1 THE COUNTERPOINT
2 THE COUNTERPOINT
Editor’s Note
Editors-in-Chief Paresh Pandey Pearl Mak Content Contributors
T
The advent of the 21st century brought sweeping changes to the production, proliferation and consumption of information and media, especially among Millennials. The internet has expanded every Canadian’s reach beyond libraries, to every nook and corner of the information trove that is human knowledge. From Feynman’s equations and Ricardo’s growth models, to simply the recipes for Palak Paneer and New York Cheesecakes, information previously accessible only by the elite in society is now freely available and distributed over the internet. As we moved from Oxford dictionaries to Google, this mass accessibility of unfathomable amounts of information begs the question, should information cost money? Specifically, should university textbooks be so expensive, considering they provide information already available online to the author, professor and student at very low marginal costs, but package it into an expensive, mandatory purchase? The internet as a medium has seemingly transformed Information itself into a public good. The equations in my mathematics textbook can be easily found on Google, along with the Marxist Theory readings from law class. The ethical dilemma is whether to knowingly get ripped off by my institution and publisher, by paying a small fortune every semester for textbooks, or to access the same content online, with negligible marginal costs? The value addition of textbooks to the classroom and learning is immense, but the exorbitant costs are not justified. One thing is for certain, information distribution in the digital age has evolved such that archaic laws have not kept up with the advancement in technology, and textbook prices are suspiciously rising in an age where information is becoming cheaper. Through the example of textbooks, we hoped to highlight the changing costs of information in the digital era. Institutions and market firms need to incorporate for the changes in which millennials are consuming information. But in the short run, a drastic shift away from expensive textbooks is needed, the debt burden is already breaking our back.
3 THE COUNTERPOINT
Andre Tsang Harshil Dhanky John Dias Mikael Castaldo Tasnia Hussain Design Directors Athiya Rastogi Ernest Nyarko Vingston Satguanm Thanks to : Anna How Jerry Yin Printed By : SHERWOOD
4 THE COUNTERPOINT
5 THE COUNTERPOINT
ECONOMICS
The Cash Cow: Explaining the Hydro One Conundrum
-Tasnia Hussain
Which of the following statements best describes the problem with the sale of Hydro One?
know much about the new owners and are likely to be taken advantage of in any milk purchases that happen after Bessie is sold.
A. Farmer Joe owns a cow named Bessie. In July, he wants to rent out a milking machine to yield as much milk as possible from her. The machine is very expensive to rent but Farmer Joe finances this rental by selling his cow at the end of July. He has successfully maximized the amount of milk he could get from the cow during July but now he has no cow left. The problem with this sale was the unequal trade off. He has given up a lifetime’s worth of milk revenue for an asset that is worthless now.
Solution:
B. Farmer Joe wishes to purchase a new flat screen TV. He sells his cow to a shadowy entity in exchange for a one time cash fix to purchase his TV. The profiteering entity gives him the equivalent of all the milk revenue that his poor cow Bessie could have earned him during his lifetime. The problem with this sale is the disadvantages it poses for Farmer Joe’s milk customers. They don’t 6 THE COUNTERPOINT
Examining Scenario A Hydro One is Ontario’s electricity transmission utility that is currently government owned. With an annual profit of nearly $750 million, it hands over $287 million of this profit to the provincial government. Wynne’s government wants to privatize Hydro One. The goal is to raise $9 billion dollars by selling the government’s 60% stake, pay off $5 billion of Hydro One’s debt, and use the remaining $4 billion to fund Wynne’s 10 year transit infrastructure building plan which has a price tag of $29 billion. Many critics have compared this plan to the situation described in Option A. Hydro One is the cow and Farmer Joe is our provincial government. In this scenario, Farmer Joe sells a high return asset in exchange for one that is essentially worthless post-sale.Yes, he has
paid today’s bills but will now struggle to pay all his bills till his demise. Queen’s Park, the critics say, has given up an infinite amount of dividend payments from Hydro One in exchange for a one time cash fix. While this idea makes intuitive sense, it is actually completely wrong and rooted in a poor understanding of finance. Different financial techniques were used to determine how to value Hydro One. If valued appropriately, selling its right to $287 million a year every year is exactly equivalent to getting $9 billion today. Farmer Joe may have sold off his cow but the price he got for it is exactly equivalent to all the profit it could have made for it during its lifetime. Option A is not a correct summation of the problem with the Hydro One sale.
