On Tilman Fertitta’s acquisition of the Houston Rockets [Part 2]

In Part 1 of my ongoing discussion of Tilman Fertitta’s acquisition of the Houston Rockets, I looked at how the Landry’s, Inc. CEO acquired the team, as well as his rationale for doing so. The acquisition, at $2.2 billion, was the most expensive in NBA history.   

With the trade deadline having elapsed this past Thursday, certain circles of the Houston Rockets’ fan base were surprised and, at worst, extremely upset, by the Rockets’ tepid moves and emphasis on shedding player salaries, despite the team saying all season that they are “all in” on this James Harden / Chris Paul championship window.  

Three teams in the East – the Toronto Raptors, Milwaukee Bucks and Philadelphia 76ers – all swung for the fences, acquiring top players (Marc Gasol, Nikola Mirotic and Tobias Harris, respectively) who will most likely help their new teams compete come playoff time. Separately, three non-playoff teams – the Los Angeles Clippers, New York Knicks and Dallas Mavericks – made moves to create 1-2 max player slots in preparation for the upcoming fruitful 2019 free agency class. Anthony Davis remains a New Orleans Pelican despite trade demands, but he may ultimately join Boston, New York or Los Angeles this offseason. New competitors quickly emerge in a league where the players have considerable leverage and are increasingly calling their own shots.  

Conversely, when the deadline had come to pass, the Rockets had only acquired Iman Shumpert, who, while certainly is a sizeable upgrade from James Ennis (who was essentially dumped on Philadelphia in a salary-shedding move), is probably not the needle-mover the team truly needs. And while the Rockets were able to rid themselves of the albatross contracts in Brandon Knight and Marquese Chriss, they had to give up their 2019 1st and 2022 2nd round picks to do so. Arguably, the true winner at the trade deadline was Mr. Fertitta’s pocketbook, with the team officially going under the luxury tax. The team could dip further if Clint Capela does not reach all his incentives on his contract this season, which his current right thumb injury is likely to ensure.

One could certainly argue that the team improved at the deadline.  So why are Rockets fans upset about the moves? It goes back to managing expectations. In his first offseason as the team’s owner, Mr. Fertitta put his stamp on the Rockets’ preseason. Media day was held at his newly-opened Post Oak Hotel in Houston while training camp was in Lake Charles, Louisiana, home of his Golden Nugget casino. Most notably, Mr. Fertitta did his part in assuring fans that the team would be willing to go over the luxury tax during the James Harden / Chris Paul championship window:  

“I am here to win championships and I’m not going to let five or 10 or 15 or 20 million dollars make the difference, because if you do win the championship, then that’s easy money back.” 

This is not the only assurance Tilman has made with regards to the luxury tax, making you wonder, as our website’s founder, Rahat Huq, did, why an owner must be so insistent about paying the luxury tax when other NBA owners are not nearly as public about it: 

It wasn’t smart PR to say this, even though everyone already knew it. https://t.co/QroIfDhUL6— RedNinetyFour (@RedNinetyFour) February 7, 2019

The team also saved its taxpayer MLE when other NBA teams spent it on free agency signings throughout Summer 2018, most notably the Golden State Warriors on NBA All-Star DeMarcus Cousins.  

The above claims, unfortunately, have not followed the actions the Rockets have taken in this choppy 2018-2019 season.  Despite James Harden having one of the greatest individual NBA seasons of all time, the Rockets have surrounded the transcendent star player with predominantly veteran minimum or buyout signings, apart from signings from the last few seasons and two of the team’s “Big 3” (Chris Paul, Clint Capela, Eric Gordon, PJ Tucker and Nene). General Manager Daryl Morey has continuously preached the importance of having your best team by April 15th, but there is an opportunity cost associated with not having the right players in place at the beginning of the season. It takes time for players to gel and learn a team’s system, so the trade deadline and buyout markets should be viewed as ways to make minor additions to the roster rather than major overhauls if your team is competing for the championship that season. The moves are arguably more important for the following season when the players can start fresh and work on chemistry together day one. It is a big reason why the team was so successful in 2017-2018 – its key rotation players and team were largely in place since opening day, apart from Gerald Green.

This current Rockets team clearly has one of the worst defenses in the league, and Iman Shumpert is probably not going to dramatically change that – the team honestly needs more height to improve its sub-par rebounding. Much of the current slippage has been due to Capela’s absence, but Rockets fans have a right to be upset and believe the team is wasting perhaps Harden’s greatest season ever and another year of Chris Paul before Father Time gets the best of him.

