Manchester United – the potential financial cost of failure

It’s crystal clear that a Champions League place, that sad modern non-trophy victory we’ve watched Arsenal "win" in recent years, is the most Manchester United will achieve in the league this season.

But what if even a top four finish or, whisper it, the Europa League, prove out of reach? How much would United’s profitability be harmed?

This post looks at how much the club earned last year from the Champions League, how much a Europa League spot would provide instead and the implications of no European football at Old Trafford for the first time since the Berlin Wall came down.

The lessons from LFC

In the long-term, repeated failure to qualify for the Champions League would damage the club’s ability to negotiate the sort of commercial contracts that have been so important to United’s finances in recent years. In the short-term I do not see significant risk to commercial revenue from one (or even two) seasons on the sidelines. If this seems blasé, the evidence from Liverpool is that such damage takes a very, very long time to have an impact.

In 2011/12, the last season for which we have figures, Liverpool FC had the 6^th highest commercial revenue in European club football (of course City, with the fifth highest, have the benefit of a suspicious number of Abu Dhabi companies queuing to give them money). Liverpool, who haven’t played in the Champions League since 2009/10, had higher commercial income than Arsenal that season. Furthermore the club’s decline hasn’t prevented more deals being signed since 2012, with companies like Chevrolet and Garuda.

Where United may be vulnerable if the current slump persists, is the very fact that the club has pushed the boundaries when it comes to sponsorship. Manchester United have identified numerous industry “verticals” where football clubs have never attempted to find commercial sponsors, hence the official “office equipment supplier”, “medical systems partner”, “savoury snack partner”, “motorcycle partner in Thailand”. These deals are unproven for the “partners” and may be more vulnerable if the football club isn’t on the top stage for several seasons.

TV cash

The most obvious impact of not finishing in the top 4 (or implausibly winning the Champions League to ensure qualification, hello Chelsea), is the loss of TV income.

In 2012/13, United earned £31.3m in CL broadcasting revenue, which accounted for 8.6% of the club’s income (the third most important source after PL TV money and the Nike contract).

The bloated Europa League is the financial poor relation of the Champions League. A club getting from the group stage all the way to the semi-finals in 2012/13 would have earned €4.7m (around £3.8m) before payments from the competition's market pool. For a club from a large nation like Italy, Germany or England, the market pool payment could add €3-4m more. The most United could earn from actually winning the Europa League (hardly a certainty obviously) would be around €14m (about £11m), a loss of £20m compared to 2012/13. A more plausible run to the quarter finals would bring in around £7m, a loss of £24m.

Europa League (to the quarter-finals): £24m lost income

No European football: £31m lost income

Matchday

At United, Champions League matches command premium prices for season ticket holders and members. Cup games, including European matches are however included in seasonal hospitality packages. What would happen to hospitality prices if there was no European football for a season is one of the great uncertainties in analysing the financial impact on United. I find it hard to believe the club could hold the prices of executive seats and boxes whilst the number of home games falls from a “normal” 29-30 per season to as potentially few as 19 or 20 (the exact number in a season with no European football obviously depends on the draws for the domestic cups).

The Europa League clearly lacks the appeal of the Champions League, and another factor to consider in the event that United ended up in the second tier competition, would be whether the EL would be included in the daft “Automatic Cup Scheme” that compels season ticket holders to buy their ticket for cup games even if they don’t want to/can’t attend. When the club ended up playing in the competition in 2011/12, the games were excluded from the ACS, to much relief from many fans. Would the management be so generous if the Europa League was the only European football on offer?

There is also a possible impact on summer tour revenue if United had to play in July Europa League qualifiers (although there would be home gate receipts to compensate). All these uncertainties make it very hard to predict accurately the impact on Matchday revenue of either time in the Europa League or no European football at all.

One useful way to consider the sums involved is to look at how Matchday revenue has changed in recent years in response to the changes in the number of home games. A home game generates around £3.8-3.9m of revenue.

Assuming a season with no European football at all and two home cup games, to make a total of 21 home games, the impact would be around £20-25m of lost income. In my view a season in the Europa League might be expected to cost around half that figure from lower attendances.

