How Washington Destroyed Value by Trading for Alex Smith: a Lesson in Opportunity Costs
Alex Smith. Now that the dust has settled a on the trade that has assuredly dominated sports talk radio in DC the last week, I’ve had time to gather my thoughts on the deal that went down. Friends and family know I’m one of the most optimistic fans you’ll meet. This is not one of those moments. I think Washington waaaaaay overpaid for Smith. Below is a detailed explanation of why.
As far as face value is concerned, the trade looks simple: Washington receives Alex Smith in exchange for Kendall Fuller and a 2018 3rd round pick. Reasonable price for a competent starting QB, albeit an older one who probably isn’t going to light the league on fire anytime soon. At least the price looks reasonable on the surface.
When you look at the trade at the end of the day, all you care about is whether your roster has holistically been strengthened (both immediately and over a targeted period of time in which you aim to “contend” for a title). This is analogous to an investor evaluating a security not just because he or she likes the price relative to its value, but because that security’s overall profile strengthens the investor’s entire portfolio of assets.
Keeping in mind the above, there are really three different costs associated with acquiring Alex Smith:
1. Financial cost: what you’re paying him
2. Acquisition cost: what you traded to get him
3. Opportunity cost: what you could have otherwise done that you can now no longer do
It can be really difficult to keep all of the direct and indirect effects of the trade in mind as you follow each logical consequence, so I propose a simple framework: start at a baseline assumption of what the roster looks like (beginning period balance sheet), and then track the net flow of assets. What came in the door and what went out of the door. And in the NFL, there are three primary types of assets: players, draft picks, and cap space.
When you look at the trade from the lens described above (assuming Kirk Cousins was already gone in free agency), you see it as follows:
What came in the door:
Alex Smith
What went out of the door:
Kendall Fuller
2018 3rd round pick
$17M in cap space in 2018
$22.5M in cap space from 2019-2022
This details the financial cost and acquisition cost of acquiring Alex Smith; it does not factor in opportunity costs. The opportunity cost could be considered the analog to an investor’s required internal rate of return on an investment (or using Valuation guru Aswath Damodaran’s lexicon: Hurdle Rate).
One NFL asset that is less common and has rarely been cited by pundits assessing the deal is the franchise tag. Washington has the right to force Kirk Cousins to play an extra year in Washington at a price of approximately $34M. They also had the right to match any salary offered to Kirk Cousins in free agency by designating Kirk its Transition Tag player (if no offer, 1-year at $28M).
Think of this as an analogy to a call option. In finance, a call option gives an investor the right to purchase a security for a predetermined “exercise price.” Call options have value. Washington held a call option on the single most valuable asset on the market. By trading for Alex Smith, Washington almost completely eliminates any chance it could return value by “selling” the call option on Kirk Cousins (Washington cannot tie up $50M+ in QBs to explore a trade and teams know that Washington will not carry Kirk Cousins into 2018).
So the opportunity cost of acquiring Alex Smith is the return Washington could have gotten in a tag and trade scenario with Kirk Cousins. The history of QB trades in the NFL is rich, and demand is extraordinarily high. Six teams reportedly contacted Kansas City about acquiring Smith. Alex Smith was dealt five years earlier too, for a price of two 2nd round picks. Sam Bradford was traded for a 1st rounder and a 4th rounder. Kevin Kolb was traded for a Pro Bowl CB and a 2nd. Carson Palmer was traded for a 1st and a 2nd. Jay Cutler was traded for two 1sts, a 3rd, and Kyle Orton (a former 3rd round QB). Cousins is hitting the market as a 29-year old entering his prime after producing over 13,000 yards and 94 TDs the last three years. He may be the most sought after free agent QB in NFL history, given age, production, and a clean bill of health. This is why he’s likely to set an NFL record for the biggest contract in history. Clearly, he would have had demand on the trade market.
(Note: “most sought after FA QB” does not equal “most talented FA QB.” Peyton Manning hit the market in 2012, but many teams were scared of Manning’s potentially career-ending neck injury that caused the Colts to cut him. Drew Brees hit the market in 2006, but Brees was also coming off a significant injury—one that actually caused him to fail his physical in a free agent visit to Miami. Cousins is hitting the FA market after starting 16 games a year for three straight years and has never had a serious injury. This is, to put it lightly, rare.)
As many will astutely point out, there is also risk in the attempt to tag and trade. After all, what if nobody bites? Fair question. Let’s explore the risk.
The ultimately downside risk is WSH franchise tags Kirk and is forced to eat the one-year contract. Here’s the *worst case* scenario then.
What comes in (relative to Smith scenario):
Cousins
Fuller
2018 3rd round pick
$22.5M cap space from 2019-2022
What goes out:
Smith
2019 3rd round pick (compensatory pick if Kirk walks in FA)
$17M cap space in 2018
That’s the WORST CASE scenario of attempting to tag and trade Cousins.
