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(The following is being syndicated from The Captain’s Blog).

The Cliff Lee sweepstakes has turned into a guessing game over which mystery teams have supposedly offered the ace lefthander a seven-year contract. Although no confirmations have been forthcoming, the addition of a seventh year seems to be a major sticking point, at least for the Yankees, who, again according to unsubstantiated rumors, are unwilling to go beyond six.

On his Twitter account, columnist John Heyman reported that although the Yankees intend on sticking to six years, they would try to “steal” Lee with an inflated offer of $140-150 million. Aside from the fact that a thief isn’t supposed to come away lighter in the pockets, the biggest problem with Heyman’s exclusive is the Yankees’ supposed logic doesn’t really make much economic sense (or cents, for that matter).

All long-term contracts carry heightened risk because of the increased uncertainty that comes from peering too far into the future. For many, the burden of carrying a star player past his prime at an inflated salary seems like a fate worse than being a fan of the Pittsburgh Pirates. However, we can sometimes get too carried away with the length of a contract, especially when what we should be focusing upon is the overall value.

Back loading a contract is one way teams seek to defray the exorbitant cost of long-term deals. Even though that goes completely against the misplaced logic summarized above (now, the star player is paid even more as he gets further from his prime), the economic reasoning is very sound. Why? Because money has time value. In other words, $1 in the present is not the same as $1 in the future ($1 in the present is usually worth more). Factors such as inflation, interest and tax rates can all have an impact on the value of money as time passes, which, brings us back to the Yankees’ reported aversion to giving Lee a seven-year deal.

Let’s assume that Heyman is correct and the Yankees are willing to pay Lee $150 million over the next six years. Instead of dismissing the notion of a seven-year deal out of hand, our next question should be at what terms would such a contract be equivalent? One way to determine that is to consider the present value of two different contracts and see how they compare.

Present Value Comparison of Two Contracts

  Deal 1: $150mn / 6 years   Deal 2: $164.5mn / 7 years
Year Salary Present Value   Salary Present Value
1 $25,000,000 $25,000,000   23,500,000 $23,500,000
2 $25,000,000 $22,186,231   23,500,000 $20,855,057
3 $25,000,000 $19,689,153   23,500,000 $18,507,804
4 $25,000,000 $17,473,124   23,500,000 $16,424,736
5 $25,000,000 $15,506,510   23,500,000 $14,576,120
6 $25,000,000 $13,761,240   23,500,000 $12,935,566
7 NA NA   23,500,000 $11,479,658
Total $150,000,000 $113,616,258   $164,500,000 $118,278,941

Note: Based on a nominal interest rate of 12% compounded monthly. Assumes salary paid in full each year (which favors shorter-term deal).

Source: zenwealth.com

At this point, it might be worthwhile to take a quick diversion and explain what present value means. Basically, in this instance, it refers to the amount of money the Yankees need today to pay off a debt tomorrow (think about Wimpy and hamburgers). Of course, the concept assumes that the money is invested wisely, not spent frivolously (think Carl Pavano). With that in mind, let’s assume the Yankees invested $22,186, 231 on day one of the rumored contract and received a 12% annual rate compounded monthly. At the end of the year, the Yankees initial investment would amount to $25,000,000 (principal plus interest of just over $2.8 million). As a result, with a discounted initial sum, the Yankees could pay Cliff Lee’s salary in the following season.

Now, let’s fast forward back to the comparison. Although it does look as if the Yankees’ shorter deal is less expensive, we aren’t finished yet. In addition to calculating the present value of each term year, we also need to consider the opportunity value of the $1.5 million “saved” under the longer contract. Once again, assuming that the Yankees invested the saving (125,000 per month) at an annual rate of 12%, they would end up with just over $4 million in return. When subtracted from the present value of the deal, the two terms presented in the chart above become near equivalent. For the Yankees, however, there is also the issue of luxury tax. Assuming the team’s payroll would hover around the same level regardless of either deal, it would enjoy a luxury tax savings of $3.6 million (or more, if the Yankees also invested that sum) over the first six years of the seven-year deal. When these factors are also considered, the seven-year deal comes in almost $3 million cheaper than the shorter version.