Europa League (to the quarter-finals): c. £10m lost income

No European football: c. £20-25m lost income

Cost savings

The current terrible season means of course no substantial bonuses for the playing squad, which could save the club around £7m compared to the title winning year of 2012/13.

Fewer cup games saves the club money on match day staff, policing and other related costs. In total, a season with no European football could see cost savings of £2-3m from a locked up Old Trafford.

No European football: c. £2-3m cost savings

The Glazers, the share price and investment

Manchester United’s owners and the club’s board are not stupid and the possibility of one or more years out of the Champions League has no doubt crossed their minds.

The SEC filings the club has had to publish since the IPO show that the scenario is part of the club’s planning. The club can actually be released, twice (in non-consecutive years), from the covenants built into its “Revolving Credit Facility” (think of these as the financial rules governing United's emergency overdraft) if it fails to qualify for the Champions League.

One season, or even two, of failure to qualify for the Champions League doesn’t destroy the Glazers’ business model which envisages ever more commercial relationships and ever greater TV deals. What it definitely does do is make the already expensive shares look very expensive.

A fifth place league finish this season means the club will make EBITDA (cash profits) of around £120m (depending on what happens in the Champions League knock-out stages). At the current share price that values the club at 15x EV/EBITDA ("EV" is "enterprise value" which is market capitalisation plus net debt). No Champions League football, even allowing for more commercial growth (such as the Chevrolet contract and a new kit deal) pushes that multiple up to around 19x. For a company where profitability is failing and which needs to invest more cash to remain competitive that is very expensive.

Europa League (to the quarter-finals): EBITDA down c. £30m in 2014/15

No European football: EBITDA down c. £45m in 2014/15

The big question the owners and Ed Woodward face if things continue poorly on the pitch, is whether they will properly back David Moyes and invest in the squad. The club proudly stated in the IPO prospectus that average annual net transfer spend over the last 15 years (from 1997/98) had been £14.3m (or £20.1m excluding Ronaldo, which one shouldn’t). That level of spending is far too low for any major club, let alone one that has let its engine room decline over years, a decline masked by the genius of the manager.

There is no shortage of cash to strengthen the playing side. At 30th September the club had over £80m in the bank. This season the club will generate at least the same amount again. Debt is down to a manageable level. There really are no excuses.

LUHG

Manchester United's shares in issue: a quick guide

The news that George and Robert Soros own 3,114,588 shares in Manchester United has led to some confusion about the number of shares the club has and hence the relative size of this stake. This is a quick guide.

Pre-IPO

Before the IPO on 9th August, the club's share structure was reorganised to create two classes of shares, "A" Shares and "B" Shares. 

Red Football LLC, the Glazers' Delaware company owned 100% of each class of share.

The IPO - two elements

The IPO was an offer of a total of 16,666,667 "A" Shares at $14 per share. No "B" Shares were offered. 

This total offer had two separate elements, the issue of 8,333,334 new "A" Shares by the company and the sale of 8,333,333 existing "A" Shares by the Glazers. The first element had the effect of increasing the total number of "A" Shares from the 31,352,366 before the offer to 39,685,700 afterwards. The number of "B" Shares remained unchanged.

The Glazers therefore ended up owning 58% of the "A" Shares and 100% of the "B" Shares, so 90% of all the shares in issue. Third party investors own 42% of the "A" Shares and none of the "B" Shares, so 10% of all the shares in issue.

Votes or lack of them

Each "B" Share has 10 votes, and each "A" Share has 1 vote. Because of this structure the 10% of total shares owned by third parties only command 1.3% of the company's votes. In aggregate all the "A" Shares representing 24% of the company, only command 3.1% of the votes.

The Soros position

The Soros family bought 3,114,588 "A" Shares in the IPO. That is a pretty significant 18.7% of the shares sold in the IPO, but only 7.85% of the total number of "A" Shares and 1.9% of the whole company. Being "A" Shares this stake only has 0.24% of the votes.

At a price of $14 per share, the Soros family paid $43.6m for this stake. At yesterday's closing price of $13.06, the stake is now worth c. $40.7m.

LUHG

The MUFC IPO - why the club won't benefit for over two years...

So the Manchester United IPO has finally happened. Having failed in Hong Kong and Singapore, the Glazers and their increasingly desperate bankers ditched their own ludicrous $16-20 per share price range and the shares have limped on to the NYSE at a still very, very aggressive price of $14 per share.