Examining Scenario B In this scenario, Farmer Joe sells his cow for exactly how much she’s worth. It’s exactly the same whether he keeps his cow and sells her milk every day until she dies or if he sells her now. Scenario B is also correct in two other ways.
Farmer Joe bought a TV. Bessie is sold to buy a TV which will earn Farmer Joe nothing. Instead of using the proceeds from selling his cow to fund a more attractive investment opportunity, he buys something with a dismal rate of return. Wynne’s government wants to funnel the proceeds into better transit infrastructure but it’s not easy to put a number on the financial rate of return that investment in transit infrastructure will yield. In fact, the social rate of return – that is, the benefit that consumers and daily transit users will feel – is probably higher than the actual financial benefits. In return for a “social rate of return” from building better infrastructure, the government is giving up an asset that earns them an average of 10% a year on its equity. It’s hard to specify what this social rate of return actually is, which makes it even harder to determine whether this trade off even passes the cost benefit analysis. Because it’s hard to identify, we don’t have enough information to judge whether the government is utilizing the proceeds from Hydro One’s sale in the most effective way. One thing is for certain: Hydro One is an 7 THE COUNTERPOINT
excellent investment opportunity, one whose return is guaranteed, because rates are set by the Ontario Energy Board. Whether investment into transit lives up to the same standard is less certain. It’s not as bad as buying a TV but Farmer Joe would certainly have been better off if he bought a tractor and started farming corn.
The Profiteering Entity Bessie was sold off to a profiteering group of stockholders who will make the milking process more efficient and split the proceeds from selling Bessie’s milk amongst themselves. Privatization is often credited with ushering in a new era of innovation, improvement, and cost efficiency. While this may be true, what is less certain is whether these cost savings will be passed down to the consumers of electricity. In 1992, Nova Scotia Power Corporation generated and delivered electricity to the entire province but its $2.4 billion debt hung over the province’s balance sheet until Premier Donald Cameron started selling it off in 1992. By 2000, the entire utility had been sold and renamed Emera Inc. While the privatization has in many respects been successful for the corporation – financial stability, more expansion, some efficiency – this success has not trickled down to consumers. Nova Scotia has the second highest average electricity bill in all of Canada. Nevertheless, Wynne tries to convince consumers that the government will protect electricity rates. It is the Ontario Energy Board (OEB), not Hydro One, which sets those rates, she assures us. While this is true, there are doubts as to whether that regulatory body is in the business of protecting consumers. In a move akin to tasking the fox to guard the hen house, the provincial government gave a Hydro One executive a seat at the OEB just this past November, effectively giving them a position of influence over electricity rates. Accompanying the sale of Hydro One are changes to the regulatory rules governing OEB and very few of those changes actually help consumers. Among those new rules is a provision that gives the government power to prevent consumer protection groups from sitting at the OEB table to review the processes. Instead, the government will appoint a consumer advocate in their place. The privatization also means that consumer complaints against Hydro One will no longer
Data as of May 1, 2013
be investigated by the ombudsman’s office. Instead, all complaints will be dealt with in-house by an internal Hydro One body. Along with the jettison of the Ombudsman’s office, even the Auditor General Bonnie Lysyk can no longer probe into Hydro One’s financial affairs. It is no wonder then that many independent legislative officers have unanimously condemned the sell-off, fearing the ramifications of the privatization on Ontario’s residents. In light of such opposition, the Hydro Union, surprisingly, has not protested. Unions that work for Crown Corporations have no love for privatization. It threatens their pensions, wages, and even the terms of their contracts. But we’ve seen no opposition to the privatization from the Hydro One union for one simple reason; they have been paid off. The provincial government forged out a new contract with the Power Worker’s Union before the privatization began to buy their co-operation by offering workers Hydro One stock, raises, and a one-time payout. 8 THE COUNTERPOINT
Scenario B sums up the Hydro One sale. Anyone who buys Bessie’s milk now no longer has the same protection they had when they purchased it from Farmer Joe because, unlike Farmer Joe who knew and cared for his clients, the shadow entity is only interested in milking Bessie the cash cow for all she’s worth.
