’ TV contract also includes the Houston Rockets, thus the $3.2 billion over 20 years, $160 million per year, is divided in half. Thus, the $80 million per year for each team.

What does that mean? Equity stakes provide additional income that is not subject to the MLB revenue-sharing program. The equity stakes serve as partial ownership in the network. In other words, it’s stock that entitles its owners (in this case the respective teams) to their percentage share in the network’s profits. While income received per year for the broadcasting rights is falls under Net Local Revenue, income from equity shares does not. In essence, it’s tax-free revenue (at least regarding the league offices).

For that reason, it is imperative that the Indians find a way to negotiate an equity stake into their agreement with Fox Sports Ohio. In addition to the $10 million dollar annual increase in broadcasting fees, equity stake could result in added revenue not taxable under the MLB revenue sharing program. It may also provide the added financial boost to compete that was promised but never fully delivered by STO.

The Tigers missed the boat in this regard. They agreed to their deal with Fox Sports Detroit four years too soon and didn’t get in on the equity stake movement. (You can make a case that it hasn’t hindered their spending at all, but surely the extra funds would have helped them.) The Indians can’t afford to fall into the same trap. They need every advantage they can get as one of the smaller markets in baseball even if it’s only an extra $5 million per year (a complete and total guess) every little bit helps.

Based on everything presented, I think it’s safe to say that the Sports Time Ohio venture has been either a failure or has not been used in the way it was originally intended. Why else would the Dolans be willing to sell it off so soon? I have two theories, both of which are total conjecture on my part:

1. The network was not bringing in enough revenue (if not outright bleeding money) to justify its continuation. Thus, the extra $10 million per year in broadcast rights the Dolans can receive from Fox Sports Ohio far exceeds the yearly profits the network was able to make on its own and put back into the Indians, even with the revenue sharing implications involved.
2. The Dolans never invested additional income generated from STO back into the team. Instead, profits were distributed back into the network or simply pocketed by the Dolans for other ventures. Thus, Fox Sports Ohio’s offer of upwards of $250 million was too good to pass up because money today is more valuable than money tomorrow. The extra $10 million per year in broadcast rights would then serve as a convenient band aid to present to fans to justify the sale.

Like I said, there’s no way of knowing whether or not either of those theories are even close to being correct. It might be for reasons no one has even presented yet. But, you can make an interesting case for either based on recent history.

The pending sale of STO puts to rest another interesting chapter in the history of the Cleveland Indians. While it may not have achieved its anticipated results, it did what it had to do and it did it well for the most part. That being said, STO brought the Indians and the joy of baseball to hundreds of thousands of Indians fans each and every summer for seven years—unless, of course, you prefer the sweet, sweet sounds of Tom Hamilton on WTAM.