Income up, costs down - Chelsea getting in shape for FFP

Chelsea have a rather irritating habit of issuing an anodyne press release trumpeting their financial results (this year on 31st January), several days before the real accounts become available at Companies House (today). Normally, the detailed figures hide a whole host of nasties not in the release. This year however, the accounts show real progress in the club's aim to meet UEFA's new Financial Fair Play rules.

Rising income and falling costs - the holy grail of football finance

Football clubs find it incredibly hard not to pass increases in revenue straight on to players, managers and agents in the form of higher staff costs. It is the achilles heal of the financial side of the sport. These results from Chelsea show revenue rising by 8% and pre-exceptional costs falling by 5%, including a 2.6% fall in wages. That is a remarkable achievement. To put it into context, in the last five years there has only been one other occasion when the wage bill at any of the old "big 4", City or Spurs has fallen year-on-year.

Readers who think "oh cutting the wage bill is easy, CFC let loads of old, expensive players go", should remember that United did the same last summer when VDS, Neville, O'Shea, Brown, Hargreaves and Scholes (temporarily) all left, yet we can see from MUFC's Q1 results that wage costs are still up on last year (by 12.2%). The trick is not just offloading players, it is preventing endemic wage inflation amongst the remaining squad, especially when TV money is increasing as it was in 2010/11.

The only cautionary point to make about Chelsea's wage control in these figures is that Fernando Torres and David Luiz will only be in these numbers for six months. On an annualised basis they would add c. £4m to these salary figures (although there have been offsetting cost reductions from the sales of Alex, Anelka etc).

Revenue

Chelsea's revenue (excluding the digital JV) rose £16.5m or 8% in 2010/11. Chelsea unhelpfully do not give the usual "matchday/media/commercial" split other clubs provide. We know from UEFA figures that CFC received £10.3m in CL TV income in 2010/11 vs. 2009/10. We also know from Premier League figures that CFC's receipts from the league rose £4.9m. 

Using these PL and UEFA figures, Deloitte's estimated segmental split for last season and adjusting for one fewer home game in 2010/11 vs. 2009/10 and we can get quite a good estimate for the club's segmental revenue performance for 2010/11:

The table above shows quite an encouraging growth in commercial income, especially in difficult economic conditions, although at c. £60m pa, CFC's commercial revenue is far behind that of MUFC (£103m) or Real Madrid (£127m).

Decent revenue growth and tight cost control meant that Chelsea made positive EBITDA (before profit on player sales and exceptionals) for only the second time since Abramovich bought the club (the other occasion was a £1m profit in 2007/08). The c. £4m EBITDA in 2010/11 is not huge (Arsenal made £47m from non-property activities) but being able to cover cash costs (pre-transfers) from earned income is a key first step in achieving financial sustainability, . The contrast with City's £71m EBITDA loss is stark.

Below EBITDA - messy

Unfortunately neither the profit and loss account nor UEFA's FFP "breakeven" calculation finishes at the EBITDA line.

On the plus side, Chelsea made a profit on player sales of £18.4m, boosting EBITDA to £22.4m. After that, things get worse quite fast.

Chelsea are still hampered by a very significant amortisation charge (the way transfers spending is recognised across the life of a player's contract). This charge has fallen in recent years, something that is key for meeting FFP, reflecting a reining back of the very aggressive transfer spending of the early Abramovich years. The charge rose in 2010/11 however, and this rise only includes six months of amortisation from the c. £75m spent on Torres and Luiz in the January 2011 transfer window (see chart below):

At around £40-45m, the amortisation charge nowhere close to being covered by EBITDA. Once depreciation is added too, the club made on operating (EBIT) loss of £26m (inc player sales), a loss but a great improvement on last year's £71m.

Exceptionals (again)

In the last four years, CFC have reported "exceptional" costs relating to firing their manager on no less than three occasions. Nothing very exceptional there.... In 2010/11 there were £41.9m of exceptional charges. These split as follows:

Termination of Ancellotti + back room staff contracts/compensation to Porto for AVB: £28m

Impairment of player registrations: £7.4m

Payments to HMRC for unpaid NI on "image rights": £6.4m

Now these costs are individually "one-off" in nature, but Chelsea's managerial merry go round has cost the club no less than £64m in compensation to various parties over the last four years. That is equivalent to 25% of the club's matchday revenue over that period, a staggering waste.

Adding the exceptional charge, a small interest bill and the share of profit from the media JV takes the £26m EBIT loss to a pre-tax loss of £67.4m. Ignore the exceptionals and the loss would be £25.6m. This compares to £70.4m in 2009/10. There is definite progress being made.

