Dear NHL Teams: Burn The Bridge Contract
The National Hockey League (NHL) is changing with a greater emphasis on speed and skill and that is being provided by younger players. Teams are building younger rosters than ever before and looking for significant contributions from their young players early on. With this trend, it is more critical than ever for teams to properly manage their young players from a contract perspective.
Players typically enter the league between the age of 18 and 21 on a three-year entry-level contract (ELC). This means the player will sign their second contract between the ages of 21-24. For our work, we will ignore players who entered the league at age 18 because those players are typically fantastic players like Connor McDavid, Jack Eichel or Auston Matthews. There is no doubt these players will be receiving 8-year deals as their second contract. The focus instead is on the players who enter the league between 19 and 21, with a narrowed focus on 19 and 20. This means that they will be up for the second contract at age 22 or 23 and they figure to be candidates for a bridge type contract (a two or three-year contract signed by a restricted free agent (RFA) that expires while the player is still a RFA) or a long-term deal (a contract that will cover some of the player’s unrestricted free agent (UFA) years).
When a player’s ELC expires, we believe it is the most critical decision point a team must make in regards to that player. It certainly goes against the mindset most statisticians have as teams would be making their most important decisions based on a maximum of three seasons of NHL data. At this critical decision point, we believe the team has three options. They can sign a player to a long-term contract, sign them to a short-term contract, or trade the player. Rarely are players traded at this point in their careers because they can be under team control at a low cost. Simply put, players are likely going to be negotiating their second contract with the team that drafted them.
In traditional negotiations, teams will likely discuss both short-term and long-term deals with a player and their agent. By even offering a short-term deal the teams are giving leverage to the agents. A short-term offer does not buy any UFA years and allows the player to bet on themselves. What will become apparent as we work our way through the numbers is when teams push for the bridge contract, they are in fact betting a player has peaked or plateaued, meaning they don’t expect the player to get any better. If those are their thoughts on the player, they should look to trade the player as their value will never be higher. Too often, teams look at a player’s past performance rather than what their future value to the team would be. This philosophy is likely one of the reasons teams hesitate to give long-term contracts off the bat. As an aside, this is where a team should be leaning on their analysts to look at trends and determine how they expect the player to progress. The following tweet from Travis Yost demonstrates this point:
In short, any short-term offer made by a team is giving away the leverage they have over the restricted free agent player. By following the status quo teams continue to make these types of mistakes at the critical decision point.
GETTING TO THE BREAKEVEN POINT
This research revolves around the acceptance of the following premise: When a player and team are going to negotiate the second contract, there will be discussions of both a short-term contract (We will refer to this as Contract A) and a long-term contract (We will refer to this as Contract B). Once Contract A expires, and now the team wants to commit to the player long-term, they will offer them Contract C. The premise that must be accepted is in all situations: Contract’s C AAV > Contract B’s AAV > Contract A’s AAV. The following graphic serves of a visualization of how Contract A, B, & C are connected. For the purposes of this discussion, we have stuck with an eight-year window, with Contract A being equal to two years. We can assess this premise for all different contract lengths using the same approach, but to keep things simpler we will stick with the eight-year length for the majority of this discussion.
TIME VALUE OF MONEY
There is a theory in finance that one dollar today is worth more than one dollar in the future because of the ability to invest that dollar and because of inflation. Let’s use buying a candy bar as an example. In a year from now, you know you are going to want a candy bar. You walk into the store with a dollar in your wallet and see that today you can buy that candy bar for exactly one dollar. If you decide to buy it today and save it for one year from now, you are assured of having your candy bar (though old, likely still good). However, maybe you don’t like the idea of buying a candy bar today and saving it for a year so instead, you decide that you are going to save your money to buy it a year from now. Being the finance guru you are, you assume the rate of inflation will be around 3%, meaning in one year that candy bar will cost $1.03. This means if you keep that dollar in your wallet for a year, you will no longer be able to buy that candy bar! Since you know the candy bar will cost more in the future, you know you must invest your dollar to make it worth more in one year. You go to the bank and open a candy bar account that you invest your dollar in. It will return 5%, meaning in one year, your candy bar account will have $1.05. Hurray! This will give you enough money to buy your candy bar!
Now that we understand the premise of the time value of money, we must accept another premise. Because we have established that a dollar is more valuable today, a team’s goal should be to minimize a player’s cap hit in today’s dollars. That means every contract scenario should be converted to today’s dollars using the present value (PV) formula (PV = Future Dollar Amount/(1+salary cap inflation rate)^number of years from today). In our calculations, we have used a salary cap inflation rate of 4.59%, the average increase over the past five years. What this does not necessarily mean is a team should not look to give a player a bridge contract because it will come with the lowest immediate cost.
