iStar, Jay Sugarman and the Missing Million-Dollar Player

The Union have never been a team to invest big money on players. Since they've been in the league, their average rank in player compensation is 11^th out of an average of 18 teams. In 2015 they rank tenth out of the 20 teams, but about an eighth of their base salary was loaned out this season, so they likely rank lower. Of the 20 current franchises, 13 have paid a single player more than $1,000,000 for the season, and there are 11 such clubs in 2015. The Union are not one of those clubs.

The question then becomes, is a million-dollar player that important? Maybe a little. Maybe more than a little.

Currently seven of the eleven teams with million-dollar players are in a table position that would qualify for the playoffs. Two of the clubs with expensive players that are not in playoff positions are expansion clubs. Playoffs for them would be quite an achievement. Including the current table and going back to 2013, over 65% of the clubs with million-dollar players make the playoffs compared to the league rate of 55% over the same period. Can million-dollar players increase the odds of making the playoffs by over 25% (65% versus 52% for teams without such a player)? It's hard to tell but it appears to be worth something in terms of winning.

Why the Union have chosen not to spend a large sum on a single player is a much-debated topic. Because they represent the source of the money, much of the debate centers around the ownership group: Keystone Sports and Entertainment LLC and the majority owner Jay Sugarman, CEO of iStar Financial Inc. (STAR), which as of August 19th was to be called iStar Inc. iStar has been a poorly performing stock since the economic crises and there is speculation that the stock's performance has caused funds for the Union to dry up.

A while back, Union beat writer Kevin Kinkead tweeted this was the case.

Just tell the truth: iStar financial stock plummeted after Sugarman bought the team, and that's why there is no money to spend

— Kevin Kinkead (@KevinKCBS3) June 30, 2015

Some questions are worth exploring in some detail. Just what has been the story of iStar's financial performance? How has that performance impacted the pay of Jay Sugarman? What is the risk profile of iStar and what can we learn about how Jay Sugarman thinks of risk and reward? Ultimately, could there be any truth to the discussion? And ultimately what does all this mean for the fans?

The Rise and Fall of iStar Inc. (name changed from iStar Financial Inc. to iStar Inc. as of August 19^th, 2015)

Before examining the history of iStar it should be made crystal clear that there is no public linkage between iStar Financial Inc. and Keystone Sports and Entertainment LLC. The iStar annual reports make no mention of Keystone Sports and Entertainment LLC, and there has been no connection made between the two companies in any public statement. This lack of connection between the two companies means that the link between iStar and the Union is solely through the compensation paid to Jay Sugarman. While the story of iStar is inextricably linked with Jay Sugarman, only Sugarman's compensation really matters from a Union perspective.

iStar is a Real Estate Investment Trust ("REIT") that finances and invests in real estate and real estate-related projects. They focus on large assets in major metropolitan areas in the United States. Their largest investment region is the Northeast, where 27% of their $5.2B portfolio is held. Jay Sugarman was appointed CEO of iStar in 1997. The stock price that year was low single digits. The stock was a huge success even through the economic downturn that occurred early in the 21^st century.

Here is the chart from Google Finance of iStar's stock from 1997 through 2006.

Note on reading the chart: iStar is represented by the lighter blue line. The red line is the S&P 500 and the other colors are a group of peer stocks highlighted by Google Finance.

Through the end of 2006 iStar was a rock star performer, outperforming the S&P 500 by over 2000% percent. If you invested $100 in iStar at the beginning of 1997, you would have had over $2600 at the end of 2006. If you had instead invested that money in the S&P 500 you would have had about $188. iStar was even outperforming a peer group of real estate stocks. Jay Sugarman was richly rewarded for the iStar's performance. In 2006 Forbes listed him as a top 25 paid CEO and they listed his compensation for the last five years at over $130M.

It was this success that had to be the genesis behind the Keystone Sports and Entertainment LLC. The group was looking for a soccer site as early as 2006 and officially received public funding for the project that resulted in PPL Park in November of 2007. The Union were awarded the franchise by Major League Soccer on February 28^th, 2008.

iStar continued to perform well into 2007 before the economic downturn took its toll on the entire market. iStar was hit more than the market due to the fact that real estate miscues in general were a major cause of the downturn. In the chart below the entire peer group performed below the S&P 500. If you had invested in iStar at the end of 2006 you would have lost nearly every penny by the end of 2008.