Cash flow and Roman's support

With £34.3m of the £41.9m of exceptional charges being real cash payments (the impairment is a non-cash charge), Chelsea's operating cash flow was weak in 2010/11, with an cash outflow before investment of £5.5m, but this is still an improvement on 2009/10, reflecting the far better underlying EBITDA performance and strong working capital inflows.

In 2009/10, Chelsea had negative net cash transfer spend. That all changed of course in January 2011 with the (panic?) purchases of Torres and Luiz. These accounts show £112m of "intangible asset" additions on the balance sheet and a  gross cash spend of £85m. As I have explained before on this blog, cash flows from transfers are very volatile but the pattern is clear. Chelsea are spending again (at least for now).

Even adding in £24m from player sales, the accounts show net cash spending on transfers of £60.6m. Add in capex and there is a £72m cash outflow before financing. This hole is filled as it is every year by loans from Abramovich's parent company Fordstam Limited. In the past, such loans are converted to equity after a while and no doubt the same will happen again.

Some FFP maths

So how close are Chelsea to meeting the FFP rules? On the assumption that UEFA ignores exceptional items (and I believe it is reasonable to make that assumption, especially in the early years of the new rules), the club has made good progress.

I have assumed that within Chelsea's cost base is c. £8m of spending on youth development and c. £1m of spending on community development. These items are effectively "deductible" under FFP. 

The table above shows that based on these assumptions about spending on youth and community activities, Chelsea have closed their "break-even" deficit quite substantially over the last three seasons. Revenue is up and costs are down. This calculation is before any player wages based on pre-June 2010 contracts are excluded under the Annex XI exemption, which will reduce the loss further.

Most big clubs should be able to generate profits on player sales (academy products have zero "book cost"). Assuming Chelsea can match the £18.4m profit achieved in 2010/11, the core deficit is only around £8m. That is well within the the €45m (c. £38m) allowable loss over the first two years of the new rules.

As discussed above, the main risk to this happy position is a big rise in the amortisation charge (i.e. a further splurge of transfer spending). Five years ago the amortisation charge was £70m. A return to that level would blow a big hole in the FFP calculation.

The other, ever present, risk if of course that the club will abandon it's cost control in an attempt to stay competitive on the pitch. I have written before how "six into four doesn't go" when it comes to Champions League places. Chelsea can only meet FFP with the sort of squad cost they have now by being in the Champions League. The stakes are high.

Concluding thoughts

Ignoring the exceptional charges (and Chelsea will pray UEFA do just that), these are impressive figures. To continue to meet FFP and to ween the club off Abramovich's cash, Chelsea will need to repeat the trick of holding down wages whilst achieving top four finishes. That is no easy task when every other club's wage bill is rising and when the squad needs a significant overhaul.

The other long-term option of course is boosting matchday income from the current c. £65m pa to an Emirates Stadium like £90-100m. Maybe Nine Elms/Olympia/Earls Court etc is the answer.

LUHG

Financial Fair Play - crunching the numbers

This is the first in a series of posts looking at the challenges faced by English clubs in complying with UEFA's Financial Fair Play ("FFP") rules. Next season (2011/12) is the first year when clubs' "break-even result" are calculated. The tables below shows what "break-even result" the seven English clubs that played in Europe this season would have achieved on last year's figures (Liverpool numbers are for 2008/09 as they have not yet published 2009/10 results).

Relevant income

The "relevant income" calculation is the simplest bit of the FFP rules. All football club revenue (which I have divided into the common matchday/media/commercial and retail split) is of course included. In addition, the profit from selling players is included too. Profit in this sense means the difference between a player's selling price and the book value of his registration on the club's balance sheet. Players that come through a club's youth system have a zero book value and thus any sale proceeds are 100% "profit" in the FFP calculations.

Income from non-football operations is excluded, except where they are based at or close to a club's ground (such as hotel or conference facilities). Chelsea's hotel would therefore be included in the income calculation, as would Manchester City's "Sportcity" redevelopment around Eastlands. Arsenal's property income from the re-development of Highbury would be excluded.

The other major exclusion, and one no doubt likely to cause controversy, is revenue received from "related parties" (effectively the owner or people/corporations connected to them) in transactions that are carried out "above fair value". This rule (described in Annex X B 1j) says that transactions with a related party must be compared to the "fair value" that would have been achieved if the transaction was done as a normal commercial deal. Any income above this "fair value" is disregarded when calculating a club's income. This rule is designed to prevent owners subsidising their club by, for example, paying £50m per year for a box that would normally cost £250,000.