Normalization of Hypothetical Seven-Year Deal

Variables Total
Present Value $118,278,941
Interest on Lower AAS* $4,088,741
Luxury Tax Savings# $3,600,000
Final Cost $110,590,200

* Based on a nominal interest rate of 12% compounded monthly
# Based on luxury tax rate of 40% charged in years one to six of the contract.

At this point, it should be noted that there are more variables that need to be considered in order to increase the accuracy of the comparison. For starters, we’d need to determine the rate of return that the Yankees expect on their investments (it could be much more or less than 12%). Also, we’d need to have a better understanding of the team’s cash flow (i.e., does paying Lee compromise their liquidity to the point that they can not invest elsewhere). There is also the issue of taxes, which could mitigate the Yankees’ return on investment (although, considering the amount of debt held by the team as well as the favorable tax treatment it enjoys under the terms of its financing, that really might not be much of an issue), as well as inflation, which in a baseball sense would refer to the future direction of salaries (i.e., how much will star pitchers be paid 6-7 years from now). Having noted these caveats, the analysis still illustrates there are very sophisticated ways to evaluate long-term contracts that go well beyond how much an aged All Star is making during the final years of his deal.

Should the Yankees go to seven years with Lee? Or should six be the limit? It doesn’t really matter. What the Yankees need to do is decide upon a limit in terms of present day dollars, not contract years. Only after factoring in all the variables, can such a limit be determined. Then again, there probably is one other variable that also needs to be considered….the competitiveness of Hal Steinbrenner. We know how it would have factored into a negotiation with his father, but it remains to be seen how it will influence the son.

The off season has just begun, but we’re already seeing a new phenomena: a big jump the the salaries offered to players. Jason Werth earned 7 years, 126 million. Adam Dunn, in a crowded market for his services, earned 4 years, 56 million. Cliff Lee is bound to earn at least 6 years, 150 million, and could earn even more. Troy Tulowitzki earned his 157 million dollar extension.  The list goes on – John Buck, Jorge De La Rosa, Hiroki Kuroda, Ted Lilly, Bronson Arroyo – all received or will receive huge deals. Going back a little further, we can look at Joe Mauer and Ryan Howard.

We’ve been waiting for the next round of real baseball inflation to come for awhile now. It looked like it was coming in 2006 when Alfonso Soriano, Vernon Wells, Barry Zito, and Johan Santana earned big extensions. This round probably began after the 2008 season when the Yankees paid 23 million per year to Sabathia and Teixeira, and an absurd 18.5 per year for Burnett. The market corrected itself after 2006, but I don’t think that we’re going to see that again. Baseball has long waited for the AAV of major free agent contracts to balloon upwards again after most flat-lining through the 2000s. Baseball made something like $6.8 billion last year, more than double what MLB made in 2000, but the average player salaries has only increased from about $2,000,000 to $3,000,000. In graph form:

We’ve been waiting for real growth for awhile now, but haven’t seen it. I sense that it is because of a combination of teams locking up their young stars through their late-20s today, combined with an unbalanced talent base – the 2000s just didn’t have that many particularly awesome players hitting free agent age. However, teams are not awash with money, and looking for places to spend it. While there aren’t any Alex Rodriguez’s or Manny Ramirez’s out there, there are some reasonably attractive options, and the market prices are skyrocketing. Also, I think that MLB is increasingly confident in its market position once the economy gets back into full swing.

This is a mixed blessing for the Yankees. If prices correct themselves, that means other teams are spending more money. The Yankees will lose much of their financial advantage unless the Steinbrenners choose to raise Cashman’s budget. On the other hand, major baseball inflation (late-90s style) would make a lot of their long term contracts seem like dire, especially the Alex Rodriguez deal. If the Yankees do maintain their budgetary edge over other teams, they’ll be able to take advantage and reduce some of the pain from past mistakes.

