Alex, the bottom line.

[Mall]

I have a vague recollection that I went through a comparable example when Smarty retired, but the simularities between the owners & posts are such that it might bear repeating. Let\'s start out with the not unreasonable assumption that Alex\'s value as a stallion is the same as Smarty, $39 million. Next yr\'s premium for ASD/Fertility coverage, assuming there is capacity for the full amount, will be approx 8% of that, or $3.125 million. In other words, to race Alex as a 4 yr old, each of the 4 partners of Cash Is King stable, none of whom is \"loaded\", would have to write a personal check for $780k. In contrast, if he\'s syndicated at the end of this yr, each partner would receive a check for $9.75 million. That\'s a lot to ask relative newcomers to the game to sacrifice for the good of the sport. Even though I\'m guessing this assumption is wrong, let\'s also assume the partners understand these numbers. The question then becomes what do they get in exchange for paying the $3 million plus premium. A chance to break even if Alex wins the BC Classic & just about every other race he enters, plus the possibility, as Ritchey points out, that his value as a stallion increases as a result of his 4yr old campaign. There\'s also the chance that his value decreases, something the owner of Giacomo understood when he sold a good portion of his breeding rights before the Bel. Let\'s arbitrarily set the increase/decrease at $10 million, in which case each partner would be looking at making a $750k bet at a little better than 3-1 on the upside. The problem is that the downside isn\'t capped by the amount of the bet, so it\'s entirely possible that you\'re out the $750k for the premium plus $2.5 million for the decrease in value.  No matter how much one loves the game, that\'s a pretty hard bet to make, & it doesn\'t even take into consideration what happens if, heaven forbid, something happens to the horse. In short, the bottom line consideration driving these decisions as much or more than anything else is the cost & availability of insurance coverage, which dictates that you reach into your own pocket to pay a King\'s ransom for the privilege of forgoing vast sums of money, just so you can act in accordance with the best interests of the sport. It might happen this time around, but I wouldn\'t hold my breath.      

[HP]

Mall,

Excellent post.  I can imagine a few deals they could work out, but it would be tough to overcome the risk/reward scenario you outline here.  HP  

[Silver Charm]

Mall I remember that post and you were right on the money with Smarty and Co. The economics simply do not work out.

I think Stronach decided to take some money off the table with Ghostzapper. He currently stands Ghostzappers Stallion (Awesome Again) and I said last year after the Breeders Cup it may make sense to continue to race Ghostzapper because if he was immediately retired there would be some cannibalization of his own sire, that being Awesome Again. He promply bumped the Stud Fee on Awesome Again and briefly raced Ghostzapper. Who knows maybe he was able to get enough of a premium off that one race to justify the loss of a years Stud Fees. When confronted with a similar proposition Stronach\'s new partner probably insisted on he wanted no part of Race Horse he has just sunk $20-30M in. The nuclear scan Ghostzapper was given may have had more to do with a vetting process for a Sale than it had to do with any unsoundness he was suddenly suffering from.

Now I am hearing a lot of the same retoric from Trainer Ritchie. \"He was worth $20M before the Belmont whats he worth now\". \"The owners are committed to keep racing this horse thru his four year old season\". All comments that could be percieved as attempts to get the price up. And if thats the case then he would only be doing his job, while filling his own bank account at the same time.

Call it poker of different brand and when somebody throws $30M worth of chips in your corner of the table, its hard to image the next thing someone says is \"I\'m All In\". I know I sure as hell wouldn\'t.

How much a Nothern Afleet/Afleet/Mr Prospector is worth, who knows. We went thru the same thing last year with the Elusive Quality/Gone West/ Mr Prospector line. Don\'t be surprised if you see history repeat itself.

I agree with your analysis. No one would argue with the economic logic of retiring these horses early. However, I think it misses the point of why these economics exist. That\'s what I was talking about yesterday.

In your example, the cost of insurance coverage is related to the value of the horse. The value of the horse is related to the amount breeders can charge for services. That in turn is related to the prices for yearlings.  

IMO the prices for yearlings are insane though. That\'s demonstrable by calculating how owners are doing financially as a group. I don\'t have those current stats, but I\'d be willing to guess they are taking a massive bath these days.