Now explore one upside case in a tag & trade. Assume Cousins returns what Smith returned when he was traded from SF to KC (two 2nd rounders).
What comes in:
2nd rounder
2nd rounder
3rd rounder
Fuller
$17M in cap space in 2018, $22.5M in cap space 2019-2022
What goes out:
Smith
2019 compensatory 3rd round pick
If we assume a tag & trade return of what the Eagles got for Sam Bradford, the net flow of assets relative to the Smith scenario is such:
What comes in:
Kendall Fuller
1st rounder
3rd rounder
3rd rounder
$17M cap space in 2018, $22.5 cap space in 2019-2022
What goes out:
Alex Smith
2019 3rd rounder
As you can see, when you start to assess the other scenarios, the cost of acquiring Smith rises significantly. This is why the face value of the trade isn’t a true representation of how much Washington gave up in its acquisition of Smith.
Some will astutely point out that if Smith departs, then you need to find a starting QB. Fair. My personal preference (stated way before the trade) was that if Kirk was gone, I’d go with Colt starting and drafting a QB to sit and learn (likely first round).
Colt is already on the roster, so there’s no flow of cap space gained or lost in either scenario. He’s here under Smith and he’d be here under the alternative scenario. The net flow of assets out would then be the 1st rounder used to draft a QB.
Under the scenario of Colt + rookie pick, the “Bradford” upside case looks as follows:
What comes in:
Kendall Fuller
1st round rookie QB (e.g. Baker Mayfield)
3rd rounder
3rd rounder
~$12.5M cap space in 2018, ~$17.5M cap space 2019-2022 (adjusted for rookie salary)
What goes out:
Alex Smith
2018 1st
2019 3rd
There are dozens of different scenarios (e.g. sign Keenum/Teddy/Bradford if available, trade for other assets, etc.), but in each instance, the upside cases far outweigh the downside case of trying to tag and trade Kirk Cousins. Yes, there was risk. Nobody would deny that. I still would have attempted it because the return profile is just too enticing to pass up.
Now, if you think Smith is “That Dude” who will elevate the team beyond what the alternative collection of assets were likely to do, then the Smith trade created value. If you don’t, then the Smith trade destroyed value.
I don’t think Smith is that guy. I think Smith is a placeholder acquired to save Bruce Allen’s and Jay Gruden’s jobs (i.e. remain competitive in the immediate future) while a young QB develops. And that’s fine. But factoring in financial, acquisition, and opportunity costs, that’s a damn expensive placeholder.
As far as face value is concerned, the trade looks simple: Washington receives Alex Smith in exchange for Kendall Fuller and a 2018 3rd round pick. Reasonable price for a competent starting QB, albeit an older one who probably isn’t going to light the league on fire anytime soon. At least the price looks reasonable on the surface.
When you look at the trade at the end of the day, all you care about is whether your roster has holistically been strengthened (both immediately and over a targeted period of time in which you aim to “contend” for a title). This is analogous to an investor evaluating a security not just because he or she likes the price relative to its value, but because that security’s overall profile strengthens the investor’s entire portfolio of assets.
Keeping in mind the above, there are really three different costs associated with acquiring Alex Smith:
1. Financial cost: what you’re paying him
2. Acquisition cost: what you traded to get him
3. Opportunity cost: what you could have otherwise done that you can now no longer do
It can be really difficult to keep all of the direct and indirect effects of the trade in mind as you follow each logical consequence, so I propose a simple framework: start at a baseline assumption of what the roster looks like (beginning period balance sheet), and then track the net flow of assets. What came in the door and what went out of the door. And in the NFL, there are three primary types of assets: players, draft picks, and cap space.
When you look at the trade from the lens described above (assuming Kirk Cousins was already gone in free agency), you see it as follows:
What came in the door:
Alex Smith
What went out of the door:
Kendall Fuller
2018 3rd round pick
$17M in cap space in 2018
$22.5M in cap space from 2019-2022
This details the financial cost and acquisition cost of acquiring Alex Smith; it does not factor in opportunity costs. The opportunity cost could be considered the analog to an investor’s required internal rate of return on an investment (or using Valuation guru Aswath Damodaran’s lexicon: Hurdle Rate).
One NFL asset that is less common and has rarely been cited by pundits assessing the deal is the franchise tag. Washington has the right to force Kirk Cousins to play an extra year in Washington at a price of approximately $34M. They also had the right to match any salary offered to Kirk Cousins in free agency by designating Kirk its Transition Tag player (if no offer, 1-year at $28M).
Think of this as an analogy to a call option. In finance, a call option gives an investor the right to purchase a security for a predetermined “exercise price.” Call options have value. Washington held a call option on the single most valuable asset on the market. By trading for Alex Smith, Washington almost completely eliminates any chance it could return value by “selling” the call option on Kirk Cousins (Washington cannot tie up $50M+ in QBs to explore a trade and teams know that Washington will not carry Kirk Cousins into 2018).