The whole saga has been a grubby and unedifying spectacle in our club's history that does very, very little indeed to improve the club's finances. The whole exercise has only been undertaken to help the Glazer family with their cash flow problems.

From the latest SEC filing we have confirmation that at the lower issue price, the club will receive net proceeds (after underwriters' discounts and commissions) of c. $110.3m (around £70.7m).

The club will use all this $110.3m to repay $101.7m face value (£63.6m) of the 2017 US$ notes at a price of 108.375% of nominal value.

These US$ notes pay 8.375% interest so the annual saving before tax will be:

£63.6m x 8.375% = £5.3m per year

Because interest is tax deductible, this reduction in interest paid will increase taxable profits. As a consequence of the IPO, United will pay US Federal Income Taxes at a rate of 35%. The net interest saving  after tax will therefore be:

£5.3m x (1 - 0.35) = £3.46m per year

This net saving is the equivalent of the matchday income from one game at Old Trafford. It is just over 1% of the club's annual revenue and around 3-4% of EBITDA.

Before any United fans begin celebrating this tiny saving, there is a further sting in the tail.

The prospectus informs us that the club, and not the family, will bear the expenses of the IPO. From page 151 we can see that these expenses total $12.3m (c. £7.9m).

With so little debt repaid and United bearing the £7.9m of expenses, it will take until the end of 2014 for the club to even break-even from the IPO, let alone benefit financially.

And the Glazer family? They receive their $110m straight away.

That's "Glazernomics" folks.....!

LUHG

An apology to Sir Alex and a restatement of the fundamental issues

Sir Alex Ferguson

Readers will no doubt have seen Sir Alex Ferguson's statement that he will not benefit financially from the IPO. As one of the people suggesting he was likely to participate in the $288m "2012 Equity Incentive Reward Plan" the club are putting in place, I'd like to apologise to Sir Alex for the suggestion that personal gain was a motivation in his support for the owners. I think it was a valid question to ask in the light of his comments about "real fans" last week, but I was wrong about my assertions. I have frequently stressed on this blog the miracles Sir Alex has achieved at United and was proud to promote the SAF25 fans' book last year. I'm extremely glad he is not caught up in the murky finances of our club.

The real issue

The key issue with the IPO is not however the share options that will be granted, but the continuing financial costs to the club of the Glazers' ownership. I thought it might be helpful to set out the costs and savings that stem from the financial structure that has been in place since 2005. There have been a few comments on this blog questioning the financial costs of ownership so I wanted to set them out again in full with full sources.

The costs divide into several categories. Firstly "cash costs" of £402m, money paid out of the club's coffers. The most important element of this is interest (£295m). Second are the limited repayments of debt since 2005, these comprise £37m of the original bank debt and £93m of repurchased bonds. Please note I have not included the repayment of the PIKs as the club did not pay for this. Adding these together we get costs of £531m, around two thirds of United's total wage bill over the last seven years to put the figure in context.

For information I have also set out various costs paid by the taking on of additional debt rather than paid out of cash flow. I have not added this £79m to the £531m as there would be an element of double counting (I include repayments in the cash costs so can't include debt additions too).

There are two key savings from the financial structure totalling £180m, firstly the dividends which the plc used to pay and secondly corporation tax saved because interest payments are tax deductible.

I have assumed dividends would have increased 8% per year from 2006-2012. This compares to 7.6% per year growth in the seven years up to the takeover and is faster than the 7% growth in EBITDA seen since the last full year of the plc (2003/4).

Corporation tax is as set out in the Manchester United Limited accounts (but not paid because of deductible interest higher up the corporate structure).

The net cost: £531m - £180m = £351m is a vast number. It is the gross transfer spend of the club in the ten years from 2001/2 to 2010/11. It could alternatively have funded a 60% ticket price cut in every year since the takeover. It could have been used to build out Old Trafford to be a 100,000 seat stadium. It was used for none of these things. It is the cost in cold hard cash of the Glazers' ownership.

Crucially, this figure ignores the fact that even after all this waste of money, the club still has £437m of debt on the balance sheet and that this will still be around £360m after the IPO.