CALCULATING THE BREAKEVEN POINT
Now that we have established our assumptions that we must accept as true, we can delve into some math. Since we previously established that Contract C > Contract B > Contract A, we will look at this formula: Contract A * (1+X%) = Contract B * (1+Y%) =Contract C. Since Contracts A & B are likely to be known during negotiations, X% is a known variable. We want to solve for Y% so that PV(Contract A) + PV(Contract C) = PV(Contract B). This can be thought of as a minimization problem where Y% cannot be less than 0. When solving for Y%, while changing X%, we were able to produce the following graph, which shows the relationship between the two variables.
Interpreting the results
Once we determined Contract C by arriving at the breakeven point, it was critical to be able to understand what the results tell us. By finding Contract C, we now knew what the cap hit for the player would have to be to have an equal net present value when compared to Contract B. This is where proper player analysis comes into play. At this point, the team needs to ask themselves: “Do we think this player will get more or less than the cap hit determined when solving for Contract C?” If the answer is less, then the team should go short-term. If the answer is more, the team should go long-term. One key point to consider is the expected salary cap inflation. For example, a player commanding a $5M cap hit today would command a salary of $5.469M in two years. This means if you expect the player to perform exactly the same for two more seasons you cannot expect Contract C to be less than the rate of inflation (less than $5.469 in our simple example). In essence, if you calculate Contract C to be less than the rate of inflation and accept that as a possibility, you are betting your player will regress! In that case, I would recommend trading that player.
CASE STUDY: WILLIAM NYLANDER
Let’s take all this theory and apply it to an example. Here we will focus on William Nylander. We wanted to take the pulse of hockey fans to see if their thoughts aligned with what our financial math says. As you can see by our poll results, fans think the Toronto Maple Leafs should sign Nylander to a long-term contract.
Frankly, the fans are right and the Leafs should only be looking to sign Nylander to a long-term deal, and the longer the term the better. We estimated that a short-term deal for Nylander would carry a $4.3M AAV over two years and a long-term option could be $7M per year for 8 years. If Nylander signed a two-year contract (Contract A) the next 6-year contract (Contract C) with an AAV of roughly $8M to meet the breakeven point. The breakdown of these contract schedules is shown below.
This is where the team must answer the critical question. If Nylander signs short term, would his next contact exceed $8M? If the team thinks that the player will cost more than $8M the best option is to sign long-term. If they think the player could be signed for less than $8M, then a bridge deal would be the better option. However, looking at the potential savings, we feel that long-term is a no-brainer here, especially when looking at the cap situation the Leafs find themselves in. By signing Nylander to a long-term deal the team would save nearly $1M in cap space in years 3-8. The $1M in savings would be the minimum the team would save, it is reasonable to think that Nylander could sign for more than $8M (in two years) if he continues developing.
A General Manager in favor of the bridge deal would look at the price in the first two years of the contract and say the two years at the beginning of the contract opens enough cap space to make a bridge deal worthwhile. We do not believe that to be the case, instead, we feel that this is how teams find themselves in bad cap situations when they are truly ready to compete for the Stanley Cup (or closes their cup window sooner). The difference is $2.7M greater in the first two years ($5.4M total), however, we would argue that the six years of savings ($6M total) will have the greater impact. The team will be right in the middle of being a Cup contender and those savings could be used to upgrade the bottom six forwards or it could turn a $3M player into a $4M player. The Maple Leafs may feel a little cap crunch next offseason but combining the potential long-term Nylander savings with the potential Mitch Marner long-term savings (next offseason) and the Maple Leafs could set themselves up with a four to five-year cup window.
While it may seem like a no-brainer to lock up Nylander long-term there are several reasons that teams do not lock players up long-term as soon as possible. The most obvious reason is the fact that bridge contracts are the status quo for most players. The NHL, like many other leagues, is a copycat league so if teams are giving out bridge deals there will be a hesitation to dramatically change the way business is done.
However, we think that there are two other reasons that work hand in hand with each other. General managers (GMs) are risk averse, they generally run their teams as if this season could be their last. If a GM handed out long-term contracts to players who consistently don’t perform and are forced to buy-out the players or trade them for cents on the dollar, he would be crushed in the media and fans would quickly turn against the GM, which will likely result in ownership turning on them as well.
