On Tilman Fertitta’s acquisition of the Houston Rockets (Part 3)

This article was originally posted for Red94.net on September 15th, 2019.

In June, I concluded that despite the dire luxury tax implications, the Golden State Warriors would be able to retain their four All-Stars of Stephen Curry, Kevin Durant, Klay Thompson and Draymond Green. The solution to the financial conundrum would be found in the enhanced revenue streams generated from the team’s new arena, the Chase Center.

The Westbrook trade aside, the team was remarkably more conservative compared to last season. It also seems apparent that Fertitta wants Morey to conserve resources for a “silver bullet” trade that truly increases the team’s championship odds.

How much has changed since I wrote that article; the only constant in the modern NBA is that there is no constant. Durant ultimately teamed up with Kyrie Irving to lead a new Eastern Conference top-tier competitor in the Brooklyn Nets. Durant is one of the more self-aware superstar professional athletes, so it came as no surprise that in a recent sit-down with the Wall Street Journal, he validated what many basketball fans felt of the KD era in Golden State – he ultimately felt out of place amongst the original core three of Curry, Thompson and Green.

Regardless of Durant’s intentions to sign with Brooklyn, the move ultimately changed the landscape of the NBA for the 2019-2020 season and beyond. Subsequent cataclysmic shifts in the player landscape occurred, including Kawhi Leonard luring Paul George away from the Oklahoma City Thunder to help lead the Los Angeles Clippers, which subsequently opened the window for Rockets general manager Daryl Morey to trade Chris Paul for Russell Westbrook. Once the dust settled from the 2019 NBA offseason, the league could claim to have eight contenders for the Larry O’Brien Championship Trophy – the Rockets, Clippers, Lakers, Warriors, Nuggets, Bucks, 76ers and Jazz – when in the past it was simply the Warriors. The path to an NBA championship is wide open.

The Warriors’ blueprint to absorb the luxury tax through ancillary, non-NBA revenue streams should be considered by any team looking to compete for a title. This blueprint, combined with an astute front office, is a recipe for an NBA championship or, even grander, dynasty. It is just one more competitive advantage a luxury tax team like the Rockets could exploit. Arguably, the upper hand Morey and the Houston front office possessed in style-of-play optimization has diminished over the years, so finding a competitive advantage through astute business planning can help the team achieve its ultimate goal of winning another championship and bringing the party back to Richmond Avenue.

In February of this year, I argued that more time would need to elapse in order to be able to judge Tilman Fertitta’s track record as owner of the Houston Rockets. Observations have begun to materialize into consistent themes heading into year three of the Tilman Fertitta era:

Limited appetite for non-contributory players. Despite the team’s blockbuster trade for Russell Westbrook this offseason, by and large the Rockets still don’t have definition at the 4. Astute fans clamored for the team to expand the Westbrook trade, which would have been a rare opportunity for the Rockets to gain additional assets and avoid hard-capping its payroll. Even if such assets were nothing more than salary filler, they could have helped the Rockets solve their depth issues through a future trade. When this desire ultimately didn’t materialize, fans pointed the finger at ownership for not being willing to spend. The team did in fact try to expand the trade, as Morey later iterated, but the Rockets could have picked the lowest hanging fruit in taking back former Rocket Patrick Patterson, who ultimately signed with the Clippers. An already season-long narrative of ownership being “cheap” was further compounded by Marc Stein’s report that the team successfully re-negotiated Russell Westbrook’s pay structure on his max contract.

The above begs the question as to whether Fertitta is looking to smooth out team expenses and, hence, free cash flow, in order to better cover debt service obligations related to the leverage used by him to acquire the team in 2017. This is unfounded speculation, and the move makes complete business sense, but it certainly raised a few eyebrows – take a quick scroll through the Twitter comments to Stein’s original post and a reactionary piece from Deadspin.

The flip side of the argument is perhaps the team, following the inability to gain value from Brandon Knight and Marquese Chriss, is now more conservative with bringing on players that cannot contribute to the roster.

Promote from within rather than hire from outside. Perhaps the biggest unknown heading into the season (at least on the player side) was Eric Gordon’s expiring contract. So, it came with much elation from this author that the Rockets extended Gordon through the 2023-2024 season for $76 million. In a weak 2020 free agency class, Gordon most likely would have commanded a max contract, and it would have been quite difficult to replace his value if the team lost him to free agency, given his extension was enacted using Bird rights.

The Gordon extension proved something that is now becoming more apparent with ownership during the Harden era – the Rockets rather invest in proven players than hire from outside. Last offseason, Capela was given a 5-year contract and Chris Paul a 4-year one. The combined value of both of these contracts was $250mm. This season, Gordon was the next piece of the team’s core to be extended, and PJ Tucker may soon be next.

