Felix’s Contract From Felix’s Perspective
We’ve talked about what kind of deal the M’s should offer Felix this winter to try to avoid arbitration and buy out a couple of his free agent years, coming to the conclusion that something like 4 years, $60-$70 million should be their target offer. However, let’s take a look at what Felix should do, if we assume that he’s simply interested in maximizing total future value.
He’s arbitration eligible the next two years, then hits free agency as a 25-year-old. Based on historical comparisons, I’ve estimated his arbitration payouts at $10 million and $15 million each of the next two seasons. If he stays healthy and continues to pitch well, I’d expect him to sign the biggest free agent contract for any pitcher in history. For this purpose, I’ve assumed that he’ll get an eight year, $204 million contract, giving him an average annual salary of $25.5 million per season from 2012 to 2019, though with the salaries escalating at $1 million per season throughout. That would give Felix these estimated yearly payouts for the next 10 years.
2010: $10 million
2011: $15 million
2012: $22 million
2013: $23 million
2014: $24 million
2015: $25 million
2016: $26 million
2017: $27 million
2018: $28 million
2019: $29 million
His expected earnings over the next ten years would be $229 million. If we use a 5% discount rate to calculate net present value, the NPV of those cash flows over the next ten years would be $171 million. However, the actual worth of those years to Felix is less than that, because of the risk he’s bearing over the next two seasons before the big contract kicks in.
Let’s distribute the possible outcomes by probabilities in order to recalculate actual value of those potential cash flows to Felix this winter, including assumed risk.
60% – best case scenario, $171 million NPV
25% – nagging injuries reduce value of free agent offer by 40%, $112 million NPV
15% – significant injury eliminates big offer, career derailed, $23 million NPV
This is a pretty broad overview, given that there are more than three potential outcomes, but I think we can use these generalizations to get us in the ballpark of the probabilities of the scenarios that could occur. Given the present value of those odds, we could reclassify the expected value of Felix’s next ten seasons to be worth about $134 million to him right now.
In other words, we’d suggest that Felix would be willing to take about 80% of his best case scenario NPV for eliminating the risk of injury before he hits free agency. What would a $134 million NPV offer look like in total value? About $178 million over 10 years, with annual payouts going 9/13/16/20/20/20/20/20/20/20.
If Felix is only concerned about getting set for life and is willing to negotiate away his risks for the next two years, the M’s could potentially look him up with an offer in the 10/180 range. Now, its unrealistic to think that either side would be looking for a ten year deal, so perhaps something more like 7/130 would be a deal more along the lines of what Felix is looking for – that would provide a similar NPV while still allowing him to sign another contract before he retires, if he continued to pitch well over the next decade.
From the M’s perspective, they’re going to want to do something like 4 years, $60 to $70 million. From Felix’s perspective, he’s probably going to want something like 7 years, $140 to $150 million. That’s a big gap to overcome.
I wish i could be more optimistic about this getting done, but Felix is at the point where he doesn’t need to take a short term deal anymore, and long term deals for pitchers are historically bad ideas. Trying to find middle ground is going to be a challenge.
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If we were to sign Felix to a long term, $20M+ a year contract, there is a huge risk of him getting injured and us being in the hole for a long time. I’d rather sign a 5 win a year position player to that kind of deal that a 5 win a year pitcher, the risk is lower.
I’d be happy to see the Mariners trade Felix this offseason or at next years deadline for good value, or to sign a shorter contract if they can pull it off. But the mega contract is an enormous risk.
Excellent work. This reasoned, rational and analytical approach you’ve laid out stands in stark contrast to the dialog I’ve heard on this subject from our local radio and newspaper outlets. Thanks for doing the math. 🙂
What impact, if any, does Roy Halladay have on Felix’s trade value if they are both on the market this Winter?
[spelling, look them up on Cot’s Baseball Contracts]
Good link there. I usually looked them up on Baseball-Reference.com, but this is far better.
I am not convinced of the underlying premise that we have to get something done on Felix’s contract this winter. If GMZ is really as good we say he is, this team should be a serious contender in 2011. And if that is the case the financial picture will be substantially improved, especially our payroll. Why not wait for the 2011/12 off-season and compete with the Redsox and Yankees for his services.
