Max Scherzer and When $210 Million Isn’t $210 Million by Dave Cameron January 19, 2015 Scott Boras has done it again. After months of what appeared to be mild interest from the clubs one would assume would be in the bidding for the best free agent on the market, Boras found an unexpected bidder with $200 million burning a hole in their pockets. Or, more precisely, $210 million in this case, as the Nationals joined the club of teams paying $30 million per year for premium talent. Or, at least, they did on paper. Scherzer signed a seven year contract, and in exchange for pitching for them for those seven years, the Nationals have agreed to pay him $210 million in salary. Divide $210 million by seven years and you get $30 million in AAV, which is how this deal will be reported. But because of how this deal was structured, it’s not really $30 million per year. Instead, the Nationals will pay Scherzer $15 million per season, but do so for 14 years; essentially, they’ve deferred half of each season’s salary seven years into the future. Effectively, they signed Scherzer for $105 million over the seven years that he’ll pitch for them, and then they’ll pay him the next $105 million after the contract ends, making this the most deferred money contract in baseball history. Teams have been deferring money in contracts forever — the most famous case is Bobby Bonilla’s deal with the Mets that has them paying him through the 2035 season — but never before have we seen this size of a deferral, and so this deal serves as a nice reminder that the payment terms of a deal can have an impact on the actual value of contract. And in this case, the significant deferral has a pretty big impact. For a lot of reasons, money today is worth more than money in the future, and the further in the future you go, the less money is worth. To translate various schedules of annuities into a scale so that they can be compared side by side, financial analysts use Net Present Value to calculate the value of deals like this. In other words, what amount of money would you need to be handed in cash today to roughly equal the value of the structured payout over time? NPV calculations are pretty simple, with the primary variable being the discount rate you apply to those future dollars. Just for the sake of argument, let’s assume Scherzer’s discount rate is 7%, roughly the expected long-term rate of return on investing in the stock market. If you take $210 million spread out over 14 years and apply a 7% discount rate, then the contract is worth about $131 million in today’s dollars. Still a lot of money, obviously, but a lot less than the $210 million figure. Of course, every contract is an annuity with scheduled future payments, so we need to compare that NPV to what the NPV of this deal would have been had the Nationals not deferred half the contract into the future. So, below is a table of various NPV calculations that show the differences in contract valuation based on the payment structures. The first column is how Scherzer’s deal is going to be paid, followed by a more normal backloaded contract that we regularly see, then a completely flat payment structure with even payouts each year, and finally, the NPV equivalent if the salaries were paid on a flat basis. Year Scherzer Backloaded Flat EqualNPV 2015 $15,000,000 $20,000,000 $30,000,000 $24,341,000 2016 $15,000,000 $25,000,000 $30,000,000 $24,341,000 2017 $15,000,000 $30,000,000 $30,000,000 $24,341,000 2018 $15,000,000 $30,000,000 $30,000,000 $24,341,000 2019 $15,000,000 $35,000,000 $30,000,000 $24,341,000 2020 $15,000,000 $35,000,000 $30,000,000 $24,341,000 2021 $15,000,000 $35,000,000 $30,000,000 $24,341,000 2022 $15,000,000 $0 $0 $0 2023 $15,000,000 $0 $0 $0 2024 $15,000,000 $0 $0 $0 2025 $15,000,000 $0 $0 $0 2026 $15,000,000 $0 $0 $0 2027 $15,000,000 $0 $0 $0 2028 $15,000,000 $0 $0 $0 Total $210,000,000 $210,000,000 $210,000,000 $170,387,000 NPV $131,182,020 $157,976,085 $161,678,682 $131,180,693 The first two columns are maybe the most important. Here, you can see that if the Nationals had simply signed Scherzer to a normal backloaded deal, the kind of contract we see all the time in MLB, the contract would have been worth almost $27 million more to Scherzer than the one he signed. If he had gotten a flat payout structure, we’re talking about $30 million in additional value. Generally, deferred money doesn’t make a huge difference, but when you’re deferring half of the second largest contract for a pitcher in baseball history, the timing of the payments can make a big difference. And that’s where that last column of that table comes into play, as it shows what an equivalent flat payout AAV would be to this deal: $170 million. If Scherzer had signed for 7/$170 with an equal payout in each season that he actually played for the Nationals, that contract would be roughly equivalent in value to the $210 million deferred compensation contract he actually signed. You know what the crowd projected Scherzer to sign for this winter? $168 million over seven years. I guessed $175 million. Pretty much everyone else did too. The $210 million figure is going to grab headlines, but this is essentially the contract that we all thought Scherzer would get this winter; it’s just structured differently than we anticipated. And, as Jeff wrote last night, $170ish million is probably about what we should expect Scherzer to be worth over the next seven years. The extra $40 million in guaranteed money is just there to offset the fact that so much of it is being paid far off in the distant future. One last comparison, and then I’ll let you get back to the baseball side of baseball. On the surface, Scherzer’s deal dwarfs what Jon Lester got from the Cubs, but that deal is actually somewhat frontloaded, and so it has a very different payment timeline than the Scherzer deal. Let’s look at the NPV of both deals side by side, based on their per-season payouts. According to Cot’s Contracts, Lester’s $30 million signing bonus is paid out in four installments; half of it coming next April, and then the other half spread out over the last few years of the deal. I’ve added those signing bonus payments to the annual salaries paid out in each season, as well as including the $10 million buyout of the seventh year option. Here’s how the two contracts stack up by NPV. Year Scherzer Lester 2015 $15,000,000 $30,000,000 2016 $15,000,000 $20,000,000 2017 $15,000,000 $20,000,000 2018 $15,000,000 $22,500,000 2019 $15,000,000 $25,000,000 2020 $15,000,000 $27,500,000 2021 $15,000,000 $10,000,000 2022 $15,000,000 $0 2023 $15,000,000 $0 2024 $15,000,000 $0 2025 $15,000,000 $0 2026 $15,000,000 $0 2027 $15,000,000 $0 2028 $15,000,000 $0 Total $210,000,000 $155,000,000 NPV $131,182,020 $121,373,821 In terms of guaranteed dollars, Scherzer got $55 million more than Lester did, which makes the gap between the two contracts seem enormous. When you factor in the payout structures, though, the value of the two contracts is actually only $10 million apart; the Nationals didn’t actually pay all that much more for Scherzer than the Cubs did for Lester. Whether the Nationals needed Max Scherzer is up for debate, and I think there’s a strong case to be made that a team with the Nationals rotation could have spent this kind of money more efficiently on other things, but don’t let the initial shock of the $210 million price tag scare you. Scherzer really only needs to justify about $170 million in salary over the next seven years, because the rest of it is just there to account for the fact that the Nationals are forcing Scherzer to make them a long-term loan in order to keep their payrolls at a manageable level while he’s actually on the team.