Monday, 11 April 2011

What Stan Kroenke’s takeover of Arsenal might tell us

After years of jostling between American businessman Stan Kroenke and his Uzbek rival Alisher Usmanov, the deteriorating health of Danny Fiszman looks like it has broken the log jam in the control of Arsenal.

The price paid by Kroenke of £11,750 per share,  values  the club’s equity at £731.05m. To read across from this valuation however we have to take into account the debt on the club’s balance sheet.

The last reported balance sheet figures are for 30th November 2010 (the 2010/11 interims). This showed the following debt and cash structure:

If we add this £147.4m net debt to the value of the equity offer we get the “Enterprise Value” (“EV”) of the business.

In the case of Arsenal however, a simple EV calculation is not appropriate because the club is still selling off development properties at its old ground. The interim accounts showed the remaining properties were valued (at the lower of cost or realisable value) at £28.2m. I have assumed that these will convert into cash at a 50% premium to this carrying value and have thus adjusted the EV calculation to take this into account:

So Kroenke is acquiring control of Arsenal at an Enterprise Value of c. £836m (adjusted for the remaining property) to £878m (unadjusted).

This is a pretty hefty valuation on any measure. In 2009/10, the club generated EBITDA from its football business of £57.4m (excluding volatile profits on player sales). This implies historic adjusted EV/EBITDA multiple of 14.6x and a historic adjusted EV/Sales (football only) of 3.8x.

Comparing the valuation to Liverpool

In contrast to the Arsenal deal, Fenway Sports Group paid an EV of £300m for Liverpool last year, a historic EV/EBITDA multiple of 8.6x. At face value on that basis either FSG got a bargain or Kroenke is overpaying hugely. So what’s going on?

I think the answer here is that FSG actually paid a higher multiple for Liverpool, and Kroenke is probably getting a slightly better deal than the headline numbers imply.

The multiple of 8.6x is calculated using the £35m of EBITDA generated by Liverpool in the 2008/09 season. We do not have numbers for 2009/10 yet, but it was a poor year for the club. Having finished third in 2008/09, Liverpool only managed 6th in 2009/10 and exited the Champions League at the group stage. The failure to qualify for the Champions League in the current season will of course significantly impact profits in the current financial year too. It seems likely that it will take several years to bring Liverpool’s EBITDA back to the £35m level seen in 2008/09 and FSG’s £300m takeover should be compared to a depressed level of profitability, possibly as low as £25m which would take the multiple paid to around 12x.

Arsenal’s depressed profits and the shirt deal opportunity

In the case of Arsenal, it is possible to argue that last year’s profits of £57.4m were quite depressed. The previous year the football side of the company made EBITDA of £66.3m. The club played fewer home games in 2009/10 compared to the prior year, and this will partially reverse this season (28 played vs. 27) adding c. £3.5m to turnover and perhaps 75% of that to profits. The new overseas Premier League TV deal will also add around £5m to the club’s income this season. Even with player costs continuing to rise, EBITDA should bounce back close to 2008/09’s £66m in the current season, reducing the multiple paid to c. 12.6x:

Arsenal is also “structurally” underperforming on its Commercial side due to the (at the time prudent) decision to sign a very long stadium naming rights and shirt sponsorship deal with Emirates in 2004. The shirt element which runs to 2012 is reportedly only worth £5.5m per annum compared to the c. £20m Aon and Standard Chartered pay United and Liverpool respectively and the c. £25m pa Barcelona are to receive from the Qatar Foundation. Arsenal “should” be able to earn a similar sum to its domestic rivals from the next deal creating a step change in profitability.

Taking the expected bounce back in profits into account (and even ignoring a on better shirt deal in the future), the multiple Kroenke is paying for Arsenal looks closer to 13x than 15x EBITDA, more in line with FSG’s acquisition of a Liverpool missing out on the riches of the Champions League.

Reading across

Takeovers of Europe’s biggest clubs are very rare things, and it is therefore worth taking note when they happen. In the case of both Liverpool and Arsenal, American investors are taking a bet on the continued growth of English football which is in itself interesting. At Liverpool, John W Henry has spoken publically about UEFA’s Financial Fair Play being a key factor in buying the club and it seems reasonable to think that Stan Kroenke’s takeover show he is also a believer in the impact of the new rules. Wage inflation is a big problem even at Arsenal, where the salary bill has risen an average 7.5% per annum over the last four years. The move to the Emirates has made this affordable, but with that now complete, it is hard to see significant profit growth without the fall in player wage inflation that UEFA hope FFP will usher in.