HOW TO B RONG BE RONG BE WRONG LESS OFTEN, Part II PSYCHOLOGY
Sherlock Holmes is Rational, but Spock Isn’t: By Mikael Castaldo
9 THE COUNTERPOINT
I
n my article for the fall edition of the Counterpoint, my goal was to familiarize the reader with cognitive biases and rationality. Now, my objective is to informally discuss rationality and clear thinking more deeply. Generally, there are two definitions of rationality – the first definition of rationality is where agents are attempting to maximize their utility, discounted to the present, subject to certain constraints. This language is a bit technical, so let’s explore this a bit more thoroughly. All the definition means is that rational actors are trying to make themselves as happy as possible over their lifetime, within certain limits – information asymmetry and time being the most common constraints. For example, suppose that you’re trying to determine what type of wine to buy.You don’t have all the time, money, or information in the world, so you quickly read some online reviews, ask your friends what they think, and settle on a bottle of Malbec. This is rational, according to the first definition. What would not be rational would be creating criteria on which to judge wine, assigning weights to them, reading reviews on every bottle of wine available, inputting this information into a spreadsheet, and then, after very careful analysis, determining which bottle of wine to buy. Remember – there are limits on the time, money, and information you have – as such, conducting that level of research will not maximize your utility. It’s an enormous waste of time. Without the constraints, conducting this analysis would maximize your utility, but in the real world, time, effort, and money are limited. Sometimes, making a quick intuitive decision is far more rational than careful analysis, due to the time constraint. At the same time, being rational does not mean being cautious. Let’s explore this idea a bit further, with another example. Suppose you’re graduating from the University of Toronto, and you’re looking for a full-time job. Suppose that you really want to be an entrepreneur. You bring this up with your family, who try to persuade you to join a commercial bank instead. They tell you that it’s irrational to want to be an entrepreneur; that if only you were rational, you would join a bank. Rationality, though, according to the aforementioned definition, is about constrained maximization of your utility’s present value. If you’re the type of person who can’t be happy unless they’re building a new company, becoming an entrepreneur, despite the obvious challenges, is more rational than joining a bank. If you value other things more, joining a bank might be the rational decision. Rationality is what maximizes the present value of your 10 THE COUNTERPOINT
utility, making the most rational decision in certain situations different for different people, since we all have different utility functions. These two straw man models of rationality – the pedantically analytical straw man, and the cautious/sensible straw man, are incredibly pervasive. We should be careful, though, not to confuse utility maximization rationality with truth-seeking & logic – making certain decisions quickly might be the best way to maximize your utility, but quick analysis and “gut feelings” usually don’t provide an accurate picture of the world. As such, we need to develop our model of rationality further. Building on our constrained utility maximization model of rationality, the second layer of rationality involves making our mental model of the world as accurate as possible. In this definition of rationality, our goal is to maximize our utility, yes, but also to have the most accurate set of beliefs possible. In this more nuanced version of rationality, it is allowable to not know what to believe about X, but it is undesirable to hold incorrect beliefs about X. For example, building on the wine bottle example above, we can say “I don’t know what bottle of wine is the best for me, but I think I’ll buy bottle P because it’s good enough”. What we can’t say is “Bottle P is definitely the best bottle for me”, given that we don’t have all the information available, nor have we done all the analyses necessary. When possible, this more nuanced model of rationality dictates that we should make our beliefs more accurate. When we don’t have the time or effort, we should suspend having any strong beliefs about X, but can have an operational belief that allows us to function. Now that we properly understand what exactly rationality is, we can begin discussing how to become more rational. The focus of the remainder of this article will be on how we can make our set of beliefs more accurately represent reality, not on how to maximize the constrained present value of our utility. There is a large amount of excellent academic literature on happiness if the reader is interested in exploring it. In order to make our set of beliefs more accurately represent reality, we need to adjust both our temperament and our way of thinking. There are certain attitudes without which clear thinking are impossible, all of which are some form of intellectual humility:
1. Enter arguments not to “win” them, but to seek to correct beliefs: In order to think clearly, it is critical to treat arguments as a cooperative exercise, where both parties are working together to find the right answer. Before entering any argument, commit to be willing to change your mind if the evidence and arguments lead to a different conclusion. 2. Identify with changing your mind when you’re wrong, not with any particular beliefs: Identification with something is when you feel as if X is part of who you are. For example, if you identify with the Toronto Raptors, and somebody thinks they’re awful, it feels like a personal attack. If you identify with a particular stance on abortion, and somebody argues with you, it feels like a personal attack. In order to be able to explore ideas freely, though, not identifying with any particular belief is critical.You can think belief X is correct, but once belief X becomes part of your identity, it becomes difficult to change your mind if you’re incorrect. As such, an important step in rationality is separating your identity from your beliefs. Given human nature, though, not identifying with anything at all is extremely difficult. As such, we can’t remove identification entirely, but we can shift what we identify with. In order to be wrong less often, identifying with changing your mind when the evidence/arguments suggest you’re wrong is far more helpful than identifying with a set of beliefs. After defining rationality and exploring the attitudes necessary for clear thinking, it is now possible to discuss how we should solve particular problems. The goal of statistics – essentially applied epistemology – is to solve this problem. Statistics tells us what conclusions the evidence suggests, and, more critically, how confident to be in a particular belief. Naturally, the entire field of statistics cannot be replicated in this article. As such, we’ll focus our attention elsewhere, on how to reason from first principles. Breaking problems down into their constituent parts – reasoning from first principles – is an extremely important skill to possess if one desires to be a clearer thinker. To do this, framing problems mathematically helps tremendously. In order to do this, let’s take the case of Tom, a management consultant who wants to improve a firm’s performance. One thing Tom can do is look at what his successful competitors are doing, and copy them. Benchmarking often seems like a reasonable thing to do – and, under strong time and effort constraints, it might be good enough. Let’s assume, though, that as in real life, Tom 11 THE COUNTERPOINT
has enough time and effort to analyze the firm’s options properly. At best, benchmarking is a probabilistic suggestion or random idea generator, offering ideas that will likely help. Benchmarking doesn’t tell you, though, what the real solution likely is. In order to improve his firm’s performance, Tom should define the profitability problem mathematically and break it down into its constituent parts. Profitability is a function of revenue and costs; after some analysis, Tom realizes that costs aren’t the issue. Now, he focuses on revenue; revenue is a function of price and quantity. The firm Tom is consulting for operates in a highly regulated industry, so let’s treat prices as fixed – they can’t realistically be increased. Tom knows, now, that the issue lies somewhere with the quantity sold. Quantity sold is a function of overall market sales multiplied by market share. Data suggests that the industry is fairly large, and is growing aggressively – overall market sales aren’t the problem. Market share is. Market share can be defined as average sales per customer multiplied by number of customers, divided by total market sales. Tom knows that average sales per customer are high – as such, he now knows the real problem lies in increasing the firm’s number of customers. Now, Tom can generate ideas to acquire more customers for the firm. This line of reasoning can be applied universally – when you’re looking to determine the truth about X, all problems can be broken down into their constituent parts to be better understood. Physics and economics do this particularly well.
MESA.CA/COUNTERPOINT 11
FINANCE
12 THE COUNTERPOINT
Ticker: TSE (CTC.A) Price: $108.97 (1/20/16)
Recommendation: BUY 12 Month PT: $139.20
Investment Thesis:
though has been its shift into Smart Stores. In the last twelve months, the company converted about 70% of its stores to Smart Stores that enhance productivity and drive profitability due to lower capex requirements.
We rate Canadian Tire a buy due to the company’s steady acceleration in revenues that we project will be a constant factor in the years going forward. With margin expansion across all banners, particularly the sports section which was the result of The Forzani Group (FGL Sports) acquisition, there is significant potential for the company to grow its income statement in the near future. Furthermore, the loyalty card program has been given a new direction that we expect can provide a catalyst in the near future when used in conjunction with the brand’s deeply-rooted Canadian history to spur a Hudson’s Bay-esque loyalty.
Canadian Tire Background: Canadian Tire is one of Canada’s largest retail stores and one of the country’s oldest retailer. Some brands it operates are Sportchek, Canadian Tire Petroleum, Canadian Tire Financial Services Limited, Mark’s and FGL Sports Ltd.