Even though there are intangible benefits to ownership (I know I owned a piece of one once) and many owners are willing to take a loss in return for the excitement, there is obviously some point at which the cost is WAY too HIGH in relation to the upside. IMHO, we are way past that point. IMO, it\'s not much different  than if you charged me $1 million for a 100K boat. I might like the boat but I am still a dumbass if I bought it!

If yearling prices would fall to a level that makes economic sense, everything else would fall too - including insurance, the price you could get to retire your horse to stud, the cost of breeding etc..... As a result, the economic choice between retirement and racing would be more in line with the joys of ownership instead of so obviously weighted towards early retirement for the lottery winners.

That balance would be a huge benefit for racing because if our biggest stars didn\'t retire there would be better racing, which in turn would attract more fans, which in turn would generate more handle, which in turn would raise purses, which in turn would make the choice of racing vs. retirement even easier.

This is a virtuous circle from which good things flow.

What we have now is a vicious circle from which nothing but bad can occur.

How we got into this mess I can\'t tell you because I didn\'t follow the details closely, but it\'s a bubble just like we\'ve seen in other markets likes stocks, real estate etc....  It will eventually burst and IMO it can\'t burst too soon because the game is being destroyed even if a minority of people are getting rich due to the insanity (just like a few do in all bubbles).

[HP]

How do you \"get the prices of yearlings to fall?\"  This is what these guys are willing to pay.  There\'s nothing you can do about it.  Use your boat example and put yourself on the other side of the equation.  You have a 100K boat and a guy offers you 500K and then some other nut calls and offers you a million.  So you sell your 100K boat for a million.  There seem to be plenty of \"kooks\" out there who are willing to lay out big bucks for the yearlings.  It\'s just like the stock market or any other kind of market.  An item is worth whatever people are willing to pay...and plenty of them are willing to pay crazy prices for horses.    

HP

[Mall]

There are many reasons why the cost of insurance, assuming it\'s even available, has become prohibitive, & most have very little to do with the increase in the value of horses. Stallions with the same & higher values could be insured at much lower rates 10, & even 5yrs ago, & there were a lot more than the six Lloyd\'s syndicates which currently participate in the market. Many left after suffering huge losses, but the competition for capital has played an important role. Thus, when the last major Am carrier, Chubb, announced it was withdrawing from the market last yr, it acknowledged that the business was profitable, but left to deploy its capital in lines which were more profitable.

The yearling market is an international one, & many of the most expensive horses are purchased by foreign interests. Given the depressed value of the dollar in recent yrs, & the size of their purses, it might make perfect sense for a Japanese buyer to pay a great deal more than an American buyer for the same yearling. And many of the Arab buyers are, for obvious reasons, not constrained by economic principles. American racing suffers, but it\'s hard to blame a breeder for trying to produce a horse which will bring the highest price from whoever\'s willing to bid at a public auction, especially if you keep in mind that most breeders, like owners, lose money.    

I agree with you. You can\'t get people to stop overpaying in the short term, but the economics of a situation don\'t change just because people are being idiots. Ultimately, those that are dramatically overpaying for yearlings will lose so much money they will either be forced out of the game or come to their senses. At that point, the prices will fall or remain flat for a very long period of time because there will be fewer bidders and more sound thinking. It often takes awhile for a bubble to pop though.

I don\'t blame anyone for acting in their own best economic interests (owners, breeders, or insurance people).

If some capital in the insurance industry has moved to other more profitable lines, then it makes perfect sense that prices would rise. However, some if not most of the cost HAS to be related to the values of the horses.

Your point about the Japanese purses etc.. is a good one. It could make more sense to a Japanese buyer if the purses are larger in Japan (especially since I assume the competition is weaker). Over time I would expect market forces to bring that into sync too. Over time more US (and other) owners will take their horses there to race and pick up those bigger purses. In the end, I think the prices of yearlings have to be related to purses even if owners are losing in aggregate. It\'s a matter of what that level is. Right now, I believe prices are WAY TOO HIGH. I\'m not an expert. I\'m not even moderately informed. It just screams so loudly that that\'s the case based on basic economics that I feel very confident in my opinion that a bust is on the way.  