The IPO

The IPO is a huge wasted opportunity to stop this enormous outflow of money from Manchester United. The SEC F-1 prospectus confirms that the IPO will only reduce the club's debt by around £78m, saving (after tax) only around £5m per year. Longer term, the IPO will cost the club more each year in higher US taxes (the corporate tax rate is 35% vs. 24% in the UK).

The real beneficiaries of the IPO will be the Glazer family who will receive around $150m from their sale of 8,333,333 shares and the unnamed senior executives (but not Sir Alex) who will be entitled to 16,000,000 shares under the "2012 Equity Incentive Reward Plan". All these people will make money and the club will be left with the vast bulk of its debts.

The IPO gives no opportunity for supporters to take a meaningful stake in their club. The shares on offer represent 10% of the club but with under 2% of the votes.

It has been mentioned by some people that the club is constrained by the bond terms as to the amount of debt it can repay. It is true that until 2013, the club can only repay 35% of the bonds. That figure is £182m compared to the £78m the IPO will repay. It is in any event only five months until this restriction falls away. If this IPO was about paying down debt, the vast majority of the $300m (£193m) proceeds could be applied to debt repayment today, with the balance being applied in January.

Agendas

People have queried my "agenda". My agenda remains the same. I want Manchester United run for the glory of Manchester United, not to make money for owners who do not care about it. I want the money United makes to be ploughed back into the club, invested in players, stadium and cheaper tickets, not wasted on financing costs. I want debts taken on only to expand the facilities of the club. This is not a pipe dream. It is how almost every European football club is managed, for the glory of the club. It is how the other financial titans; Barca, Real and Bayern are run.

As part of the IPO roadshow, the senior management team at United (Woodward, Arnold and Bolingbroke)  have done a video presentation. For the next few days you can view it here: 

http://www.retailroadshow.com/custom/mu/muroadshow.asp

In the video presentation they confirm that the club's transfer budget in the future will usually be a net £20-25m, the average spend over the last fifteen years. That is a choice being made by the Glazers, more concerned with maximising profits. A debt free United run like a normal football club could afford to compete with biggest clubs in Europe, we aren't even trying.

LUHG

Why have the Glazers changed their strategy on the debt? A theory....

The big news in United's "preliminary prospectus" (the Form F-1 SEC filing) was 1) that the proceeds from the IPO will be used to repay some of the club's enormous debt and 2) that no dividends will be paid "in the foreseeable future".

The big question that stems from this, is "why?". Why after seven years of running a highly leveraged balance sheet and only two and a half years after the bond issue have the Glazers executed a huge u-turn? Why suddenly decide to reduce the club's debt?

I believe it is highly unlikely that the change is due to a sudden realisation that cash wasted on interest should be available for investment, although that may be a positive knock-on effect, but because of the financial pressures the family is under.

What follows is only my theory (and apologies if you don't like speculative articles like this), but one that I think is near the truth....

The amazing disappearing PIKs

Followers of the United financial story will know that out of the blue in November 2010, the Glazer family found £249.1m (around $400m) which they injected into the club as equity and used to repay the infamous "payment in kind securities" (PIKs). These short-term debt instruments had festered on the balance sheet of Red Football Joint Venture Limited for more than four years and had accrued £111m of rolled up interest on top of the original £138m loan.

In August 2010, the PIKs had become even more expensive as the Red Football companies breached a key debt covenant (section 8.2 of this document). The covenant stipulated that total debt in the group (from Red Football Shareholder Limited downwards) should not be more than 5x EBITDA (essentially cash profits before transfers). If debt exceeded this limit (set when the PIKs were issued in 2006), the PIK interest rate would rise from 14.25% pa to 16.25% pa. With debts in August 2010 totalling £773m and EBITDA of £102m the rate duely rose, making the PIKs even more toxic and in need of repayment.

The bond issue of February 2010 had created a "carve out" which allowed the Glazers to take £95m of the club's cash out and it was widely assumed (and mentioned in the bond prospectus as a possibility) that this money would be used to pay off a chunk of the PIKs. But the Glazers didn't use the carve out to repay them in November 2010. The exact source of funds is unknown.