As you can see from the chart above, the bad times continued from there. By the time the Union took their first kick, iStar's stock would be worth just a fraction of what it was worth when the team was announced. Jay Sugarman's compensation was greatly diminished as a result. He was awarded an incentive-laden stock grant in 2008 but the company fell short of the triggers by 2011 and Jay Sugarman didn't receive the stock. To compensate him for the miss, in 2011 iStar's Board granted him $26M in stock to be vested through 2014 if he remained employed. He received the last stock grant on June 15, 2014 and Salary.com lists his 2014 compensation at $6.5M. The stock value at the time of vesting however was $8.6M. While a nice chunk of change, that is certainly a far cry from his prior compensation. And the company's performance has continued to falter. Here is a chart of Earnings per Share for STAR from Google Finance since 2011, which shows just one profitable quarter for the company.

It gets worse for the CEO as iStar annual reports reveal no additional grant being awarded that would compensate him beyond his base salary in 2015. According to the iStar 2014 10-K released in May, only $3.8M in intrinsic value of restricted shares granted to members of the Board of Directors were outstanding. The money that was coming in since 2011 appears to have halted so far in 2015.

The CEO's base salary is listed by salary.com at $1,000,000. According to NASDAQ insider information from early 2014, Jay Sugarman has approximately 2.5M shares, which as of yesterday's price would be worth nearly $30M. Couple that with the grant he received in June, and he likely has between $35M and $40M in stock in iStar, potentially lower if he sold any shares in the last year.

The Ownership Group's investment in the Union

Philadelphia Union CEO Nick Sakiewicz recently discussed the ownership group's level of investment in an interview with the Metro.

"We as an ownership group have invested well over $100 million to date of our own capital. We are spending millions more building a practice campus for the first team that includes two top class grass pitches and a custom built building." -Nick Sakiewicz

The franchise fee alone was $30M and it was reported by Brotherly Game in 2013 that the investors contributed $49M of the $122M it took to build PPL Park. Add in investments in the Academy, the practice facilities and a myriad of other small ventures and it's within reason to get to that $100M mark. There is question as to whether some of that money would have been borrowed from other sources and not directly from the owners. The Union have mentioned debt payments for the building of the stadium in the past, which would not be from the portion of the building costs that were publicly funded, and therefore would be for money borrowed by the ownership group.

The ownership group has invested heavily, no doubt. Even if a portion of the money was borrowed they still owe the payments back on those loans in the future. And with the advent of the new USL affiliate, it appears the investments will continue. But the question at the crux of this discussion is when does the operating cash flow of the Union start to cover the ongoing investments? Said another way, when does Keystone Sports and Entertainment LLC stop investing and have the franchise revenues to fund new ventures, players and their dividend? Remember, Nick Sakiewicz has publicly stated that the investment group has continued to invest money into the Union as recently as the practice fields, which indicates that the operating cash flow of the club can't cover that level of investment.

Forbes recently reported that the Union made $2M in operating cash flow during the 2014 season. That profit does not include any interest payments made. It's conceivable that interest payments eat away at any excess profit at this point. But that $2M operating cash flow number ranked seventh in MLS, which actually puts the Union's financial situation in pretty good shape relative to the rest of the league.

Investing in a million-dollar player

Consider the investment in a million-dollar plus player a new investment. MLS pays the players' salaries except for those salaries paid above the Designated Player threshold. So the Union would be on the hook for anything above $436,250 after any allocation money used. If the Union attempt to sign a player at $2,000,000, they might need to fund $1.5M of the player's salary. There are three, maybe four, options for where this money would come from. The first and unlikeliest option is that the club has the money from profits stored in the club's coffers. The second option is they expect that the operating cash flows of the club will cover that new cost next year and no new money is needed. Third, they are reliant on incremental investment from the ownership group and likely Jay Sugarman's personal money to make that possible. There is actually a fourth option that might make fans shudder, and that is that the Union ownership might have first rights to some of the operating cash flows of the club. In which case, the club wouldn't need infusion from owners, but rather permission to re-invest the profits back into the club. But that that structure exists is just pure speculation on my part.

