Friday, 19 August 2011

Some more thoughts on United's Singapore IPO

Now that the Glazers' plans for a partial flotation of Manchester United on the Singapore stock exchange have been confirmed, here are a few more observations.

Some of the proceeds will be used to pay down the club's debts - good news but we need details

The club and its bankers are briefing journalists that some of the proceeds from the IPO will be used to repay some of the club's debt. The Telegraph even suggests that the family have realised that the debt burden is hampering the club's ability to compete in the transfer market.

This is an extraordinary turn around in my view, with the club and its owners apparently finally falling in line with the view of supporters! It also stands in stark contrast to the evidence David Gill gave to the House of Common Select Committee on 8th March 2011 (my emphasis):

David Cairns MP: "There can’t be any ambivalence about this. Obviously it would be much better if Man United was not carrying those levels of debt and servicing them, surely?"
David Gill: "In isolation, yes, but there is no issue in terms of asking whether Manchester United has been hampered in terms of what we have had to do as a club in respect of investing, as you quite rightly say, in facilities, players or player contracts. I personally believe that there has been no impact in that respect."

The devil will of course be in the detail,with the following areas particularly important:

How much will the IPO raise?
The BBC suggest between £400m and £600m.

How much of this will actually be used to pay down the club's debt?
Will we have to wait for the prospectus, expected to be published in six to eight weeks time. To make a real difference to the cash flow, a substantial amount would need to be paid down, £200m+. Debt repayment reduces the interest bill but increases the corporation tax bill so this will have an impact too.

What will the club's policy on dividends be?
This is crucial as paying down debt and reducing the £45m interest bill doesn't improve the club's financial position if interest payments are just replaced by dividend payments. The club does not have to pay dividends post flotation, but twenty eight of the the thirty companies in Singapores's Straits Times Index (the "STI", the equivalent of the FTSE) do. The STI yields over 3%. If United had a market capitalisation of (say) £1.2bn, and yielded 3%, that's an annual dividend bill of around £36m.

Looking at valuation

When considering the success of the IPO, its impact on the club and whether fans can or should invest once the shares are listed, valuation is key. I apologise if what follows gets a little technical.

When I wrote about valuation in my post on Wednesday I compared a suggested EV/EBITDA multiple for United of over 21x (on the basis of no debt repayment) to the 14.6x paid for Stan Kroenke for Arsenal. Whilst United may or may not deserve a premium valuation to Arsenal (and you have to ask which club has the most upside in improving its commercial operations in the future), it is worth noting the Kroenke was paying for control of AFC in a contested situation. In such circumstances one would expect to pay a premium price. The United IPO will be an offering of minority position, a very different situation.

I thought it might be useful to look at possible valuations in various scenarios. 

Using some IPO proceeds to repay at least some of the club's debt impacts on valuation itself when looking at measures using "enterprise value" (i.e. debt plus equity). What is in effect happening is that debt is being swapped for equity. The briefing to the press has suggested the Glazers are looking to raise £400-600m, a huge range. I have assumed 2010/11 EBITDA of £110m (we will know the exact figure in October). It is worth noting that 2010/11 was a very good year on the pitch and the media income earned from winning the league and reaching the Champions League final cannot be assumed to recur in the future!

The charts below show the EV/EBITDA valuation in two scenarios, a flotation of 1/3 of the club for £400m and for £600m and how various levels of debt repayment impact the valuation. I have deliberately kept the scales constant.

In Scenario A above, 1/3 of the club is sold for £400m, implying a market capitalisation of £1.2bn. If all the proceeds are used to repay the £400m of net debt, the club is debt free, has an enterprise value of £1.2bn or around 11x 2010/11 EBITDA. By contrast if only 25% (£100m) of the net debt is repaid, the enterprise value is £1.5bn or 13.6x EBITDA.

Scenario B above shows the same process but at a far higher IPO price with 1/3 of the club sold for £600m, giving a market capitalisation of £1.8bn. In this scenario, even if all the debt is redeemed, the EV/EBITDA multiple is still 16.4x and if only £100m is repaid, it's a very punchy 19.1x.

Discounted cash flow ("DCF") valuation
As I have said before, EBITDA is not a particularly good measure of a football club's profitability. Below EBITDA comes transfer spending which can be very significant. In 2010/11, net transfer spending equalled 30% of EBITDA. A more rigorous valuation method is to look at free cash-flow after transfers and capex. Assuming annual net spend on players and infrastructure of £35m, unlevered free cash-flow is around £65m (assuming only £3m of cash tax is paid, a low rate than cannot be relied on indefinitely). 

DCFs are notoriously bad predictors of value, but a simple two stage model growing free cash at 10% per annum to 2015, then 5% to 2021 with 3% perpetuity growth and a 9% discount rate gives an EV of £1.5bn (so a market cap around £1.2-1.3bn assuming some debt is left in place). If that sort of growth rate only justifies a valuation at the lower end of the range, the higher prices mooted rely on some very heroic assumptions.

There will no doubt be further twists and turns in this story in the weeks to come. I will endeavour to keep readers up to date.