13 THE COUNTERPOINT
Canadian Tire is a company operating that has operations in the retail and gasoline space. As one of the oldest Canadian retailers, the Canadian Tire brand has sub-categories of sporting goods (through FGL Sports), Automotive, Living, Financial Services (through CT REIT) and Apparel. Led by CEO Michael Medline, the company’s focus has recently shifted to the sporting goods segment as that has been proven to have greater margins in the recent past with great room for expansion in a hockey-loving country. Past expansions in the USA haven’t proven very successful however, which has got the company to focus exclusively on the Canadian market. The company’s most recent trend
Retail Industry Background: The retail industry in Canada is increasingly shifting towards discount retailers ad high end specialty stores that offer specialized goods, both of which compete directly with Canadian Tire. The company has so far been able to weather this landscape with few hiccups in the domestic market, a trend that was undoubtedly boosted further by the exit of Target in 2014 from the Canadian market. Retail market research firms show that retailers in Canada have grown 4% annually in the 10 year 20042014 period while Canadian Tire has grown 5% in the same period. The main drivers of the industry in the Canadian market include the level of employment, GDP and population as Canadian Tire operates in the consumer discretionary space. This also gives its revenues a cyclicality that is in tandem with the general economic cycle of the macro economy.
Investment Summary and Rationale: Summary: We recommend a Buy rating on Canadian Tire with a target price of $139.20. We are initiating coverage on CTC
with a Buy rating for the following reasons: 1) current valuation multiples show that the company’s recent expansions have been largely underappreciated by the market, indicating a discount 2) better leverage of loyalty programs and inherent Canadian identity to attract sales 3) shifting of strategic priorities that are in sync with the current retail market trends.
ployed a Price to Sales and Price to Book approach. The analysis revealed that CTC currently trades at 0.8 P/S while its peers trade at 1.7x while Price to Book is at 1.7x with peers trading at 2.7x. These multiples are sufficient to convince us that Canadian Tire, which is currently closer to its 52 week low than its high, is a diamond buying opportunity in the rough.
Underappreciated multiples offer buying opportunity: Canadian Tire currently trades at around 17.75x P/E. This figure is a significant discount from the peer average of 23.4x that we took from the analysis of multiple retailers in the specialized discount retail space. Though revenues have been on an uptick, the market has yet to take notice and the shrewd investor can thus take advantage of this mispricing. Further evidence of this undervaluation comes from the more popular EV/EBITDA multiple. Currently trading at 8.8x, the peer average from the comparable group we chose is 9.9x. After extensive analysis of the space, we conclude that this difference in pricing has been due to the investor’s propensity to gravitate towards the digital retail space (Amazon, Alibaba etc.) which has pushed the physical retail companies to the background – a trend unlikely to continue given the digital retailers’ poor operational performance over the past year.
Sporting banner providing organic sales growth opportunities: Sportchek stores rising in same store revenue. With the 2011 acquisition of the Forzani Group, which had Sportchek under its umbrella, CTC gained access to a huge segment of the sporting market in the country. The company’s main banners Sportchek and Sports Experts recorded sustained increases in market share over the last 4 years and also ensured that the US giant Dick’s Sporting Goods was kept within American territory. With this sporting goods tailwind, we expect the company to show greater growth in the apparel and footwear products particularly as the company has recently started leveraging the “Our Game” mantra where marketing is focused around hockey as a means to ignite patriotism. So far, this patriotism has been converted into dynamic sales growth of 6% YoY in 2014.