This is kinda-sorta an argument for signing Cliff Lee, even though I still have some of the reservations that I expressed earlier. If the Yankees really believe that a) major baseball inflation is coming and b) they want to increase their payroll significantly, then they should sign Lee. However, we’ve seen no indication that the Steinbrenners are willing to go into the 250+ million dollar range that this scenario would suggest.

On a side note, that graph just screams to me, “Painful CBA negotiations after this season” when the next round of labor talks begin. MLB players really are due for a big raise.

Dec 082010

Last night, I posed a bit of a question on Twitter. I asked, if the Yankees sign Russell Martin, which is definitely a possibility, what happens to their current catchers?

Jorge Posada doesn’t count. He’s the DH. I’m sure he’ll see a handful (more maybe a bit more than that) at catcher, but he’s no longer a C/DH. He’s a DH/C. I mean Jesus Montero and Francisco Cervelli. There are two ways I see this shaking out:

A) The acquisition of Russell Martin means that Jesus Montero will not be starting the season with the New York Yankees. Now, we can take that two ways. One means that the Yankees sign Martin and use him as a starting catcher while Jesus Montero gets a little more seasoning in AAA. There are obvious advantages to this. While Montero raked in the second half, a little more time in the minors (usually) never hurt anyone (Ryan Howard, Andrew McCutchen). He could work on his approach at the plate which, while good, could probably use some fine tuning. He did have solid walk rate of 9.1%, but his K% jumped up to just over 20%. The 20% K rate isn’t that bad considering Montero’s power, but it’s the highest of his career by far. And there were all sorts of conflicting reports about his defense. Was it improved? Did it deteriorate? Letting him work on it for a bit in the minors without real pressure would be a good thing. The seasoning argument is definitely one that can be made.

The other thought is that if Montero isn’t with the Yankees to start 2011, it’ll be because the Yankees will have traded him. I’m not sold that this will happen, but if the Yankees sign Martin after failing to sign Cliff Lee, it’s a possibility. That possibility is even more ramped up if Andy Pettitte does indeed retire. I’m not exactly sure this course of action is even necessary, but I definitely won’t rule it out.

B) Acquiring Russell Martin makes Francisco Cervelli very expendable. Moshe Tweeted that he thinks this will happen. If the Yankees sign Martin, Cervelli will be moved for depth in the form of a reliever/platoon bat/utility guy, if not sent down. Sending Cervelli down wouldn’t be an awful idea. If Montero’s on the big team catching and Martin is there, too, there is no need for Cervelli. Starting him in AAA allows the Yankees to let Austin Romine begin the year at AA. He hit a bit of a wall last year and could use some extra time in the Eastern League before moving to the International League. The counter to that, though, is that putting him in AAA ruins Cervelli’s trade value a bit.

Cervelli’s value is already low since a) he’s not that good and b) had a (perceived) bad season in 2010. Having him start in AAA shoots that value even more. But, at the same time, it’s not like Cervelli would be the centerpiece of a trade or bring more than what Moshe suggested. If the Yankees get Martin, I don’t care much what they do with Cervelli. Trade him? Fine. Stash him in AAA for a rainy day? Cool.

Out of these options, though, I guess I’d go with option A.1: letting Martin start for a time while Montero gets some more seasoning in Scranton. I think Montero is definitely ready to start for the Yankees behind the plate, but it wouldn’t hurt for him to see more AAA at bats first.

Other notes: It appears my Mark Prior wish could come true. I don’t know how much upside is there anymore, but it’s worth it. I think we’ve all always wanted Prior in some way. Now, the Yankees could have him.

Friend of the blog Tyler Wilkinson had a suggestion last night. If the divisions were named after players, whom would each be named for? My thoughts:

ALE: Babe Ruth
ALC: Ty Cobb
ALW: Rod Carew
NLE: Jackie Robinson
NLC: Stan Musial
NLW: Willie Mays

What do you guys think?