Turning to United, the other major club around which takeover speculation always swirls, today’s benchmark doesn’t really help the Glazers. The c. 13x “normal” EBITDA multiple Kroenke is paying would value United at c. £1.3bn. Unlike Arsenal the commercial side is already highly developed, meaning there is less “upside” to go for. Unlike Liverpool, there is no new stadium growth story to hang onto. If 13x EBITDA really is the “market valuation” for a major English club and with the Glazers reportedly looking for a £1.5bn+ price tag, it doesn’t look like much will happen soon.



GCHQ said...

This post is classic Andersred if I may say so. The sheer audacity of the bloke is quite astounding at times.

Arsenal's 09/10 profits were not depressed. You mention 08/09's £66m EBITDA but that was achieved with 32 first team home fixtures, well above the 'normal' total or indeed well above the budgeted number of home games (26).

So we'll stick with the 14.6 adjusted EV/EBITDA multiple if that's alright with you. It really does put the £1bn valuation of United by you and your Red Knight chums into perspective. Laughable really.

Clearly the price paid by Kroenke fully justifies a £1.5bn+ valuation of Manchester United, especially when you consider the tremendous commercial revenue growth achieved in the current financial year along with the premium you could reasonably expect to be paid for the number one sports franchise in the world.

You're right to say 'it doesn't look like much will happen soon', because the Glazers simply don't want to sell. Not for £1.5bn and as I've commented elsewhere, not even for £2bn. They're in it for the long haul.

You need to get used to the fact that the Glazers will be Manchester United's owners for many, many years to come.

andersred said...

Hi GCHQ, how nice of you to pop in!

The extra home game at AFC this season vs. last adds £3.5m at c. 75% gross margin, so that's c. £2.6m. We know that all PL teams get £5m extra from the PL deal. The wage inc at the interim stage was £4.5m on a total cost base of £113.5m so only c.4% vs. the 6.5% seen last year. All that in combination should take the EBITDA close to the £66m.....

The difference between United and Arsenal or Liverpool is that the latter two have relative upside. Arsenal's commercial income is only £44m vs. Utd's £100m and Liverpool's matchday income is only £42m vs. United and Arsenal's c. £100m. On that basis they justify premium valuations on any rational basis.

Have you tried justifying a c.£2bn valuation for United using any recognised metrics, DCF, multiples etc? If you had you'd realise the numbers don't work.


CI said...

Very interesting...Well Kroenke, like the Glazers, owns the Rams, an NFL football team who hasn't been to the playoffs since...2004! His Denver Nuggets have faired better getting to the playoffs, but the team has never won a championship. (It also just sold its hot property--Carmelo Anthony--to the NY Knicks.) Another team, the Colorado Avalanche, aren't major NHL contenders at the moment, either. Finally, the Colorado Rapids, his MLS team...They won the MLS Cup, but I don't know if anyone knows (or cares!) in the States.

So based on your article and the record of his sports empire, is it fair to say that Kroenke isn't a 'sugar daddy' a la Roman? Do you think Arsenal fans will be receptive to Mr. Kroenke, or did they want someone to come in and give Wenger a big check to sign new players?

One last thing...In the paragraph "Comparing the valuation to Liverpool," you accidently wrote "of" instead of "or" in the second sentence.

andersred said...

Hi CI,

I very much doubt Kroenke is a Abramovich type. I think he sees upside at Arsenal from kicking the Commercial operation into shape.

Thanks for spotting the typo.


GCHQ said...

It's one extra home domestic cup game, Anders. There's no way that adds £2.6m net. Arsenal would only receive 45% net of costs for that game. Then you have to consider that the vast majority of their corporate hospitality is sold on a seasonal basis so an additional home domestic cup game brings in far less than £3.5m gross revenue, less than £2m I'd say. Arsenal also often charge lower ticket prices for their domestic cup games compared to League/CL matches. A figure of 500K net for that one extra home cup game is far more realistic once operating costs have been deducted.

I'd confidently state that Arsenal's 10/11 football EBITDA will be less than £60m which puts your assertion that their 09/10 profits were 'depressed' into perspective.

There's huge upside on United's commercial income, Anders. There will be a massive uplift on the Nike deal when that's renegotiated and there's amazing potential for further 'second tier' partnership growth.

The Glazers would be able to justify declining a £2bn offer because they can appreciate Manchester United's enormous potential for growth. Growth that will be in a completely different league to that achieved at Arsenal or Liverpool. Try pricing in the correct premium to one of those recognised metrics and you'd realise that the numbers certainly do work.

andersred said...

We will have to agree to disagree on Arsenal's figures GCHQ. As for United, with a cost of capital of 9%, to get a £2bn valuation from a base unlevered FCF figure of £66m in 2010 requires some pretty heroic growth assumptions and zero slip ups over the next few years.