So the opportunity cost of acquiring Alex Smith is the return Washington could have gotten in a tag and trade scenario with Kirk Cousins. The history of QB trades in the NFL is rich, and demand is extraordinarily high. Six teams reportedly contacted Kansas City about acquiring Smith. Alex Smith was dealt five years earlier too, for a price of two 2nd round picks. Sam Bradford was traded for a 1st rounder and a 4th rounder. Kevin Kolb was traded for a Pro Bowl CB and a 2nd. Carson Palmer was traded for a 1st and a 2nd. Jay Cutler was traded for two 1sts, a 3rd, and Kyle Orton (a former 3rd round QB). Cousins is hitting the market as a 29-year old entering his prime after producing over 13,000 yards and 94 TDs the last three years. He may be the most sought after free agent QB in NFL history, given age, production, and a clean bill of health. This is why he’s likely to set an NFL record for the biggest contract in history. Clearly, he would have had demand on the trade market.
(Note: “most sought after FA QB” does not equal “most talented FA QB.” Peyton Manning hit the market in 2012, but many teams were scared of Manning’s potentially career-ending neck injury that caused the Colts to cut him. Drew Brees hit the market in 2006, but Brees was also coming off a significant injury—one that actually caused him to fail his physical in a free agent visit to Miami. Cousins is hitting the FA market after starting 16 games a year for three straight years and has never had a serious injury. This is, to put it lightly, rare.)
As many will astutely point out, there is also risk in the attempt to tag and trade. After all, what if nobody bites? Fair question. Let’s explore the risk.
The ultimately downside risk is WSH franchise tags Kirk and is forced to eat the one-year contract. Here’s the *worst case* scenario then.
What comes in (relative to Smith scenario):
Cousins
Fuller
2018 3rd round pick
$22.5M cap space from 2019-2022
What goes out:
Smith
2019 3rd round pick (compensatory pick if Kirk walks in FA)
$17M cap space in 2018
That’s the WORST CASE scenario of attempting to tag and trade Cousins.
Now explore one upside case in a tag & trade. Assume Cousins returns what Smith returned when he was traded from SF to KC (two 2nd rounders).
What comes in:
2nd rounder
2nd rounder
3rd rounder
Fuller
$17M in cap space in 2018, $22.5M in cap space 2019-2022
What goes out:
Smith
2019 compensatory 3rd round pick
If we assume a tag & trade return of what the Eagles got for Sam Bradford, the net flow of assets relative to the Smith scenario is such:
What comes in:
Kendall Fuller
1st rounder
3rd rounder
3rd rounder
$17M cap space in 2018, $22.5 cap space in 2019-2022
What goes out:
Alex Smith
2019 3rd rounder
As you can see, when you start to assess the other scenarios, the cost of acquiring Smith rises significantly. This is why the face value of the trade isn’t a true representation of how much Washington gave up in its acquisition of Smith.
Some will astutely point out that if Smith departs, then you need to find a starting QB. Fair. My personal preference (stated way before the trade) was that if Kirk was gone, I’d go with Colt starting and drafting a QB to sit and learn (likely first round).
Colt is already on the roster, so there’s no flow of cap space gained or lost in either scenario. He’s here under Smith and he’d be here under the alternative scenario. The net flow of assets out would then be the 1st rounder used to draft a QB.
Under the scenario of Colt + rookie pick, the “Bradford” upside case looks as follows:
What comes in:
Kendall Fuller
1st round rookie QB (e.g. Baker Mayfield)
3rd rounder
3rd rounder
~$12.5M cap space in 2018, ~$17.5M cap space 2019-2022 (adjusted for rookie salary)
What goes out:
Alex Smith
2018 1st
2019 3rd
There are dozens of different scenarios (e.g. sign Keenum/Teddy/Bradford if available, trade for other assets, etc.), but in each instance, the upside cases far outweigh the downside case of trying to tag and trade Kirk Cousins. Yes, there was risk. Nobody would deny that. I still would have attempted it because the return profile is just too enticing to pass up.
Now, if you think Smith is “That Dude” who will elevate the team beyond what the alternative collection of assets were likely to do, then the Smith trade created value. If you don’t, then the Smith trade destroyed value.
I don’t think Smith is that guy. I think Smith is a placeholder acquired to save Bruce Allen’s and Jay Gruden’s jobs (i.e. remain competitive in the immediate future) while a young QB develops. And that’s fine. But factoring in financial, acquisition, and opportunity costs, that’s a damn expensive placeholder.
Glad I went to graduate business school. I get your points that are well made. I have my doubts that others (who work at Redskins Part) will grasp the concepts. But then, weak skills at long-term strategic thinking has long been the bane.of this team.
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