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Does the Cleveland Indians’ Recent Trade Comply with Sound Valuation Principles?

August 3rd, 2011 by Brian Bornino

As a life-long Cleveland Indians fan, and I can’t help but wonder if my Tribe used proper “valuation techniques” when making their recent trade to acquire former All-Star pitcher Ubaldo Jimenez in exchange for 5 prospects:

  1. Value of what the Indians received: Ubaldo has a 4-year track record and improved each season through 2010, his banner year when he finished 3rd in Cy Young balloting.  He is 27 years old and should be reaching his peak; however, his 2011 season has been mediocre to-date.  Placing a value on Ubaldo is much like valuing a company that had been chugging along fine until the Great Recession of 2009, but has struggled in the year or two since… Do you believe the Company will soon jump back to its pre-recession performance?  Or has the recession permanently impaired its outlook?   Since valuation is forward-looking, the key to Ubaldo’s value is what the Indians’ talent evaluators believe his future performance will be.  He is still a young pitcher, so there may be some upside, but it’s hard to believe he can improve upon his 2010 season.  Therefore, my discounted cash flow analysis on Ubaldo would probably assume a starting point of “normalized” performance (perhaps between 2010 and 2011 performance), incorporate a very modest growth rate, and use a fairly low discount rate, since I view Ubaldo as a fairly safe investment.
  2. Value of what the Indians traded: In exchange for Ubaldo, the Indians dealt 5 prospects, a couple of which were labeled as high potential future stars.  Therefore, the value of these prospects is analogous to valuing 5 start-up companies by utilizing discounted cash flow analyses with hockey-stick growth projections and a very high (perhaps venture capital) rate of return, given the high risk that these players will never pan out (just like countless prospects that carried the “high potential” label before them).  However, if just one player eventually becomes a superstar, their value alone could eclipse that of Ubaldo.  In addition the “correlation coefficient” of these prospects is very low (i.e., the success of one will not affect the others); therefore, it is fairly likely that at least one of these players might eventually hit it big.

Based on this valuation analysis, it appears my Tribe overpaid for Ubaldo, and this deal could come back to haunt them.  I’ll concede that the value of a win today (from Ubaldo) is worth more than a win or a home run down the road (from the prospects), just as $1 today is worth more than $1 tomorrow – the finance concept of present value.  Further, a study of baseball trade databases for similar recent transactions in the market (the market approach to valuation) reveals that other teams have paid a similarly-high price to acquire players of Ubaldo’s pedigree.  So it’s up for debate as to whether the Indians paid a fair price.  Regardless of the final outcome, as a fan, I am certainly happy to see the Indians being an acquirer rather than a seller during this trade season!

* Thank you to Joe Borowski, CFA, Manager, Valuation Services
for his contributions to this post!

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