We will explain why the fear of the buyout is misguided but the stigma around buyouts is certainly real and it is something that no GM would want to deal with. The GMs are focused on keeping their job year in and year out, a two-year bridge contract minimizes the current cap hit and any cap issues that will arise in two years are pushed to the back burner. The GM will either cross that bridge when he gets to it, or the contracts will be a problem for a different GM altogether. We feel that if GMs were to look more into the future when negotiating contracts with restricted free agents their respective teams would be much better at managing the salary cap.
LOOKING AT THE BUYOUT
There is a unique collective bargain agreement (CBA) clause that essentially builds a bridge contract into a young player’s long-term contract. If a player is under 26 years old, the team has the ability to buy the player out the player at one-third the cost of the remaining contract versus two-thirds of the cost once they turn 26 years old. The cost is spread equally over double the remaining term of the contract. Let’s look at a quick example. Two players each have four years and $20M remaining on their contract. One player is under 26 and the other is over 26. Both players will count against the salary cap for eight additional years. However, the younger player will only have a cap hit of $833,333.33 while the older player will count for $1,666,666.67. A place of future study is to look at the relationship between the buyout cost and the cap savings of going with a long-term contract instead of a bridge deal. The real question to answer though is how likely is a buyout to take place?
Probability of a Buyout
The burning question everyone wants to know is how likely is a team going to want to exercise a buyout? To answer that question, we need to accept the following as true: A team will only exercise a buyout of a young player if they see regression in consecutive seasons. This bears the questions, how likely is that to occur? The simple answer is not likely.
To determine that the probability of a buyout is unlikely we utilized simulation to determine the probability of a player regressing in two consecutive seasons. We started by gathering data on every player that was 23 years old in the 2014 season. Those players also had to have played (at least 200 minutes of time on ice) in the NHL for the next two seasons as well; they were divided into forwards and defense. We then determined the average performance and standard deviation for the sample for each age (23, 24, 25) and ran a Monte Carlo simulation (10,000 instances) with a normal distribution. This was done for Corsi For%, Time on Ice per Game, Goals per 60, First Assists per 60, Total Points per 60, and Individual Corsi For per 60. All statistics are courtesy of NaturalStattrick.com. These stats sought to best capture a player’s individual performance. The results of the simulation are shown in the table below.
To simply interpret the results of the simulation, there is approximately a two in ten chance of a team potentially wanting to buyout a young player. Another way to look at it is a team would expect to exercise a buyout on two out of every ten young players. If the team is smart and properly projects the player’s career (finds indicators that the player has already peaked or soon will peak), the team could trade those players that they expect to regress and avoid handing out any buyouts. They could also utilize a bridge deal but that seems less favorable if they think the player will get worse. It is important to acknowledge that even if a player does progress or regress in the statistics we have assessed, it does not necessarily mean the team will want to exercise a buyout as there are certainly other factors to consider. Even if the team is wrong two out of ten times and exercises the buyout twice in ten contracts, they are probably going to end up ahead in terms of cap hit in present value if they hand out exclusively long-term contracts opposed to bridging and then going long-term. This is another area where we will likely do further research.
Looking at Older Players
Another important consideration when discussing a long-term versus bridge contract is the back end of the contract. Some people might argue that using the bridge contract is favorable because it will allow a team to potentially keep the player longer as they can sign the player for two to three years, retain their RFA rights, then sign them to a long-term contract, which could give the team nine, ten, or eleven years of service from the player without having to worry about the player becoming an unrestricted free agent. However, keeping a player for those extra years might actually be to the detriment of the team. To support this point, we once again looked to simulation. This time instead of looking at players at age 23, we looked at players age 30 and repeated our process detailed above instead looking at those players who were 30, 31, and 32. We sought to determine the probability of a player getting worse.
Much like you would be betting against the odds of a young player regressing in two consecutive seasons, you would be going against the odds in thinking a player going from age 30 to 31 to 32 is not going to see a drop in play. Betting an older player is going to maintain their level or even improve is a bet I wouldn’t make. The table below supports this notion.
CASE STUDY: SAM REINHART
The Buffalo Sabres have a very tough decision to make when it comes to Sam Reinhart. Reinhart’s underlying numbers indicate he is a quality player, but his career has seen extreme swings. The 2017-2018 season saw Reinhart struggle mightily for the first half of the season and then in the second half of the season showed the abilities expected of a player drafted second overall. This poll we ran shows the opinion of him are mixed as well.
Below are the tables showing two possible Reinhart contract schedules. The numbers calculated for Contract A and Contract B are based on our market value model. If you think the numbers are way off, our apologies. We will likely write an article when Reinhart’s contract is signed to assess the Sabres’ decision.