Secondary valuation multiples supplement our thesis of undervaluation. To ensure that the valuations were not skewed, further analysis was conducted across various metrics. We em14 THE COUNTERPOINT
Sustained growth in diluted EPS and EBITDA. EPS has grown exponentially over the past five years, rising 13.29% CAGR between 2010 and 2015 as evidenced by it going from $4.10 to $7.65 currently. This has been a testament to the greater cost con-
trol that CTC has exercised as well as the sustained revenue increases across all it banners. One particular banner that also deserves attention is the Automotive division. As the main engine driving CTC’s growth, we believe that there is tremendous potential to expand margins in this division which dominates 35% of CTC’s sales. The change in this division that causes us to believe so involves the moving away from a product offering to service offerings – a route to lower capex costs which boosts EBITDA margins. This, along with their loyalty platforms and Canadian Tire e-commerce capabilities can offer customers significant technological benefits which we strongly opine can translate into tangible income growth. Improving fundamentals cascading into performance: Gross and EBITDA margins at all-time highs. Canadian Tire is well positioned to take advantage of the new opportunities arising in the sporting goods market as a direct result of their recent profitability. Since 2009, the company has enhanced its gross margins from 10%% to 32.5% while their EBITDA has risen from 10% to 11.04%. Furthermore, their return on common equity has risen from 9.24% to 12.05% over the same time period complemented by an equally impressive dividend payout ratio of 25.66% currently from 20.5% in 2009. With steady dividend growth and prospects for organic growth, we believe Canadian Tire could not be much better placed at this point. Current ratio rising while debt is being paid off steadily.
The company moved from a current ratio of 1.68 to 1.86 in a four year period from 2011 to 2014 which would indicate that their liquidity situation is on the rise – a key factor in a seasonal business like Canadian Tire’s. Furthermore, their debt to equity is also falling fast as they’ve gone from 79% levered to just under 63% levered in the same time period. This lower reliance on debt has indicated their ability to pay down debt and fund operations using their own equity – another stable liquidity indicator. Lastly, their cash ratio has remained steady throughout the 2011-2015 period at around 0.21 to 0.25. This could potentially give rise to M&As or share buybacks that the company my participate in to boost shareholder returns.
Valuation: We valued Canadian Tire using three different methods: a Discounted Cash Flow model (DCF); Enterprise Value to EBITDA (EV/ EBITDA) and Price to Earnings (P/E). Using an extensive analysis of comparable companies to extract proper EV/EBITDA and Price/Earnings multiples, we chose to compare enterprise value to accommodate different capital structures amongst peers, EBITDA to focus on operational performances and earnings to evaluate how much the market is willing to pay per dollar earned. The weighted 12-month price target was derived as follows: • 40% Discounted Cash Flow Model (DCF): $137.34 • 30% Enterprise Value to EBIT DA (EV/EBITDA): $139.75 15 THE COUNTERPOINT
• 30% Price to Earnings (P/E): $145.89 Our calculations result in a 12-month target price of $139.20, representing a 22.5% premium to the latest closing price. Discounted Cash Flow (DCF) 12 Month Calculations Target Price: 137.34 We began with Canadian Tire’s weighted average cost of capital. Our key assumptions included a risk free rate of 1.70% (Government of Canada 10 Year Bonds). For the company’s beta, we used the Capital IQ assumption of 0.55 and for the company’s target debt to equity ratio, we used 40% as indicated by the company on its 2014 financial report. Finally, for its notes, we used the company’s 2.74% paying bonds to arrive at cost of debt. Once we got the necessary parameters, we substituted them in CAPM to arrive at 6.23%. Comparable Company Multiples: EV/EBITDA Target Price: $139.75 To arrive at the EV/EBITDA multiple, we analysed the next twelve month (NTM) EBITDA projections of 11 retail peers that are in the competitive radar of Canadian Tire. Peer multiples show an EV/EBITDA figure of 9.9x largely on the back of the market paying an undue premium on blue chip names in the digital retail space which was initially thought to be the starting point of the end of physical stores. However, once investors realize this is not yet the case, the Canadian Tire stock is due for an upward correction to an upside of 23% from the current price.
Comparable Company Multiples: Price/Earnings Target Price: $145.89 To see the market’s reaction to the retail companies’ earnings and the price they are willing to pay minus the effects of leverage, we used the P/E multiple which showed a stark undervaluation. However, we feel this is somewhat inflated due to retailers starting to add more debt to their capital structure. That being said however, there is still tremendous room for upside through this multiple again as the analysis suggests a 28% premium to current pricing.
Risks: Sales margins may be compressed due to the stronger US dollar. The strength of the US dollar has been a source of concern for Canadian companies as the weaker Canadian currency has eliminated absolute gains in many other sectors including Consumer Products Goods. So far Canadian Tire has been treading on the right side of the FX volatility, however the currency strength remains a key consideration. Amazon and/or other online retailers become the retailer of choice. The past two years prior to 2015 - saw an increased ability by online retailers to grow despite constraints like lack of a customer facing atmosphere. However, 2015 so far has returned back to normal with retail sales being a heartening prospect for companies like Canadian Tire. In future however, if the market regresses to their preference for online retailers, Amazon and other retailers could have a better time getting favour from equity investors.
