A Loan That’s Not a Loan
In all the furor over the Pirates’ leaked financial records, one aspect that’s enraged some Pirate fans yet received little attention outside Pittsburgh was the loan by the Nutting family to the Pirates. The transaction wasn’t actually a loan, not in any conventional sense at least. It was really a loan with an option to convert to equity, but it’s easiest to call it a loan. Whatever the best name for the transaction may be, however, it was not the scam that some fans seem to think.
One thing to get out of the way first: This was not a case of the Nuttings borrowing money from themselves. At the time, they didn’t control the Pirates. They didn’t own a majority of the partnership shares, they didn’t control the board, and Kevin McClatchy was the CEO. According to the leaked 2008 financial statement, the loan was carried out in the form of an amendment to the partnership agreement, which means it had to be approved by the partnership. It couldn’t have been entered into simply by McClatchy signing it, much less by Ogden Nutting signing it. There’s zero evidence that it was anything other than an arm’s length transaction.
According to the financial statement, in 2003 the Pirates had exhausted their credit, which was set up for them by MLB with its banks. Evidently unable to meet its obligations, the team received $20M in cash from the Nuttings. The Pirates made no payments for five years, but interest accumulated at the rate of 15% compounded. (See Note 1 below.) After 2008, no further interest accrued. The Nuttings had the option of converting the principal to shares in the partnership in 2008 and did so. They also had the option of converting the interest to equity, but only with the approval of the team’s lenders. The Nuttings attempted to do this in 2008 but were rebuffed. (See Note 2 below.) The Pirates instead paid the Nuttings $10M, which represented half of the interest. We don’t know whether the other half was ever paid. Under the agreement, the conversion option was to remain in effect until 2011. The Nuttings may have collected the interest in 2009 or 2010, or they may have converted the remaining $10M to equity, or neither may have happened. (See Note 3 below.) No further interest, however, has accumulated.
Although we don’t know what happened with the other $10M, let’s assume for the sake of simplicity that the Nuttings collected all of the interest in 2008. That would mean they had doubled their money: $20M in increased equity plus $20M in interest. So, should Pirate fans be outraged? No.
The problem with the argument that the Nuttings were somehow looting the franchise is that the Pirates never paid back the principal. The Nuttings got their money back, alright, but only in the form of increased equity. The equity part of the transaction had no effect whatsoever on The Baseball Team Known As The Pittsburgh Pirates. The Pirates didn’t pay out a dime due to this portion of the transaction, and never will. The Nuttings’ increased equity won’t have any impact on anybody until the team is sold and the partners divvy up the proceeds. Here’s the complete financial impact of the transaction on the Pirates (remember, we’re assuming the full $20M in interest was paid out in 2008, which it actually wasn’t):
–$20M cash received in 2003.
–$20M cash paid out in 2008.
–Cost-free use of $20M for five years.
That’s it. The cash was a wash and the team got the use of the Nuttings’ money for five years, in effect without paying interest. This was a good deal for the Pirates. It would’ve been a good deal even if they hadn’t been faced with the possibility of bankruptcy. It was also a good deal for the Nuttings.
If it was a bad deal for anybody, it was the other partners, but why should Pirate fans worry about them? They were corporations and successful businessmen. They could look out after themselves. Well, there was also McClatchy, but even he no doubt had a lawyer or other advisor to remind him not to sign important stuff in crayon. It wasn’t necessarily even a bad deal for the other partners. They evidently weren’t willing to invest any more of their own money to save the team from bankruptcy. Instead, they let the Nuttings do it, at the cost of a moderate reduction in the value of their investments. That’s the sort of loss you risk when you invest money with somebody as unqualified as McClatchy. The other partners thought this was a good enough deal. Do you think Pirate fans know more about managing Don Beaver’s investments than Don Beaver does? Really??
The end result of this transaction for the Pirates was that it let them stave off bankruptcy, it gave them the use of $20M cost-free for five years, and it probably played a significant role years later in getting rid of McClatchy. That’s it. There was no net cash impact on the team. That’s not a good deal. That’s a damn good deal.
Note 1: The fact that the interest was compounded seems to have created some of the furor, but it shouldn’t. This wasn’t a conventional loan. If you take out a convention mortgage or car loan, you make monthly payments that cover the accumulated interest plus part of the principal. The Pirates made no payments to the Nuttings for five years. Comparing this loan to a standard loan with simple interest is comparing apples to oranges.
Note 2: According to the Pittsburgh Post-Gazette, the Nuttings’ attempt to convert the interest to equity was defeated in a partnership vote, with the Nuttings abstaining due to the conflict of interest. The 2008 financial statement says nothing about a partnership vote. It leaves approval up to the team’s “lenders,” which are MLB and its banks. I don’t know the reason for the seeming discrepancy. It’s worth noting, though, that the financial statement contains only a summary of the transaction. The complete terms would be contained in the partnership agreement and in whatever financial instruments were signed when the money changed hands. Aside from that, the financial statement doesn’t necessarily conflict with the story obtained by the Post-Gazette. The matter could have been put to a vote even though one wasn’t required. For example, the team’s lawyer may have recommended it to avoid accusations of over-reaching. By 2008, the Nuttings controlled the franchise. When the original deal took place in 2003, they did not.
Note 3: Dejan Kovacevic of the Post-Gazette has noted at his blog that the Pirates told him the remaining $10M has not been paid. I can already hear the screams of “Lies! Lies! Lies!,” though, so I’ll continue to assume, for the sake of argument, that we don’t know what happened with that money.