Pine Tar,
Because we can’t. If we allow Felix to get to free agency, he’s going to get a $200 million contract presuming he’s healthy. (and we probably don’t improve our financial picture that much if he’s not healthy and winning)
The Mariners are not a low payroll team, but they are not the kind of team that can make a $200 million gamble on a pitcher.
If they don’t sign Felix this off season, they are very unlikely to do it/
One of Dave’s recent comments. Just think about what the Yankees and Red Sox would offer and then the Mariners have to beat that.
If we can’t sign him to a 4 or 5 year deal then we have to trade him this offseason. Buster Olnley did a piece on this last week and made a some valid points. According to Onley Felix’s agent is asking for a 8yr deal worth 180 mil and if we aren’t willing to pay their are many teams lined up that will. Felix’s trade value is at an all time high right now he has 2yrs left on his contract and we could get a Bedard like deal except this time we come out on the right side. We could fill some big holes in our lineup with young prospects imagine what the Z man could bring in!!!
If both player and team behave logically, front loaded contracts are not always pointless. But I am asking a lot, I know.
I am leaving out the agent, anyway, and that’s a big factor. As I understand it, an agent gets his percentage of a long-term contract even if the player wants to dump him (right? wrong?) If this is correct, this motivates agents to demand the largest dollar figure, meaning maxing the length in years.
Tumwater Mike said:
We won 116 games with middle of the rotation type pitchers and an extremely versatile bench, etc….
To which eponymous coward replied:
Top of rotation pitchers become more important in the playoffs due to off days and rotation shortening compared to the regular season, and if your goal is to actually win playoff series, you need one.
I agree more with eponymous coward, and it’s also worth bearing in mind that while the M’s starting rotation that year consisted of guys who over the course of their careers may have proved to be “middle-of-the-rotation” types, out of that rotation they had essentially 2-1/3 starting pitchers (including Pineiro’s 11 starts) who played as if they were front-line starters that year, by ERA, WHIP, BAA (three stats I know are out of favor here, but still), along with their FIP in 2001.
F. Garcia 3.05/1.12/.228/3.48
J. Moyer 3.43/1.10/.240/4.17
Pineiro 2.03/0.94/.191/2.86 (!)
Moyer’s numbers are somewhat inflated by a bumpy first half of the year. He was pretty dominant from the middle of July on. In addition, even Sele had a 4.31 FIP, not exactly terrible for the AL. So while Garcia, Moyer, and Pineiro may not be career-long aces, they all caught lightning in a bottle that year and all pitched like they were.
In other words, while it’s obviously important to add more offense and continue to find defensive gems to make the team competitive overall, pretending that a dominant team can be so without a stud starter is, I think, a bit naive. And it is difficult to imagine winning a title without one, as eponymous coward indicates.
Therefore, I think it’s worth it for the M’s to try to lock up Felix for at least a few extra years beyond his free agency eligibility. Like Dave, however, I am not optimistic about the gap between what the M’s might be willing to commit to and what Felix and his agent perceive as his market potential.
I long for the edit function.
My second paragraph’s point was meant to be independent of the first’s, but I inexplicably tried to connect them.
With Erik Bedard getting hurt, Felix should know first hand about the risks of waiting two years to cash in.
Technically, that’s second hand. Bedard knows first hand. As does Ben Sheeets.
Liam, Stunasty & Arbeck:
I just don’t see how this is so black and white for every one. Two years is a long way away. I agree that signing him for 4 or 5 years this off season in the best scenario. But, I don’t see how the only alternative is to trade him. Let me put it this way, If Felix was a free agent after this season and we signed him for a 2 year $25 million deal we would all be ecstatic.
“Baseball contracts are not fully guaranteed.”
How so … I know there’s buyouts, but what are the chances of buying out a 25-or-so year star level player after signing him to a 4-5 year deal?
It’s definitely not like the NFL where you can sign a guy to a 7 year deal and cut him the following year.