[magicnight]

Class, I don\'t think owners can \"take their horses there to race and pick up those bigger purses\" because Japan racing is a closed shop. Unless I remember incorectly, or, unless things have changed, only a few races over there are open to all comers.

Interesting.  

Are the purses based on handle in a similar fashion to ours?

[Mall]

Classhandicapper: Your post reminded me of an expression one of my favorite colleagues, a wise & cynical curmudgeon, invariably used to describe a Chicago exec we both knew: \"Never in doubt. Often in error.\" This is not the place for a long dissertation on what has happened & what is happening in equine ins. markets. Suffice it to say that you have no idea what you\'re talking about.


magicnight: My understanding, which was gained when the Japenese were more active than they are now, & could be wrong, is that a yearling purchased in the US & taken to Japan from the sale is eligible for Japanese races. I think, but am not sure, that their restrictions are designed to keep horses from other countries from shipping in to take a shot at their massive purses. My impression, for what it\'s worth, is that the current trend is to relax, & in certain big races, eliminate those restrictions. In any event, I don\'t think it changes the overall point I was trying to make.  

[bdhsheets]

CH wrote:

\"Are the purses based on handle in a similar fashion to ours?\"


No, there\'s a group of Samurai warriors that plunder the countryside to supply the purses...

[SoCalMan2]

What a sobering and depressing string.  It is very hard to argue with Mall\'s astute analysis.  Even guys who have more money than they can spend the rest of their lives unfortunately are operating this way, I think.  I guess we just need to hope for some more of the like of Forego and Kelso (looks like an \'o\' at the end helps -- maybe it signals the emptiness?)

Mall, your quote about the wise guy exec in Chicago, was apparently also often applied to Jeff Skilling at Enron (a wise guy from Illinois if my memory is correct).  We all know how that turned out!

Mall,

I do not know the details of the equine insurance market but as a shareholder of Berkshire Hathaway for the last 18 years (and a bunch of other insurance companies over the years) I do understand the cyclical nature of the business and how capital flowing in and out changes pricing and returns on capital etc... I am quite certain that the value of the item being insured is almost always a major component of the price of the insurance - generally much more so than the cyclical ups an downs and other factors.

This is not the forum to discuss it further, but as an avid insurance investor if you are correct in saying that capital has been flowing out of the industry, I might be interested in making an investment. Capital flight is usually accompanied by increased profitability from the remaining players soon after - as they are free to raise prices to levels that generate adequate returns on investment. If you have any information that could shorten my reseach path, please let me know. A few company names would help - especially if they specialize.  

I understand and agree with you points about the Japanese and Arabs. From what I can see here in the US, the prices being paid for yearlings that are racing here still don\'t make economic sense for our owners.

If US buyers of yearlings are losing massive sums of money in aggregate, they will eventually be forced to drop out or they will come to their senses.
That may leave the Japanese with their higher purse structures and Arabs with unlimited capital and economic stupidity to bid on the yearlings. I would think that Americans dropping out at the margins would still work towards lowering prices. However, if the Japanese purses are supporting these yearling prices and their owners are doing well, IMO US racing is in very deep doodoo - even worse than I thought.
 
It\'s difficult for me to imagine an industry in which owners are hemorrhaging red ink (as they are in the US) being successful over the long haul. There are  two simple paths to better results for owners. Lower prices for the horses or higher purses for doing well. The problem is what I stated. When the prices for horses are high, the pressure to retire succesful horses early is high. That works in the direction of reducing fan interest and growth, potential handle and purse growth etc...

It\'s obviously not a healthy situation when so many players within an industry are losing money except for a handful of lottery winners. Speculative prices that are not supported by income streams usually lead to heavy losses and that  usually leads to a major bust in prices.

\"No, there\'s a group of Samurai warriors that plunder the countryside to supply the purses... \"

Well that was pretty funny, but if they have a higher purse structure I\'d be curious to know if they also have a much higher handle or whether a higher percentage of the handle goes to purses instead of government etc....