Relevant expenses

The expenses element of the FFP is more complicated and less intuitive than the income side. Staff costs are included and are by far the largest element, indeed it can be argued that the whole aim of FFP is to bear down on staff costs across European football. Other cash operating expenses are included (the basic costs of running a football club), but depreciation of fixed assets is not included. This means that there is no account taken under the FFP calculation of any costs from investing in stadiums or training grounds. Owners can finance such capital expenditure without limit under FFP.

Finance costs such as interest payments are included, but not if they relate to borrowing taken on to construct "tangible fixed assets" such as stadia, training facilities etc. In the table above, I have deducted the c. £14.5m of Arsenal's £20.8m of interest costs that relate to the club's financing of the Emirates.

The interest figure for United excludes the significant one-off refinancing costs the club recognised in 2009/10. My understanding is that such costs would not be included under FFP. On an ongoing basis, United's bond interest will be around £44.5m per annum.

A vital element of the expenses calculation is the inclusion of the "amortisation of player contracts" charge, which is how the cost of transfers is accounted for.

The accounting treatment of transfer spending is one of the least intuitive elements of finance for most football supporters. In the UK, the treatment is covered by "Financial Reporting Standard 10: Goodwill and Intangible Assets". In a transfer, the asset that is being bought and sold is not of course the player himself but the player's registration. This "asset" has a finite length of course, being the length of the player's contract with the acquiring club and FRS 10 says that the cost of buying the registration must be "recognised" over that life.

So when a club "buys" a player on a five year deal for (say) £20m, the cost is recognised over the 5 years at £4m per year, this is the "amortisation charge" for that player that appears in the profit and loss account. The timing of cash payments is irrelevant. The money could be paid up front or in agreed stages but the "cost" is recognised evenly over the contract. If after (say) three years the player negotiates a new five year deal, the remaining value (£8m in this example) plus any costs of negotiating the new contract (hello Paul Stretford et al) are added together and then recognised over the life of the new contract.

By including the amortisation charge in the expenses calculation, FFP captures transfer spending over an extended period. Even if a club stops spending after a period of heavy investment, the amortisation charge will stay high for a prolonged period. The chart below shows my estimate of Manchester City's charge over the next five years assuming no further purchases or sales (other than those players currently out on loan).

Dividend payments are captured in the calculation (in order to ensure debt is not disguised as equity). If the Glazers exercise any of their dividend rights (currently around £95m), such payments would have to be included in the FFP calculation.

As with the income calculation, transactions with "related parties" not done at "fair value" are adjusted for in the relevant expenses calculation. This is to prevent owners subsidising their clubs through taking on club costs (such as directly paying players for example).

The final major adjustments in the expense calculation relate to spending on youth development and community activities. Both are excluded from the FFP numbers, meaning clubs can spend as much as they wish on these areas. I have estimated figures for all seven clubs as they are not separately disclosed in the accounts.

Income minus expenses = "break-even result"

Subtracting "relevant expenses" from "relevant income" gives us the all important "break-even result". This is the key figure under the new regulations. In the first two "monitoring periods", seasons 2011/12 and 2012/13, clubs are not permitted to make a loss greater than €45m (c. £39.5m) over these two years combined if they are to receive a licence to play in Europe in 2013/14.

As you can see from the table above, only three or the seven English clubs would have made a profit under the break-even calculation last year, and Spurs' profit was only due to profits on player sales. United would have shown a loss if the exceptional financing costs were included. The losses at both Chelsea and City stand out. The figures for Liverpool are misleading, because they include significant finance costs relating to the debt Hicks and Gillet loaded on the club which have now been cleared.

Enforcement and exemptions
Meeting the new rules is going to be hard for many clubs across Europe. A key question is the extent to which  UEFA actually enforce their new rules. The credibility of Michel Platini and UEFA as an organisation are clearly on the line, and I believe they will be enforced, although that may well mean banning a major club from European competition.

The rules do give one notable exemption to the calculations I have outlined for the first two seasons in which the rules apply (2013/14 and 2014/15), set out in Annex XI 2, the final page of the regulations. If a club breaches the "break-even" target in the "monitoring periods" for either of these seasons because of a loss in the 2011/12 season caused by wages paid to players under contracts signed before 1st June 2010 (when the FFP rules were published) the club will be let off (as long as losses are reducing over time). That is quite a big get out, and may well mean that City and Chelsea do not face the imminent prospect of a European ban. The exemption is only temporary however and the principle remains the same, if UEFA enforce FFP, many clubs are going to have to cut their wage bills and/or radically boost their revenues in the next few years.

