Monday, 19 April 2010

Should we worry if the Red Knights took over and kept the bonds in place?

In the last week, the press has been full of speculation about the timing and structure of any offer from the “Red Knights”.  One often repeated idea is that the RKs might keep the recently issued bonds in place, at least for the time being.  Reading various United forums, it seems this possibility is worrying a lot of supporters.  Obviously the ideal thing for United would be to turn the financial clock back to May 2005, when we had no debt at all. But if the only way to get the Glazers out involves keeping the bonds for a few years at least, then I still believe this would produce a transformation of the club’s financial position.

The first key thing to bear in mind, is that if the Glazers sell United, they will repay the PIKs from the proceeds, removing this terrifying millstone from around our necks.  The PIKs are central to everything, because the Glazer family do not have the money to repay them and are therefore using the clubs money.  So any successful takeover would immediately reduce the debt that our football club is supporting from over £750m to the £534m of bonds.

In the event of the Glazer family selling United, the bondholders can demand that they are repaid at 101% of the bond’s face value.  The cost of this would be around £540m.  This would be money that any buyer would have to find on top of the amount they had to pay the Glazers and would therefore hugely increase the amount of equity (cash) that had to be found.  Theoretically, a buyer could raise new debt to repay the bonds, but this is a complex, difficult process in what remain tough credit markets.  The third option would therefore be to make an offer to the Glazers that was conditional on the bondholders waiving their right to be repaid.  Why would bondholders accept this?  There are two main reasons, firstly the price of the bonds has risen very sharply since speculation about a takeover began in March.  Prior to the RK announcement on 2nd March, they traded at £92.5.  Today they trade at around £97. If the bondholders did not waive their rights, there would be no bid and the price would almost certainly fall back towards its February levels.  Secondly, new owners who (unlike the Glazers) were not seeking to take significant dividends out of the club would be far more attractive for bondholders.  The more of the club’s profits that are retained inside United, the safer bondholders are.

But wouldn’t keeping the bonds just leave the club in the same position as we are now?

The answer to this is a definite no.

In these successful times (which may not last, just ask a scouser about dominating the league), United is making cash profits (EBITDA) of around £90-100m a year.  From this has to be paid the cost of the bonds, around £45m pa, and then a whole host of payments to which the Glazers are entitled.  These include £6m a year in “management fees”, £3m a year in “parent company corporate expenses” and around £20-25m of permitted dividends.  That’s £30-35m of extra profit that can be saved by removing the Glazers, over £200m during the remaining life of the bonds. 

So an ownership structure that removed all the Glazers’s non-interest costs would be a huge improvement on the current situation.  Under the Glazers, in a season when United make around £95m of EBITDA, only around £26m is left after interest, fees and dividends are paid (and this actually overstates the cash flow).  Under the sort of structure the press say the Red Knights are looking at, this would rise to £60m a year. This extra money could go towards investing in the playing squad, reducing ticket prices and, over time, starting to pay down the bonds.

If the bonds were retained post any takeover, the rules relating to repaying them would still apply.  The bonds cannot start to be repaid until 2013 and early repayment in that year costs an additional 8.75%, falling to 4.375% in 2014, 2.1888% in 2015 and zero in 2016.   So any new owners would have around five years before it became economical to repay the bonds.  In addition to the cash that the club should have generated over this period, it is very likely that by this time lending markets will also be more benign than they are now.  If banks are more willing to lend, the club could repay a large chunk of the bonds and refinance the rest of the debt at far less punitive rates than it is currently paying.  Just to give an illustration, the bank debt the Glazers put in place in 2006 cost 3.5% above LIBOR (roughly similar to base rates), so around 4.5% at today’s LIBOR.  This compares to the 8.5%+ being paid on the bonds.  Similar terms to the 2006 deal would not be achievable today in the post credit crunch world, but in the next few years I would expect credit conditions to improve, allowing a refinancing of the bonds and significantly lower interest costs.

In an ideal world, a new owner would take over our club and sweep away all of the debt so pointlessly loaded onto it by the Glazers.  In the real world, the most we can hope for from a financial point of view is to staunch the flow of cash into the Glazers’ pockets and then gradually rebuild the club’s balance sheet.  It is natural for supporters, all too used to years of financially motivated owners, to be sceptical about the motivation of the Red Knights and people should of course wait and see what they propose. But if supporters can gain a substantial stake in Manchester United in a  structure that provides an extra £200m between now and 2017 to pay down debt, cut ticket prices for kids or to buy world class replacements for Giggs, Scholes and Neville then it sounds pretty good to me.