I find it telling that the whole LFC sale process could only conjure up a £300m deal despite pretty significant upside at Liverpool if they can find a new ground.

The Arsenal deleveraging effect is probably greater than I estimated in reality and the upside from replacing Emirates could be c. 15% on EBITDA, taking the multiple closer to 11x....


LSD_Eindhoven said...

Fine work, Anders.

I am not quite convinced by the market metric approach using ebitda multipliers- it is underpinned by the assumption that previous comparable transactions (takeovers and further equity purchase) were correctly priced to begin with. The Liverpool takeover by Gilett and Hicks implied an EV/Prior season ebitda of 17.7; it wasn't a success.

From the JPM report, prior transactions by Kroenke and Usmanov at Arsenal implied multipliers ranging from 12.3 to 15.3. I agree that if we insist on using this approach we need to smooth out variance introduced by an unreflective ebitda; we could use an averaged ebitda for instance.

There is, in theory, a way to link the multiple approach to a more fundamental approach involving FCF, reinvestment rate, WACC, and growth rate though it is difficult to derive values for some of the parameters for a private company such as Manchester United. Nevertheless, we can say that in order to support high multiples and consequently a high EV, the club would have to have modest reinvestment rates going forward ( like under the Glazers!) and the growth rate, as you suggested, would have to pretty heroic. We have seen strong commercial growth at tier 2 level but I suspect that this rate will start to reduce to a more sustainable long term rate going forward. Growth in other revenue streams has been pretty modest. While Manchester United might demand a premium to EV by virtue of its unique position, its singularity works against it when it comes to marketability.

I am not sure that FFP regs will deliver wage stagnation\low inflation in the long run. Better adjusted, more compliant FFP clubs will benefit from the adjustments required by their imprudent counterparts; there might be a reduction in transfer fees and salary stagnation when FFP proper begins to bite, and this, in theory, should produce better financials and accounts for the FFP ready clubs; better financials means more to spend on players and salaries thus kicking salary escalation into gear one again. I think FFP is a temporary impediment to the salary problem but not a permanent solution.

andersred said...

Interesting stuff as ever LSD. Apologies for the spam filter, not sure why it picks on you!

I agree about EBITDA, it is even less perfect in football (given the need to buy players) than in most industries. DCFs would appear the best route but the volatility of cash flows makes them very hard to use too sadly.


Anonymous said...

Cheers for the article. As a Gooner with no more than a maths GCSE, understanding corporate finance is a bit of a minefield! Always interesting to see it explained in what appears to be fair analysis, even from a fan of the enemy!

Terry Weston said...

Terry Weston - As an elderly Arsenal fan in his 70s, I am not bothered about trophies so long as the team plays with heart and is entertaining - neve a dull moment with our defence. Kroenke does not put in or take out significant money into his other sports clubs, so I hope the same will apply at Arsenal. Keeping the club solvent and competitive is the aim.

terry weston

Anonymous said...

Very interesting and appreciated analysis of the Kroenke-Arsenal take over situation. As a person that seems to have such a commanding grasp of Football economics, I would like request a layout on how Arsenal's wage bill has surpassed the 100 million mark so easily.

Anonymous said...

Hi AndersRed,

Long time reader, first time poster. A friend and myself have been debating on where United's transfer budget stands at present. I have used the calculation that it is our net profit, less our deductions for interest and player amortisation (or in reality the annual player payments from the previous seasons that this figure masks) that leaves the final transfer budget.

If only money from the revenue account profits is used, i get that figure to be around £30 million a season. under the uefa calculations, i took the figure to be around £23 million a season from now on.

my friend takes the net profit and simply minuses the interest figure off, saying that all other deductions are irrelevant accountancy tricks. he reckons we have 60 to 70 million a season to spend on players now the bond refinancing is out of the way.

which one of us is right?

Anonymous said...

Nice lucid analysis. Thanks! :-)

A small point - "historic" is the wrong term to use when simply referring to the past - rather use "historical".It is a very common error in financial reporting. "Historic" does mean something in the past but of great significance, not a commonplace event such as last year's numbers.

Anonymous said...

Hi Andy
Could you maybe explore/Explain Mr Kroenkes role in Real Estate Assets in the USA.Is his Exposure to a Broken industry more so than the Glazer Family?

charlie said...

andersred - what an excellent article, very clear.
also the one below on financial fair play, but i think you could have saved yourself the time as it's clear the likes of citeh, chelsea, the spanish and the italians are going to cheat... pay players via separate legal entities or do some kind of dodgy accounting