We perhaps were less critical of Les Alexander’s tenure because he was able to oversee two championships in his first two years as the team’s owner. That immediately secured his legacy, even if the construction of those championship teams were largely not under his watch. The reality was that Mr. Alexander was reluctant to pay the luxury tax himself, forcing Daryl to operate the team like a value investor. Necessity is the mother of invention, and it was arguably this constraint that helped hone Daryl’s unparalleled ability to identify mispriced value-add players and find advantages at the margins through statistical analysis.

Two things need to happen before we can truly pass judgment on Mr. Fertitta.  

First, we need to see how the Rockets continue playing this season’s buyout market. If the team comes away with acquiring a marquee player, then the plan at the start of the season remains largely true. In fact, Kelly Iko of the Athletic said the team is after Markieff Morris, who would undoubtedly be an upgrade to the team. However, with the Rockets now under the tax, they will most likely be more selective in who they sign. Nate Duncan has gone as far to say that the team will not use the MLE now – he has, by and large, remained critical of the team’s moves this season:  

If the Rockets go back into the tax and use some of their MLE to get buyout guys, I’ll gladly eat crow on this one. I do not foresee that though.— Nate Duncan (@NateDuncanNBA) February 7, 2019

Tilman has gone on record about his reluctance to avoid the repeater tax, which means the team only has three consecutive years of being in the luxury tax to work with. If the Rockets avoid the luxury tax this year, they will be able to line up their luxury tax period with that of Chris Paul’s and James Harden’s contracts. This is an important strategy in extending the team’s championship window. However, as stated before, time is not on CP’s side. It is not unrealistic to believe that Paul may only have one year left of reaching the ability he achieved last season and this season, outside of his hamstring injury. In addition, Danny Leroux of the Athletic made the case for the repeater tax simply being an excuse for Tilman to get under the luxury tax this season. These things only raise more questions about the team’s cost-cutting.

The second thing that needs to happen is the 2019-2020 season. With only a one-and-a-half year track record to currently work with, it is important to remember that new owners should not be judged in one-year intervals but rather, at the minimum, three-year ones. If the 2019 offseason is more of the same moves the Rockets made this past offseason, (i.e., if the team lets go of current standouts Kenneth Faried and Austin Rivers and signs less than stellar replacements, similar to Ariza being substituted for Ennis), claims of Mr. Fertitta being frugal will only ring louder.

It is also critical to view the Rockets moves in relation to Tilman’s ongoing businesses outside of the team. $30.5mm is still owed by Fertitta to contractors for his Post Oak Hotel project.  Further, as laid out in my first article in this series, the team is well levered at 65% loan-to-cost at a high interest rate to boot, so Tilman being able to pay down the team’s debt, cover its interest payments and offset his investment is critical. There are real-world implications here that will impact the team going forward. From Tilman in an October 2017 article following his acquisition of the team:

“We want to cross promote anything we can — I’ve got to offset that $2.2 billion! There is a contract with the Levy organization. We have a good relationship with them and they’ll let us do basically whatever we want to do. So will you start seeing some of our brands and our food? Yes.” 

A logical next step is for Fertitta to renegotiate and, if possible, eventually obtain Levy’s food services contract with Toyota Center. This would help dramatically boost Landry’s, Inc. top line, thereby improving the team’s overall profitability and debt service coverage. However, the price to buy out that contract would most likely be substantial. In the meantime, Tilman continues to dot the arena with his concepts such as Cadillac and Salt Grass Steakhouse in order to enhance Landry’s brand awareness amongst arena-goers and extract revenue synergies.

It is easy to be critical of an owner when a team has largely underperformed expectations following a year when it was one hamstring away from winning it all. However, as fans, we still owe Fertitta the benefit of the doubt, and Daryl has always made moves that maximize optionality and are long-term in nature. Morey is thinking much farther ahead than this season. From Iko’s piece:

“[We were] also able to create flexibility for buyouts this year, to add players down the stretch and into the future as well,” Morey explained. “It’s going to make it a lot easier to add players down the road.”

However, it is equally important, as fans, to keep team ownership in check and not take things at face value. 2019-2020 will help answer a lot of the questions posed in this article and by Rockets fans. The NBA, perhaps more than any other league, is one where your team needs to be a top spender in order to get a shot at winning it all. Ownership truly is the greatest competitive advantage a team can have in sports. We will ultimately see if that is the case with the Houston Rockets under Tilman Fertitta.

About the author: Justin Levine is a commercial real estate investor and developer for Levcor, Inc., based in Houston, TX. Justin’s business career includes experiences in Wall Street, private equity, media and tech. He has a B.S. from Northwestern University and an M.B.A. from The Wharton School. A lifelong Rockets fan since the team won it all, he regrets being too young to party on Richmond Avenue that fateful eve in ’94. Twitter: @JustinLev

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