Potential Catalysts: • Share buybacks or growth in dividends • M&A activity considering cash reserves • Greater expansion of Sportchek stores across Canada and possibly beyond • Greater leveraging of on line and loyalty platforms in future.
16 THE COUNTERPOINT
ECONOMICS
17 THE COUNTERPOINT
18 THE THE COUNTERPOINT COUNTERPOINT
19 THE COUNTERPOINT
MESA>CA/COUNTERPOINT 19
20 THE THE COUNTERPOINT COUNTERPOINT
SPORTS
Sports Data Analytics A Competitive Edge “In God We Trust—All Others Must Bring Data.”
Andre Tsang
I
n the world of sports, data analytics have become an integral part of teams that have decided that future performance is closely correlated to past performance. Many forward thinking General Managers of sports teams have now implemented sports analytics as a part of their competitive strategy in order to try and stay ahead of the curve or at the very least, not get left behind. Often times, historic performance has closely been indicative of future performance, in sports, based on a variety of factors. These factors can and are not limited to include: age, strength, athleticism and intangible qualities. Specifically speaking, athleticism was the primary factor in the past of projecting a player’s potential. However, ever since the rise of “Moneyball” based on the Oakland Athletics data analytics driven system, many teams have since realized that analytics plays a big part in sports. Recently, the St. Louis Cardinals, a team in Major League Baseball (MLB), has hired a former management consultant at McKinsey & Company named Jeff Lunhow. In this article, we seek to analyze the system that Jeff Lunhow has implemented in the Houston Astros and the success they have achieved because of this. Jeff Lunhow would be a peculiar hire as the General Manager for any baseball team because of the closed business environment the MLB typically employs. The extent of all the knowledge Jeff Lunhow knew about baseball included being involved in the fantasy baseball league at McKinsey and a business paper written in school on how the Chicago Cubs would win the World Series. At his time of employment, the Houston Astros were last place in their division with 56 wins and 106 losses. Jeff employed a brutally efficient strategy that management consultant had taught him. He stripped the Houston Astros with ruthless efficiency and tried to build it up stronger than before. An example
21 THE COUNTERPOINT
would be that looking at the 2011 roster for the Astros, only one player still exists on the roster with every other single player either traded or let go in 2016. Jeff employed the strategy that every rebuilding team implements, which is to decrease payroll wherever they could and obtain the first overall draft every single year. However, in addition to this, Jeff Lunhow implemented a purely data analytics driven system within the Houston Astros. The results are astounding. In 2011, the team had 56 wins at the end of the season. In 2015, the team achieved 86 wins and made the playoffs for the first time in 10 years. Seeing this ruthless efficiency from the Houston Astros, one begins to speculate how their data analytics system works. Based on an overall analysis of the Houston Astros, I have concluded their efficient data analytics system consists of, but is not limited to, five steps. These steps are show below:
Houston Astros have a program called Ground Control that weighs every single variable and assigns them value according to multiple statisticians, physicists, doctors, baseball scouts and coaches. Obviously, having a larger amount of input on multiple variables allows for a more accurate representation of data and values assigned to players. Ground Control allows for a highly accurate projection of a player next to their real time statistics. Ground Control, a computer system, acquires mass amounts of data in real time, filters and interprets the data and presents the Decision Makers with a final analysis of players within the team and around the league. Ground Control presents a colored tab next to a player within the Astros organization. Green means he should be promoted, grey means the player should be demoted and black signals the player should be cut. This program essentially amalgamates the entire five step process and provides empirical evidence on a players perceived worth through historical data and expert anaylsis. In terms of a data analytics sports team, many teams have a variation of the above strategy implemented in their team. However, the degree in which this system is implemented and enforced by Jeff Lunhow is relentless and ruthless. As the Houston Astros front office sums it up with their motto, “In God we trust – all others must bring data.� 22 THE COUNTERPOINT
Become a PRO, Become a CPA
23 THE COUNTERPOINT
24 THE COUNTERPOINT