October 22nd, 2012

A-Rod’s Future with the Yankees

I’m not advocating trading Alex Rodriguez because his skills may have diminished. I’m not convinced his poor showing late in the regular season and the playoffs is indicative of his new baseline level of performance, resulting from an irreversible decline in his skills. Didn’t we learn our lesson with Derek Jeter? At points during the second-half of 2010 and the first-half of 2011, there was convincing talk that we were witnessing the sunset of Jeter’s glorious career. Those perceptions proved to be wrong. Since the day Jeter registered his 3000th hit in 2011, through the end of the 2012 season—his last 224 games—he tallied an .806 OPS. This strong performance immediately followed a 145-game stretch when Jeter logged a puny .657 OPS. In the 2012 season, A-Rod posted an .806 OPS in 94 games before his hand injury. After he missed six weeks of action he returned for 28 regular season games and performed at a .710 OPS level. While his post-injury (including postseason) performance was clearly disappointing, it is far from a referendum on his future.

I’m advocating trading Alex Rodriguez because it makes financial sense for the Yankees and gives them the flexibility they need to maintain a championship caliber team over the next several years. Aside from the debate around the expectations of A-Rod’s future performance, he has five years and $114 million in salary remaining on his contract. In addition, he is entitled to a potential $30 million in milestone bonuses for achieving various historic home run totals, beginning with his 660th HR (he currently sits at 647). While this is what A-Rod is owed, it does not fully reflect the true cost to the Yankees. Let’s acknowledge that the Yankees will likely be in a 40% or even 50% luxury tax bracket for the life of Rodriguez’s contract. This means they may end up paying out over $200 million for the remaining 5 years of his deal, including the marketing incentives for achieving his milestone HRs. The Yankees seem to have an aspiration to duck under the luxury tax threshold for at least one year—and for good reason. Doing so would put significant dollars in their pockets. Not only would they save money by not paying the maximum luxury tax rate, they would also reset their future tax rate to a modest 17½% , should they exceed the luxury tax threshold in a subsequent year. In addition, if a team is below the luxury tax threshold, they are entitled to additional shared revenues from MLB. Shedding A-Rod’s salary and marketing incentive obligations could be the key to allowing the Yankees to get below the luxury tax threshold in 2014, when it escalates to $189 million.

There are two ways the Yankees could attempt to deal A-Rod. One approach is to eat a modest amount of his future compensation. Perhaps if the Yankees pay $50 million—the equivalent of $10 million per year—of his remaining $114 million in salary, they might generate interest from a few MLB teams. This would allow them to ship A-Rod to another club with a $13 million per year salary obligation, plus the possibility of another $30 million in incentives for historic HRs. Under this scenario, New York would likely not command much in return, in the form of players or prospects, but they would reduce their $27.5 million (plus any incentives they payout) annual charge against their luxury tax threshold to $10 million per year. This gives them a fighting chance to get underneath the $189 million annual payroll, or at least redeploy the payroll dollars more efficiently towards more productive assets.

The second approach is more aggressive—a scenario where the Yankees eat more of A-Rod’s compensation, say $15 million per year, but position themselves to acquire a highly ranked prospect in return. If they leave their trade partner with a more manageable $8 million per year salary obligation, plus the potential incentives, they should also be able to acquire a top prospect or a young, high ceiling player with less than a year or two of service time. This could further aid their attempt to get under the luxury tax threshold—adding an inexpensive, but productive player. Regardless of the Yankees trade strategy, A-Rod would need to approve any deal, which will not be easy to accomplish. Rodriguez would perceive any exit from New York as a personal embarrassment, which is an important consideration for someone who seems highly concerned about other people’s perceptions. The Yankees would need to convince A-Rod that life will be even more miserable if he stayed, than if he left. The Yankees’ treatment of A-Rod during the playoffs helps their cause in this regard. They certainly showed they are capable of embarrassing him. The right trade partner may help sway A-Rod. Perhaps a small, home run-oriented ballpark that increases the likelihood that Alex reaches his HR milestones and hence, baseball immortality, will raise the appeal a trade scenario.

Bottom line—this is more about an arbitrage opportunity on the luxury tax threshold, than it is about Alex’s talent level. A-Rod is an asset that might cost the Yankees $200 million over the next 5 years—a staggering $40 million per year—plus the opportunity cost of sharing in additional revenues and lowering their luxury tax rate in future years. The same A-Rod would cost another team between $40 million and $70 million less—the equivalent of the Yankee luxury tax payments. This equation means the Yankees should be willing to pay a chunk of dollars to subsidize A-Rod’s cost to another team. There seems to be plenty of room to create a win-win scenario for the Yankees and a trade partner. It’s making the equation work for Alex that’s the tough part, but the Yankees have done a nice job of laying the groundwork.

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