Focusing on the third option, the owners would be taking something of a risk if they signed a million-dollar player. If Jay Sugarman had to write a personal check and presumably take a slightly higher percentage of the company to do so, would he feel good about the return on that new investment? This begs the question, what kind of risk-taker might Jay Sugarman be?

iStar's Risk Profile

As CEO of iStar for almost 20 years, Jay Sugarman has been entrusted with billions in shareholder money. As all serious investors understand, there is a trade-off between the level of risk an investor is willing to take and the return they expect for taking that risk. The US 10-year T-Bill is about as safe an investment as one can make and it currently returns about 2.2% per year. Meanwhile the average return of the S&P 500, which carries considerably more risk, has averaged just under 11% a year since its inception.

Suffice it to say, Jay Sugarman completely understands this concept and by looking at iStar's profile it's easy to surmise he is comfortable on the riskier side of the spectrum. There are a few ways a company's risk profile can be examined. The first is by looking at its stock beta. The beta is a historical calculation of how the stock's performance has correlated with the overall market. A beta of one means that a company's stock price moves in lock step with the market. A beta less than one indicates less volatility than the market and a beta of greater than one indicates more volatility. Investors generally don't like volatility, and see it as a point of risk, therefore they require a higher return for companies with higher betas. Recently, iStar's beta according to Google Finance was 2.17. That's a high beta.

But that's just one measure of the stock risk - an investor also wants to understand the inherent risks in the company and in the market they operate. Another way to look at risk is how much debt they carry to fund their assets and operations. Leverage ratios are one way to examine this. Funding a portion of the operations with debt is considered standard and normally increases the financial value of a company overall. However, too much debt can put the company at risk, as a sudden downtick in profits could result in the company unable to cover the payments on the loans. Generally a CEO wants to carry debt but at a level safe from the risks of a sudden change in fortune.

Real estate enterprises in general carry more debt than other industries. In order to examine iStar's profile, a comparison to their peer group is necessary. Here is a chart of the leverage of iStar and the Google Finance peer group.

The leverage calculation in that chart is simply the ratio of debt to equity, which approximates the level of money borrowed from debtors to the money from shareholders and retained profits. As you can see, iStar's assets are funded with a higher percentage of debt than their competition. The peer group has deleveraged over the years, while iStar has not deleveraged nearly as much. Whether or not that is a shrewd move on Sugarman's part or a desperate one is unclear, but it is a calculated risk.

Jay Sugarman is acutely aware of these figures and what they mean for iStar and the shareholders to whom he is responsible. He must be comfortable with the high level of risk his company carries. Why all this background on risk and reward? Because Sugarman and the rest of the Union owners see new expensive players they will fund as risky investments that need to come with an appropriate reward. Could it be that the Union owners simply see million-dollar players as a reward not worth the risk?

Union fans are left with two possible scenarios

Going back to the three or maybe four ways to fund a million-dollar player, there are two real scenarios for Union fans to consider. The first is that the operations of the club can fund a million-dollar player, but either profits are being taken by the owners, the owners don't like taking the risk of spending that kind of money on a player, or they are currently investing the excess in non-player-related activities. Whatever the reason for the lack of first-team investment, only the last reason for not investing in a million-dollar player offers fans comfort, and not in the near term.

The second scenario is that the operating cash flows of the Union can't fund a more expensive Designated Player and the club needs further investment from the owners. Forbes data would suggest that this shouldn't be the case, but this scenario does not bode well for the future of the organization. The stadium sells to near capacity every game and they just got a cash infusion, theoretically, from the increase in television revenues across the league. New large revenue sources are not around the corner. If this is the case, the business plan for the team was flawed from the start, and the Union are destined to be mired in this situation until new revenue streams emerge, or until the owners can and want to invest more money in the club. Even worse, Jay Sugarman's larger paydays appear to be in the past.

The best-case scenario is that the Union are putting the excess money from the club into building out the club and eventually it will go into payroll and a million-dollar player. The worst case scenario is the club does not spit out enough cash to warrant high spending and therefore won't for some time. Jay Sugarman's bigger paydays have stalled and the owners won't take the risk on adding top-level talent with their own money. The reality is probably somewhere in the middle. The club does not foresee making money at the upper end of the league, but they also appear to be making a small profit. The profit is not enough to take a risk on a million-dollar player. The owners appear risk averse as far as spending on an elite player that may not pay back in terms of wins and return their money. That's counter to Jay Sugarman's management of risk with iStar, but I guess a person's take on risk changes when it's their money.

Brotherly Game reached out to the Philadelphia Union with questions related to this article, but the team did not respond.