What I do know, from impeccable sources, is that the money was borrowed by the Glazer family. They didn't have £249m in cash, few people do (and the other bits of the family empire are leveraged up already). The money was borrowed by one of their US companies from a single US financial firm.

Throughout the summer of 2010, the family and their advisers were hawking the deal around the market. Amusingly an old college friend working for a private "intelligence company" was retained by an American debt investor (I won't embarrass him by naming the investor) to look at the deal and initially asked me for help. The invitation to meet the potential investor was quickly dropped after they did some due diligence on who I was.

So that's what we know. Since November 2010, the club has been carrying the bond debt, and the Glazers have been stuck with what you might call "PIK2", expensive personal debt secured on their equity in United, presumably costing less than the eye watering 16.25% of the PIKs, but more than the senior bond debt's c. 8.7%.

Could there be another total debt covenant attached to "PIK2"?

Stories about a potential IPO (in Asia) first started to circulate in mid 2011 as the first anniversary of the PIK repayment approached. As we now know, nothing came of the attempts to list in either Hong Kong or Singapore, but the Glazers kept going. Despite terrible market conditions, a moribund IPO market, weak results due to the Champions League etc, they have persisted.

The explanation for this burning desire to IPO the club must be to do with their personal circumstaces, and yet they are not seeking to cash out but to repay debt. I believe that it is highly likely that the PIK2 debt has "total debt to EBITDA" covenants attached to it of a similar sort to those in the original PIKs. Such covenants would be very common for quasi-equity financing of this sort. Breaching these covenants could be very costly for the Glazer family and the existence of such would go a long way in explaining their apparent change of heart on the debt. Under such a scenario there would be a very strong incentive to try to reduce the debt across the Red Football group of companies, and the easiest method is an IPO.

The change of strategy actually dates back to Q4 2010 and PIK repayment

It is worth noting that although the prospectus sets the new strategy down in black and white for the first time, the Glazers have been pursuing deleveraging for a while, using bond buy backs, and that this new approach began as soon as the PIKs were repaid.

The club first bought back bonds in the final quarter of 2010 (when £24m were repurchased) and has now spent a total of £92.3m. No less than two-thirds of the cash the club had at the time of the bond issue (all that Ronaldo and Aon windfall) has been used on bond buy backs. The peculiarity of holding almost £150m of cash when issuing £520m of bonds and then, just a few months later, using that cash to buy back those bonds is striking.

Something has definitely changed...

So since the repayment of the PIKs and their replacement with "PIK2" we have seen a completely new financial strategy. The best part of £100m has been whipped to buy bonds and now we have an IPO being launched into terrible markets to reduce the debt further. None of this proves they are under pressure from debt covenants in PIK2, but it all fits with the theory.

Even fellow "lineal descendants" can fall out

The other chat coming out of the US about the Glazers is that Darcie, Edward and Kevin don't like having wealth tied up in this pesky soccer club that Joel, Avram and Bryan are so fixated with. If the six of them are personally on the hook for $400m of "PIK2" and covenants are in danger of being breached, you can sort of see their point.

Theories and facts

Apologies again for such a speculative post. My theory may ring true to you or may sound like laughable rubbish. It would be lovely to think the Glazers have had a damascene conversion to prudent financial management and eschewed the crippling debts of the last seven years, but you'll forgive me for seeking a baser motive.

Perhaps there are multiple reasons for the change in tack, including fears that becoming uncompetitive on the pitch will hurt the club's value, as well as the sort of direct pressure on the family I have described above, and perhaps the reasons are less important than the fact the burden on the club is being reduced. That won't stop this blog trying to identify the "whys" not just the "whats" of the whole sorry saga.

LUHG

The Manchester United IPO some initial observations

There’s been a lot written about Manchester United’s proposed listing on the New York Stock Exchange (“NYSE”) since it was announced on Tuesday night by the filing of an SEC Form F-1 (the document is available here), this post is designed as a brief summary of my thoughts on the subject.

This is a massive change in strategy by the Glazers and a positive one financially

Since the takeover, the club have insisted that the debt loaded onto United is not in any way a problem. As recently as last March, David Gill was reiterating this to the House of Commons Culture Media and Sport Select Committee.

