The value of serial deferred payments: a deconstruction of Bobby Bonilla Day

Do you prefer $1.00 today or tomorrow? What is the value of deferred payments? Let's deconstruct a famous deferred payment story: Bobby Bonilla, the New York Mets, and Bernie Madoff.

Most people want their money now. Some, however, are smart enough to defer their payments and end up earning far more. Let’s deconstruct one of the most famous deferred payment structures in the history of US sports: the case of Bobby Bonilla, the New York Mets, and a huge curveball named Bernie Madoff.

Background

Bobby Bonilla played his last season with the New York Mets in 1999. He was injury-prone and the Mets wanted to use his remaining salary to invest in new players. He was owed $5.9 million in CY 2000. Rather than pay him that amount, the Mets wanted to use the money to

The Deal: Deferral #1

The Mets and Bonilla agreed to the following terms

The Mets from 2000 - 2011

The Mets needed the $5.9 million in CY 2000 to invest in new players. They also had a *great* investment endeavor that was returning 12-15% annual returns (more on this later). From the Mets perspective, they could use the $5.9 million and the intervening 11 years to earn on their investment and still be in a good position to pay Bonilla.

The amount of returns the Mets would have realized by investing $5.9 million with a 12% return every year | 2011 is when they would first have to begin paying Bonilla.

Shown to the right is how much the Mets would have in CY 2011 - the first year they would have to pay Bonilla. With an annual return of 12%, the mystery investment would grow their initial $5.9 million to $20.5 million.

Bobby Bonilla from 2000 - 2011

In the meantime, Bonilla wasn’t receiving any payments (cash flows) from the Mets between 2000 and 2011. All of his payments were deferred at 8%. At the end of 11 years, Bonilla would have expected $13 million.

Increasing liability from the Mets to Bonilla over the 11 year deferral period at 8% interest.

At the start of CY 2011, the Mets liability to Bonilla, which started at $5.9 million, grew to $13.8 million.

Why this deal looked good in CY 2000

For the Mets, this was a good deal. By growing the $5.9 million at a rate (12% annually) greater than their liability to Bonilla (8% annually), they would have made approximately $6.7 million ($20.5 million - $13.8 million) at the start of CY 2011. That return would have allowed them to invest further into players or continue with their high-returning, 12% per annum investment endeavor.

For Bonilla, he would stand to gain $13.8 million at the start of CY 2011 — if he agreed to have it all paid at once.

He didn’t.

Deferral #2: 2011 to 2035

In CY 2000, Bonilla agreed to deferral #1: postponing payment of his remaining $5.9 million for 11 years. At the same time, he agreed to deferral #2: not receiving the $13.8 million in CY 2011 as one lump-sum.

Instead, he agreed to a gradual payout of the $13.8 million over the next 25 years (from CY 2011 to CY 2035). Again, this payout would be another deferral, and would be assessed an 8% required rate of return.

So, Bonilla signs an agreement in CY 2000 to receive $13.8 million over the following 25 years (from CY 2011 to CY 2035) at 8% interest. His yearly payouts, to be made every year on 1 July from 2011 to 2035, would be $1.19 million.

First payment of a series of cash flows from 2011 to 2035, at 8% interest, on a present value (in CY 2011) of $13.8 million = $1.19 million.

Bobby Bonilla from 2011 to 2035

With regularly scheduled payments of $1.19 million every year on a liability of $13.8 million and at 8% interest per annum, Bonilla would collect a total of $29.8 million over the lifetime of the payment period (25 years from 2011 to 2035).

Amortization schedule of the Mets liability to Bobby Bonilla from CY 2000 to CY 2035.

The power of two deferrals

Bonilla made two financial decisions that resulted in a ballooning of his salary from $5.9 million (t = CY 2000) to $29.8 million (t = CY 2035)

Choice #1 allowed him to grow the balance of his salary from $5.9 million (t = CY 2000) to $13.8 million (t = CY 2011).

Choice #2 allowed him to grow the balance of his salary from $13.8 million (t = CY 2011) to $29.8 million (t = CY 2035).

The Mets from 2008 to 2035

The Mets made a fiscally-sound decision by agreeing to deferral #1. Remember, Bobby Bonilla wanted an annual 8% rate of return on his $5.9 million, while the Mets were participating in an investment that returned 12% annually. On paper, this was a sound decision.

Unfortunately, the “mystery investment” that the Mets used to earn 12% annually was with Bernie Madoff, the perpetrator of the largest Ponzi scheme in the history of the United States. The Mets never had 12% returns per annum - they had 0% returns. So in CY 2008, when the Madoff Ponzi scheme began to unravel, the Mets had a phony investment worth $14.6 million. By the time CY 2011 rolled around (the first year that Bonilla would receive payments), the Mets had a confirmed investment value of $0.00.

The value of serial deferrals

The case of Bobby Bonilla, the Mets, and Bernie Madoff illustrate the power of deferrals. It’s okay to defer payments as long as you’ve attached a cost to that deferral. In this case, Bonilla attached the average market return of 8% per year.

It’s also okay to defer a one-time lump-sum payment for scheduled payments, provided that you attach a cost to that schedule. In this case, Bonilla declined taking the $13.8 million in CY 2011 and spread the payments over the next 25 years at the same annual average market return of 8%.

There you have it. The value of payment deferrals and spreads. Leave a comment below and tell us how you celebrate Bobby Bonilla Day (1 July every year until 2035).