Pine Tar
Trading him is not the only alternative, but the 2nd best alternative to signing him to a 4-5 year deal. We would be able to get all our players back from Baltimore if we traded him next year. We’d get slighly less than that if waited a year, and then just a draft choice if we let his Arb years run out.
A 4-5 year deal sounds nice, but it sounds like people are saying that he will sign if we offer him that. However, Felix makes the final decision and does he really want a deal for 4-5 years? Thoughts?
If you can somehow sign Felix for 4/84 then you’re probably paying close to $4 million for every WAR, assuming Felix has 3 great years and one lousy one ravaged by injury. We should all do cartwheels if the M’s manage to pull that off.
But again, that scenario only works if he covets the two large paydays more than the insane single payday.
From a related “sell high” situation… [deleted, off-topic]
One way to look at this:
In 2006, the Red Sox were willing to pay $51M just to have the right to negotiate with a pitcher who had not yet pitched in the MLB (and the day he finally had a start at Fenway, Felix out-pitched him and held the Sox to a one-hitter). Now, talent is in some ways more precious than dollars, especially for a certain couple of AL East teams, so a haul of prospects is harder to come by than a fat check (unless Bavasi is your trading partner). But if Felix was a Japanese player being posted in the offseason, is there any doubt he’d set a new record for posting fees — or that New York or Boston would be happy to pay it? Except that when that payday comes, it is Felix cashing the check, not the Seibu Lions. That’s what the M’s are up against, and I just don’t see them digging that deep… especially with Carlos “dead albatross” Silva’s contract weighing down the payroll.
The only question, I think, is this: will the greater number of potential trading partners this offseason offer a better chance for the best possible deal vs the possible frantic desperation of one or two teams at next July’s trading deadline?
With the opportunity cost involved with the amount of money for Felix, wouldn’t we be better off trading Felix for prospects and then using that money on other free agents? Felix is about a 5 WAR player, correct? It seems that we’d be able to add a lot more than 5 wins/yr if we received cheap talent in return and then wisely spent the money. What is the incentive to keep him vs trading?
The assumption that we could trade him for this amazing, Bedard-style haul of players is faulty. The Blue Jays just tried to do exactly that with Roy Halladay and found that teams are not willing to overpay for pitchers anymore.
The Bedard deal did not set the price of pitching.
Sorry to beat the very dead horse, but although this does explain Dave’s viewpoint, I still wonder why the marginal utility (in 2010) is lower to Felix than it is to the Mariners?
One obvious explanation is that Felix in 2010 is going to be busy playing, and won’t be able to fully spend, much less enjoy, $10M or $20M from his employer. Whereas the Mariners, as a business, would very much like to have that money in 2010 so they can do something with it, invest it if nothing else.
But — and this is why I still have trouble understanding Dave’s argument — Felix has investment opportunities too. $20M is way more valuable to him in 2010 than it is in say 2015 for the exact same reason: the time value of money.
If anything, Dave has offered reasons why Felix should value up-front money even MORE than the Mariners do, given his claim that the Mariners have a low return-on-investment, 5%, whereas someone else noted that just about anyone can expect to make more than that on the stock market. (However his claim of a 12% return seems too high, especially given the dis-investment that we will soon start seeing as Baby Boomers retire.)
In other words, there’s reason to expect that Felix has an even HIGHER time value of money than the Mariners do, causing him to have a greater preference for upfront payments. A weak reason perhaps, but when I look for reasons why Felix should have a lower time value of Money than the Mariners, I don’t see what they are.
Felix is at 5.5 this year, with a month left. It’s reasonable to expect him to be at 6+ WAR for a while. And those guys don’t grow on trees. If they did, this whole debate would be even more pointless than it already is. 🙂
Great article, as usual.
Felix Hernandez is a special talent, but if I’m the Mariners, nobody is worth the kind of money it would take to sign him to a long-term deal.
Also, is it now a given that Felix has turned the corner and will be a dominant starter (if healthy) for years to come? Or is it possible that he could take one step forward (2009) and two steps back (2010-11)?
$20M is way more valuable to him in 2010 than it is in say 2015 for the exact same reason: the time value of money.