Suddenly, the attitude to debt has changed. The SEC filing clearly states:

“We intend to use all of our net proceeds from this offering to reduce our indebtedness”

The Glazers do not need to take this approach, they could float United and retain the proceeds themselves. The fact they have chosen not to do so is very telling and has the potential to transform the financial position of the club. As I have mentioned again and again on this blog, over £500m has been spent on interest, debt repayments, fees and derivative costs since 2005. In the first nine months of the 2011/12 financial year alone the club spent £71m on interest and bond buybacks. The elimination or significant reduction of these costs is huge news.


The other key aspect of this debt reduction is that the prospectus makes it clear that there is no intention to pay dividends in the forseeable future. Interest payments will not simply be replaced with dividend payments.

The 2010 bond issue was supposed to lock in long-term (seven year) funding, and yet only two years later, that entire costly structure is being ripped up.  A major change of heart has taken place.

The family can still cash in some shares under the "over allotment" mechanism

Although the prospectus says all the net proceeds will be used to reduce debt, the family can still sell some of their shares (as opposed to the new shares in the main offer) under the "over allotment" option. This is a feature of many IPOs, whereby the owners make additional shares available for sale if demand is higher than expected. Over allotment is not normally for more than 10-15% of the shares being offered.

At this early stage we are missing some very key details

The SEC filing is a “preliminary prospectus”. It contains no details on the number of shares being issued or the price of these shares. It is subject to revision.

The success or failure of the offer will have a lot to do with the valuation the offer puts on United. In the past, the Glazers have appeared to have placed a higher value on the club than most analysts or potential buyers. The FT recently reported that Morgan Stanley had left the IPO syndicate (of underwriters) because of disagreement over the valuation.

It is not too late for this offer to collapse spectacularly if the Glazers attempt to sell shares on too high a valuation or if financial markets weaken further. This is not a “done deal”.

The share offer will be significantly greater than $100m

The much quoted “$100m” issue is a red herring. There is a requirement in a preliminary prospectus to estimate the cost of registration fees and as these are dependent on the size of the share offer, a “placeholding” assumption has to be made. That is where the $100m figure comes from. It is not a guide to the size of the eventual offer. There is little or no point raising $100m (£64m). The exact amount raised will depend on the valuation placed on the company and the state of the markets in the next few weeks but I would expect at least $300m.

This is not a change of ownership

Sadly for those of us who want supporters to have a meaningful stake in Manchester United, this IPO is of virtually no use at all. The “A shares” on offer will only have very limited voting rights. Even if the Glazers sold 90% of the club in the IPO (which they won’t), the “B shares” the family will hold would still have a majority of the votes as each B share has 10x the votes of an A share.

Non-Glazer shareholders will therefore have virtually no influence over the club.

This remains a very short-sighted and depressing approach to governance. The experience from Spain and Germany shows that supporter participation in ownership is a huge plus for football clubs. United’s unwillingness to engage with supporters as anything other than potential customers remains an enormous problem that can probably only be solved by intervention by government.

They’ve chosen New York rather than London because they want to maintain control

The principal advantage to the Glazers from listing in New York rather than London is that the A/B dual share structure is acceptable in the US and not in the UK. Well known companies such as Google, Ford, Facebook and (infamously) News Corporation all have dual voting structures. It would be very hard to float a company with such diminished voting rights for outside shareholders in London.

The downside of US listing is the higher tax that the club will have to pay. United has been UK tax registered for all of its existence but will now be subject to US Federal Income tax on profits at the high rate of 35% (the UK rate is 28%). The fact that the Glazers are happy for the club to pay a higher tax rate tells us a lot about the importance of the A/B share structure to them.

Is this all about a post Fergie world?

Why is this all happening now? We can only speculate, but it seems to me that the Glazers are preparing for a Manchester United without Sir Alex Ferguson. As we know, the club has achieved great success on the pitch on a pretty low transfer spending since 2005. Would another “big name” manager come on board with this limited budget, especially as City, Chelsea, Real Madrid and Barcelona continue to flex their financial muscles?

What happens next?

The underwriting banks and the company will now undertake a road show for potential investors. United have ninety days from the date of the preliminary prospectus to file their “final prospectus”, which includes the price and number of shares being offered. The IPO can still be cancelled at any time prior to this….

Watch this space.

LUHG