Though we have detailed this point many times, it is critical to once again emphasize that the contract shown in the blue is the breakeven contract. This means that based off of our numbers by offering Reinhart this bridge deal, the Sabres think his next contract would not exceed $5.765M. This is probably not a smart bet to make. Purely due to inflation, it would be expected that Reinhart’s $5.2M long-term contract today (~6.5% of the salary cap) would be equal to ~$5.7M in two years. This basically means if Reinhart performs at the same level as he has, the Sabres wouldn’t be able to sign him to less than the breakeven point. In order for the Sabres to save money in today’s dollars, Sam Reinhart would have to get worse! If that is the bet the team is making, they probably should’ve traded Reinhart this offseason.
CASE STUDY: NIKITA KUCHEROV
For our last case study, we decided to look at a situation that has already played out. Nikita Kucherov recently signed an 8-year extension with a $9.5M cap hit. Prior to signing his extension, the Lightning signed Kucherov to a 3-year bridge deal with a cap hit of 4.76M. At the time of signing the reaction to the contract was that Yzerman did well to minimize the cap hit but observers were not blind to the salary cap issues that could arise when the contract would end. We decided to investigate whether the bridge was the right deal for Tampa to make.
The total present value of the 11 years is roughly $67M. We wanted to figure out what the breakeven number was for the Lightning if the team opted to sign Kucherov to an 8-year extension right away. The number we calculated is $7.5M. This means if the Lightning could have signed Kucherov to an 8-year extension for $7.5M or less they made a mistake in bridging Kucherov. However, if Kucherov would have cost more than the $7.5M then the bridge was the right choice. The summer prior to Kucherov signing his extension Ryan O’Reilly and Vladimir Tarasenko signed long-term deals with $7.5M cap hits. Hindsight is 20/20 and locking up Kucherov at $7.5M would look like a steal now but at the time it seems reasonable that Yzerman could have negotiated a contract for somewhere around that number, especially when Johnny Gaudreau signed for less than $7M over 6 years.
The first 8 years is only the beginning of the questions that need to be asked. The final 3 years of the 11 would require Kucherov to sign another contract. We already discussed how likely it is for players to decline in their level of play once they turn 30. It is easy to argue that Kucherov is better than most players, so it is more than likely that he will still be playing well once he does turn 30. The question then becomes, would Tampa Bay be willing to pay $95M over at least the next 3 years to make the present value even with what happened. Of course, they would be, because they made the commitment to Kucherov. We would argue that by signing long-term initially the team would be in a better spot once year 9 comes around. The largest contract ever given to a 30-year-old would equate to a $9.5M dollar cap hit when Kucherov would be up for his next deal in our hypothetical situation. We have included tables to show the two possibilities below.
If the Lightning had decided to sign Kucherov long-term initially they would have created $2M of cap space for 5 seasons. For a team as good as Tampa, every dollar counts, and that money could have changed the way they approached this offseason and future offseasons. The immediate counter-argument is that the team did not have the cap space at the time of signing to offer Kucherov $7.5M. We would argue that any GM looking forward would move current bad contracts to sign Kucherov. Using bad contracts to justify another questionable contract decision is a lousy excuse and continue to perpetuate the problem.
With the NHL trending younger than ever, proper management of younger assets has become more critical than ever. We think a team who properly manages young assets can build a perennial contender for many years. Observers often talk about capitalizing on a stud young player’s entry-level contract, but often times teams who draft those stud young are not in a position to turn around their futures that quickly. Although there will never be more value than when a player is on an ELC, teams can create value by signing players to long-term contracts in lieu of short-term deals. One issue many championship teams run into is they have a quality player or two that end up being salary cap casualties. By properly managing five young players, a team should be looking at upwards of $10M in additional salary cap space! That is enough room to pay two quality players or one borderline superstar!
We will continue to update our bridge contract analysis in future posts. Please follow us on Twitter (@afpanalytics) so you know when those are up.
Banner image courtesy of: https://www.theodysseyonline.com/burning-bridges-2016
KYLE STICH is the Director of AFP Analytics. In addition, Mr. Stich is a tax specialist and Director of Operations at AFP Consulting LLC, whose clientele include professional athletes performing services on three separate continents. Mr. Stich earned his Master of Science in Sport Management with a Concentration in Sport Analytics from Columbia University in 2017. He earned his undergraduate degrees in Accounting and Sport Management from St. John Fisher College in 2015, where he has served as an adjunct professor teaching Sport Finance and Baseball Analytics.
JUSTIN WHITE is an intern AFP Analytics. Justin is a graduate of St. John Fisher College where he earned his degree in Sport Management and Statistics. He has worked with the Rochester Americans and members of their coaching staff on various analytics and statistics-based projects.