It isn’t the quantity of dollars that are the determinant of utility in a situation with significant diminishing returns. To any one person, including Felix, the extra dollars are significant luxuries. The difference between a $10 million and a $30 million paycheck, even when viewed as an investment vehicle, is only going to determine the amount of winter homes he can purchase or the size of his back-up yacht. There is very little actual utility gained in his life through the addition of those dollars.
This is not true at the team level, of course. Those extra $20 million represent a significant utility to the 2010 Mariners in terms of player acquisition abilities. They are not anywhere near surplus luxury dollars – they are dollars that contribute directly to the success of the team. Which, of course, contributes to Felix’s happiness utility.
In reality, players don’t seek the highest possible wages because they care about that extra thing they can purchase with it – they view the total contract value as a proxy for respect. It is the feeling that comes with being “paid what they are worth” that is the incentive to grab for money, not the goods they can buy with their maximized wealth. Thus, as long as Felix gets a total contract that makes him feel valued, the timeframe of the payouts of those dollars aren’t all that significant – he is not a corporation trying to maximize profit at every last opportunity.
Also, is it now a given that Felix has turned the corner and will be a dominant starter (if healthy) for years to come? Or is it possible that he could take one step forward (2009) and two steps back (2010-11)?
It’s always a possibility. With any kind of talent. Just ask Cliff Lee.
Dave, a question. It seems to me that a hidden x-factor in much of this revolves around Felix’ agent, Alan Nero.
How likely is he to hinder the process to sign Felix to a team-friendly contract in terms of years?
I’m going on the assumption that like any capable agent, he’s going to go in there and get as much of top dollar for his client as he can. Ergo, he won’t help the team’s best interests in any special way.
And where’s Felix’ head?
Does he want to be like Edgar and be the superstar talent that stayed with one team and made it his own team over the years?
Or is his mind more like A-Rod, whom I think probably counted the days until he could sign elsewhere?
Personally, I don’t think he’s anywhere near as shallow and disingenuous a guy as Alex Rodriguez.
And I’d be willing to bet that the idea of being a career-#1 pitcher for one team (in an era where that just doesn’t happen) intrigues him on some level.
But with that in mind, does any five-year deal make sense for Camp Felix?
What about 5 years, $108 million? With an opt-out after Year Four that Felix can exercise after Year Three?
The yearly breakdown could go something like this:
2010: 14 mil.
2011: 20 mil.
2012: 22 mil. (opt-out clause here if Felix wants)
2013: 24 mil.
2014: 28 mil. (if Felix stays)
Or am I smoking crack and it takes math much more complex than this to get ‘er done?
If this is really true then players are dumb about money.
Not really. Luxury dollars have diminished utility for everyone. They are often exchanged for lower value items that provide some kind of feeling and not real tangible value.
That is the secondary point, though – the main issue is that the dollars are significantly more important to the Mariners in building their team than they are to Felix in doing whatever it is he will do with his money when he gets it.
The value of money in hand when considering marginal tax rates. Capital gains and dividend tax rates. And the biggest wealth destroyer of all, inflation rates. That money is worth significantly more than money deferred to a later date. Even if players don’t understand this, their investment managers do.
In the beginning of the big contract era players normally received the same dollars year after year of the contract. This is still more valuable than backloading by a wide margin. Backloading contracts is just a way for the owners to make more money now and pay players less in real dollar terms.
High profile players in the NFL have figured this out. They take signing bonus and roster bonus money in early years and reduced salaries at the end of contracts. It works well for them because when they reach the low salary years they have the contract torn up and negotiate more bonus money or they hold out. Players in baseball and basketball will be the next to realize the truth of this very old cliche;
“A bird in hand is worth two in the bush.”
Excuse me it’s late;
“A bird in hand is better than two in the bush.”
Much of this talk relies on the future continually being the same as the past — that is, that the real thing to look out for is continued inflationary pressure.
Trouble is, especially if one is looking at a 10-year timeframe, I’d guess the odds are 50-50 we may be looking at a period of deflation, a la the US in the 1930s, or Japan in the 1990s. If so, then backloaded contracts will absolutely explode.
There’s also the strategic principle, as old as Sun Tzu, and as recent as John Boyd — “Zig where they zag.”