LUHG

Chelsea 2009/10 results: spin and red ink

Chelsea FC do not want the public to know much about their finances. On 31^st January they put out a 326 word press release entitled "Chelsea Becomes Cash Positive" which went on to laud the club's financial achievements in the last financial year. Including the statement:

"Operating Loss for the financial year reduced from £72.3m to £68.6m"

Today (at the same time Torres was doing his first press conference at the club) Chelsea FC plc's accounts became available at Companies House. They paint a very different picture from that set out in the press release.

Revenue

Chelsea do not give a proper income split in their accounts (unlike United, Arsenal, Spurs, City, Liverpool, Villa, Bolton etc, etc). Instead they divide revenue between "Football activities" and four other tiny categories including Car parking and Hotel/Catering. Overall, turnover from "Football activities" (90% of turnover) only rose 0.1% despite the far better Champions League TV deal that came in last season. This was also the season that Chelsea won the domestic double. Total turnover rose 1.2%, roughly in-line with Arsenal (-1% ex-property) but behind United (+3%) and Spurs (+6%). All major English clubs are struggling to grow the top-line.

The JV with Sky (Chelsea Digital Media) saw decent turnover growth of 19%.

Costs

Football has a problem with cost inflation, especially wages, and Chelsea is no different. In 2008/09 Chelsea paid £12.6m in termination payments to Felipe Scolari and his backroom team. Stripping out this exceptional item, Chelsea's total staff costs rose an eye watering 12.8% in 2009/10 (see table).

No doubt there were bonuses payable following the league and FA Cup wins, but it is an unpleasant upward spike given that staff costs had fallen the previous year. Staff costs are 84% of revenue vs. 46% at United and 47% at Arsenal (and a bonkers 107% at City). Other costs (excluding depreciation and player contract amortisation) rose 8.0%.

EBITDA

With (pre-exceptional) costs up 11.5% and revenue up only 1.2%, EBITDA losses rose sharply to £23.8m from £2.5m. EBITDA (earnings before interest, tax, depreciation and amortisation) is effectively cash profit before transfers and interest. This number shows CFC running a long way behind break-even even before considering transfer spend and in a pretty good season.

Player sales and amortisation

Most large clubs make a book profit on selling players (because their value is written down over their contracts). In 2008/09, Chelsea made £28.6m from selling Bridge, Ben Haim and Sidwell. In 2009/10 by contrast, the sales of Pizzaro and Shevchenko netted a loss of £1m.

Shifting players off the books and little transfer spending caused a big fall in the amortisation charge for player contracts. This is an important number as UEFA will include it in "costs" when assessing clubs for Financial Fair Play. Amortisation was over £57m in 2007/8, fell to £49.0m in 2008/9 and only £37.6m last year. By contrast City's amortisation last year was £71m.

Operating profits

Adding amortisation and depreciation and the £1.5m profit from the TV joint-venture gives an operating loss of £68.6m. This is the number Chelsea were so keen to quote in their press release. They compared it to the £72.3m loss the previous year, but this number includes the £12.6m paid to Scolari and his boys. Excluding that exceptional, the loss actually increased by £9m. Nice spin.

Cash flow

The other area the press release was keen to focus on was cash flow. The club was cash positive in the year (by £3.8m before financing), but only because net cash transfer spending was an in-flow of £18.2m. Before transfers, there was a cash outflow of £14.4m. Obviously this year, Chelsea have gone on an enormous spending spree, incurring c. £87m of net transfer spending.

Financial Fair Play

There is a lot more to be written about Chelsea and FFP, but for the moment, this is my estimate of the "break-even result" for Chelsea for 2009/10. I have excluded the one-off exemption for player contracts signed before June 2010 in the first monitoring period. This will help the club materially but only in looking at the 2011/12 year.

On these estimates, Chelsea have a £50m+ deficit on the UEFA calculation and that is before Torres, Luiz etc (offset by losing Ballack, Cole, Deco etc). "Challenging" would be the word that comes to mind when wondering whether Chelsea can comply with FFP.

Thoughts

Chelsea have a major structural problem, they have the highest wage bill in English football (see chart) but a small ground and already very high ticket prices.

On Deloitte's estimates (Chelsea don't give "matchday" revenue numbers) CFC earn around £74.5m from Stanford Bridge or £2.7m per game. Arsenal and United earn around £1m more per match than that due to their far bigger grounds. Add in Chelsea's failure to grow commercial income (around the same as City's unbelievably and half Barcelona's) and this wage bill cannot be sustained without Abramovich's money. To hit FFP rules in the medium term, something has to give.....

LUHG