Dec 082010

I just never tire of this picture.

WFAN’s Mike Francesa interviewed Yankee GM Brian Cashman yesterday on his afternoon drive radio show. As always Brian was verbose, and made some interesting statements as well as clearing up some things in and around Yankee land. Here’s the link, I transcribed the parts I found most interesting:

On Derek Jeter-

Francesa-”..you were very straightforward about making this a cut and dried negotiation..did he take umbrage with anything you said?”

Cashman-”Yes. I think he did, understandably. And I took umbrage with being in the position to have to respond to the commentary that came out from their perspective.. ”

Francesa-”So you were annoyed with his agent”

Cashman-”Well, no Casey is terrific. Believe me, Casey and I go way back. Bottom line is, when you have the New York Yankees and you’ve got Derek Jeter, and its the media capitol of the world, all the eyes are watching, what you say, what you think, what you do. It’s bound to be combustible, and it was. Obviously I responded to the ‘baffling’ comments and ‘worth more than just statistics’ and ‘modern day Babe Ruth’ and I went on behalf of the Yankee and responded to that. They went and responded on the behalf of Derek with what they felt was..’sources’ and stuff like that.”

He went on to say that he and Derek have talked, had an honest exchange and there are no longer any hard feelings.

On AJ Burnett-

Francesa-”..if you can share, what was your conversation like with Burnett?”

Cashman-”It was good. Obviously he had the disappointing year. He knows that, we know that. Our job is to attack areas of weakness and he’s physically ready to go. I’ll give you one nugget, he called Larry Rothschild directly. We hired Larry Rothschild to be our pitching coach and the first phone call he received was from AJ Burnett” It reminded me of Robinson Cano years ago when he reached out to Larry Bowa and said ‘can you help me?’ So that was a good sign….Larry’s going to work with him, early in the winter and prior to Spring Training and work on some mechanical stuff and I think you’ll see an Burnett like the one we saw prior to this year.

On Jorge Posada-

Francesa-”..he’s a proud athlete, but he’s getting older. You expect him to protect his turf, but at what expense to the team. What’s your conversation like with him?”

Cashman-”It was good. I met with him when he had the knee surgery.. over at the hospital…it was a good conversation. I just told him direct and straight that our intention is to have him DH and do of that, at that role. And I want him to prepare as a Catcher still, just in case, because the best laid plans can go south on you.  I want him to be in a position to be available, as needed, but more as a 3rd Catcher for us. We’ll take his offensive abilities and stick them at the DH spot.”

Francesa-”Was he comfortable with that?”

Cashman-”He didn’t fight it. He’s done so much over time I think he was prepared for it, to be honest.”

On the 2011 Catcher-

Francesa-”So what’s your game plan with your catching right now?”

Cashman-”We’ve got some young kids that are going to take a shot at it, between Cervelli, Montero, Romine, and were certainly exploring outside opportunities at the same time. “

Francesa-”In your mind, would you be surprised if a Montero or Romine was ready this year?”

Cashman-”Not surprised at all. There’s no doubt that we’ve been told that we have guys that are in-house that are ready, but at the same time you have to respect the difficulty of that position. I remember how long it took for us to break in Jorge Posada when we had an aging Joe Girardi here, as well as a Jim Leyritz to help give cover as Posada grew into the position. It’s such a difficult, unique position.We just want to be careful as we transition and bring the youth up. It’s not as easy as just running Robinson Cano up at second base, and sink or swim. Or Brett Gardner in Left Field, and sink or swim. Or Joba Chamberlain in the bullpen or Phil Hughes in the back of the rotation.

The Catcher’s job is unique to itself. He’s the field general. He’s responsible for those 12 (pitchers) he’s got to have the advance report, he has to be able to communicate and retain all that information, recognize all the ‘tells’ and what each pitchers mechanical issues are, in game. It’s such a responsibility that we just have to be careful with it. We have, in these young players, some of the best catching coming in the game. No question. Is it ready in 2011? We’ll find out. “

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