I dunno. This discussion could all be David Brin’s “Dogma of Otherness,” as well.
I, for one, would appreciate actual empirical evidence, though, and not the handwaving that’s been used up ’til now. I’d also like to see data on how Japanese clubs structured their contracts during the above-mentioned deflation.
Why should players be different in this respect from everyday people? Or the subset of businesspeople, if it comes to that?
Nassim Taleb’s questions to brokers come to mind: “Are you good or are you lucky? How do you know?”
If the events of the past few years have taught us anything, it’s that a large number of people in finance who thought they were good have had their noses rubbed in the fact that they were merely lucky.
That you keep referencing the NFL just tells me that you don’t really understand what’s going on.
That you of all people keep making this argument through bald assertion and ad hominem dismissal instead of using data just tells me…
Well, to quote a wise man:
I want a front loaded contract. Just personally.
By the way, all the times I mentioned a “front loaded contract” above, I am talking about something considerably less front loaded than the bad backloaded contracts we’ve seen sometimes. Dave is completely right that a severely front loaded contract would handcuff the team’s finances in the near term. Slightly front loading a contract could make some sense in some situations, but only if the player/agent took into account the time value of money and was OK with the lower salaries in the later years of the contract.
Dave you telling me I don’t know what is going on is insulting. When you have lived through the ups and downs of a long lifetime as a poor and not so poor person, money is important. Perhaps too much so. But I chose the business of money as my second career. I suggest you talk to someone you know who lived and worked during the inflation of the 1970’s. Everything I said about having money now versus the value of money in the future is true. What someone thinks is a lot of money now, could very well not be after ten or fifteen years of double digit inflation.
hbobrien mentioned backloaded contracts in a deflationary environment. It was a wise comment because deflationary environments would be the only time backloading a contract would mean more dollars in real tax and inflation adjusted terms.
Does it make a difference, no. I said it will never happen in my original post. But the backloading of contracts is a way for ownership to be more profitable today, and pay less in real dollars as time goes by. You’re probably right that when dealing with these ridiculous amounts of money players just don’t care. But I am right as well. Players are not maximizing the real value of the dollars they contract for when they take a backloaded contract.
CEO’s get paid in similar fashion to NFL stars, they take signing bonuses and stock options at the expense of salary. I have never heard of a CEO of a fortune five hundred company taking a backloaded contract. They know the cash number of the dollars in the out years has no bearing on the worth of those dollars when that day comes.
Um, Dave. A-Rod’s current contract is frontloaded. $32M in 2009 decreasing to $20M in 2017.
http://mlbcontracts.blogspot.com/2005/01/new-york-yankees_111398168678860040.html
You probably should check the facts before berating your readers.
I knew someone smart would be the first to do it someday.
Now Arod can use the money to hedge against inflation and tax increases.
And so could Felix if he is getting good advice.
If you assume both sides are smart, i.e. can do the math on discounting, the NPV of the contract should be the same front loaded or back loaded. Unless, of course the two sides have different discount rates. So, one reason for a front-loaded contract is the player has a higher discount rate than the team, and is willing to forgo more future salary for current salary, b/c he expects inflation, or whatever.
Otherwise, the clearest reason for it is to fit a team’s budget. The Yankees seem to play with a $200M budget. Since they had room to pay A-Rod $30M+, they buy themselves more flexibility later on to add players when he is not contributing as much.
Either front loading or back loading can make sense, depending on circumstances.
Backloading never earns the player more money in real dollar terms unless there is deflation.
Boy, is that not true.
Boy is that true $200 million backloaded after adjusting for taxes and inflation = $139 million.
(One million dollar yearly raises)
$200 million dollars paid twenty million a year again adusting for taxes and inflation = $150 million.
And $200 frontloaded with million dollar yearly decreases adusted in the same fashion = $174 million.
Since a deflationary sprial has ocurred only twice in the last 150 years. I don’t think hedging for it is very wise. Hedging for inflation is wise because even in a low inflation environment there is still some inflation. For instance the the mid to late nineties had very low inflation but it still occurred.
Seriously, you can’t think of any reason beyond “deflation” in which backloading a contract might earn a player more money?
Really?