Promoting a proven employee is a less costly endeavor than hiring from outside. If a firm fills a position externally, significant training and integrations costs are incurred, whereas an existing employee has already ingrained him or herself into the company’s culture, working environment and business processes. Similarly, Gordon and Capela understand their roles completely within the Rockets’ system and are now two of the longest tenured teammates of James Harden. Their value and contribution have been maximized in Houston, and it’s questionable as to whether the same return could be achieved via trade unless it was for a truly top 15 player.

With time such a precious commodity in the Harden era, it makes sense for the team to bank on proven assets rather than make a Ty Lawson-sized gamble on a player that may or may not mesh in the current Rockets system or, more importantly, with Harden.

The proliferation of incentive-based contract structures. Another element to Gordon’s contract was its incentive-based structure, an increasingly more consistent concept in Morey’s contract negotiations. Much like tying a senior executive’s compensation to a company’s stock performance, annual EBITDA goals or other financial metrics, the Rockets are looking to better align the incentives of the team’s players with those of ownership and the front office.

The last season of Gordon’s extension (2023-2024) is only guaranteed in the event Gordon becomes an All-Star or the Rockets win a championship. Clint Capela’s contract, similarly, was laced with performance incentives that ultimately made $10mm of the $90mm payout unguaranteed. Then, during the stalemate of the Mike D’Antoni contract negotiations this offseason, it was reported that the Rockets tried to make much of the head coach’s extension incentive-based. Contract talks with D’Antoni have since broken down, and his status as head coach heading into the next season remains an unknown. Most recently, Nene Hilario was resigned by the Rockets for two years at the minimum ($2.6mm), but the contract has up to $7.4mm in incentives, and the second year is only guaranteed if the Rockets keep Nene on the roster beyond February 15, 2020. Morey, adding to his list of exploitations of the CBA, was able to structure the contract so that the incentives count towards Nene’s trade value. Perhaps feeling outsmarted by one of the most deft GMs in the game, the contract still hasn’t been officially recognized by the NBA, as of the time of this article.

Questions around the value of an impact role player. Even though the team has discussed its willingness to “go all in” for Andre Iguodala, the reality is the Rockets haven’t spent significant dollars on signing an impact role player outside of the organization since Mr. Fertitta took over as owner. Instead, the Rockets have opted to engage in veteran minimum, two-way or relatively cost-conscious, team-friendly deals that have upside potential. Some have succeeded brilliantly, such as Austin Rivers, Kenneth Faried and Danuel House, and others have failed miserably, such as Michael-Carter Williams, James Ennis and, lest we forget, Carmelo Anthony.

A team’s revenues – gated receipts, merchandise sales and media broadcasting contracts, among other line items – are most primarily driven by its star player(s). Less determinable, however, is the impact of a lesser known yet highly valued role player that helps a team compete on the margins. What is the NPV and return of such a player in the eyes of Mr. Fertitta? Will such a player only come through trade and not through an outright signing? Nene’s contract seems set up to do so.

Under the luxury tax, once again… The team finds itself under the luxury tax much like last year, despite repeated claims from ownership indicating their intentions to go over the tax. As the team’s financial flexibility has been stymied, Morey has had to get even more creative in signing players in order to stay under the tax, as noted in the aforementioned Nene signing. It is a true testament to Morey’s resourcefulness and ingenuity as one of the best general managers in the NBA.

Even though the team perhaps bought a couple more years of contention with a younger duo in Harden and Westbrook, the opportunity for the Houston Rockets to win its first championship in 25 years is greater than ever. Why not maximize that opportunity now? The additional expenses incurred from the luxury tax pale in comparison to the exponential boon in revenues that follow a championship, as the Golden State Warriors can attest.

…yet, still a top 4 payroll. Despite fans’ desire for Mr. Fertitta to spend above the luxury tax, it’s important to remember that Mr. Fertitta is the owner of the 4th-largest payroll in the NBA. Further, FiveThirtyEight gave Houston the best odds to win the 2020 NBA Finals, while ESPN had the team finishing at the top of the Western Conference. The Rockets, knowing this, are now only going to make a move during the season once the Harden/Westbrook tandem has been given time to develop and Nene becomes tradeable.

The Westbrook trade aside, the team was remarkably more conservative compared to last season – it is clear the failed gambles made on veteran minimum signings and the trade for Brandon Knight / Marquese Chriss impacted Fertitta and Morey’s approach to the 2019 offseason. It also seems apparent that Fertitta wants Morey to conserve resources for a “silver bullet” trade that truly increases the team’s championship odds. But exercising prudence with both Harden and Westbrook in their prime is a delicate balancing act with very little room for error – time is not on the team’s side if they want to ultimately win it all, and the stakes will only increase over the next few seasons. Mr. Fertitta knows this, but it will be up to him and Morey to make the final one or two moves this season that makes the City of Houston dust off that 1995 championship parade route.