Shohei Ohtani is a Japanese baseball star who just signed a $700MM contract with the Los Angeles Dodgers making him one of the highest paid players in sports history. The full contract hasn’t been made public, and is pending a few details before being finalized. That means Deep Knowledge Investing hasn’t been able to read it, but enough information has been made public that some analysis is possible. We thought it would be fun to dive into a situation where pop culture meets finance and loop in some of the topics we frequently discuss here at DKI!

Ohtani has agreed to play for the Dodgers for the next 10 years and get paid $2MM a year during that time. The other $680MM of the contract will be paid during the following 10 years. That means 97% of his salary will be paid after he is presumably done playing. It’s been reported that Ohtani is the one who proposed the unusual terms. Why would he do this?

Let’s dive in:

Did Ohtani Really Disadvantage Himself

The time value of money matters. We’d all like to be paid today, and Ohtani appears to be agreeing to delay $680MM of compensation by 10 years. At a 5% discount rate, that would cost him a little over $250MM dollars. Does that mean he just gave up a quarter of a billion dollars in value to the Dodgers?

Of course he didn’t. Remember that any value created by the contract structure can be transferred or shared. Another way to think about this is Ohtani really agreed to be paid $450MM in value assuming a more standard contract without deferred payments, but structured the deal in a way that allowed for there to be a $700MM headline number. There are marketing-related reasons on both sides to do this.

Ohtani is rumored to have other income of about $50MM a year so he’ll definitely be able to pay his grocery bill and rent on “only” $2MM a year for those first 10 years. The key point here is Ohtani chose a deal where he gets paid more in later years instead of one where he gets paid less overall, but sooner. This represents rational thinking from both sides.

Note that the current yield on the 10-year Treasury is 4.2% and the 20-year is 4.5%. One could reasonably argue we should be using a higher discount rate here. The objective isn’t to precisely value Ohtani’s contract; but rather, to give you a sense of where the big levers of value are.

Deep Knowledge Investing regularly writes about inflation. If your expenses have gone up considerably in the past few years, you understand why it’s an issue. As the government issues more dollars, the value of the dollars you hold decreases. That decline in purchasing power is felt as inflation, or higher prices. The reason we’re talking about the value of Ohtani’s contract being worth closer to $450MM than the headline $700MM is because when he receives the $680MM of payments 10 years later, his purchasing power will be much lower then than it would be if he were to receive the money while playing instead of deferred by a decade. That loss of purchasing power is one main reason the stated value of the contract is so high.

The “Luxury Tax” As It Relates To Ohtani’s Deal

Major League Baseball has a “Competitive Balance Tax” that’s referred to as the luxury tax. If a team is over the payroll limit for three years in a row, that team has to pay up to 50% of the excess amount to lower-income teams. This was designed to prevent wealthy big market teams like the Dodgers and Yankees from buying championships and relegating small market or less wealthy teams to the bottom of the standings each year. That was the intention. You are invited to draw your own conclusions on the results.

It's also reasonable to assume the threshold for the luxury tax will continue to rise meaning when the bill for the Dodgers’ deferred contract obligations comes due, it’s likely to be against a higher luxury tax amount. The overall payments to the small market teams would be lower under this scenario.

Is The Ohtani Deal Legal?

I’ve seen speculation that other Major League Baseball owners should reject this deal as abusive and outside the spirit of the competitive balance tax. I’m not an expert in baseball rules, but I don’t think there’s a limit to the amount of contract dollars that can be deferred. The Dodgers may have found a way to abuse the system while technically complying with it.

That means the deal is likely to be approved. It’s possible some teams will succeed in preventing it. Another potential outcome is to approve this deal as within the letter of the law and then change the rules to prevent future deals that are so blatant in luxury tax avoidance. At this point, it’s too early to know.

The key takeaway is that by deferring payments, the Dodgers give themselves additional financial firepower and can keep or share all or some of that value with their new star.

Competition And Defining Success

Taxes And Tax Avoidance For Consideration

Marketing Value of Ohtani’s Deal:

The massive sticker shock of being the $700MM man is a benefit to both Ohtani and the Dodgers. Sports stars are often judged on their earnings and this big number both elevates Ohtani and confirms his position as the biggest name in the game.

There are benefits to the Dodgers as well. If you’re a fan of the team, you just saw headlines that management is paying $700MM to bring you the best player available. The move confirms that the Dodgers are committed to winning and takes your fandom seriously. I’m not the only one predicting increasing sales of season tickets, jerseys, and other Dodgers’ merchandise.

Structuring the deal in a way that allows for the maximum headline compensation number while deferring payments to a time when they have lesser value is smart marketing by both the Dodgers and Ohtani.

Conclusion:

It’s a weird and exciting deal with a huge headline number and lots of quieter clauses that reduce the value to something below the stated $700MM. It will be fascinating to see what additional detail becomes available in the upcoming weeks and if Major League Baseball either approves the contract and/or changes the rules for future deals.

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