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

No David Gill, the bond issue is NOT "like remortgaging your house"

As David Gill hasn’t made many public statements about the club’s financial position since the bond issue, I always look out for his comments with interest.  On Sunday the News of the World and various other media outlets reported David’s comments in the latest edition of the Manchester United Disabled Supporters Association magazine “Rollin’ Reds”.  This is what he was quoted as saying about the debt:

"In essence, it changed third-party bank debt with various maturities into new debt, so it was like remortgaging your house with what we feel is a better instrument.

"There are no covenants if you meet interest payments every quarter - you are very much left to your own devices.

"So while debt is obviously on the minds of the supporters the simple answer is while we didn't reduce overall debt we now have more flexibility with what we believe is a better instrument and the bond issue attracted roughly double the target, so in that sense it was a success."

Doesn’t that sound reassuring?  It’s just like switching your mortgage to get a better deal....  Well here’s a question, how many people move their mortgage to a lender who charges them more interest than they were paying before?  Because that’s what Red Football has done by switching the bank debt for the bonds.

Let me explain....

The cheap bank debt

This is how the old bank loans were described in note 17 of Red Footballs accounts for the year to June 2009:

£501,707,000 of senior facilities drawn down by Red Football Limited, by way of four term loans that attract interest based on LlBOR plus a margin which ranges between 2.125% and 5.00%.

The senior facilities have terms between 7 and 10 years from the 16 August 2006, and the term loans have an average life of 5.6 years at the balance sheet date. Term loan A accrues interest at LIBOR + 2.125% and amortises over its term with a final re-payment in June 2013. Term loan B accrues interest at LIBOR + 2.5% and is repayable in two equal instalments in February 2014 and August 2014. Term loan C accrues interest at LIBOR + 2.75% and is repayable in two equal instalments in February 2015 and August 2015. Term loan D accrues interest at LIBOR + 5.0% and is repayable in one instalment in August 2016. The above loans are redeemable at par.

  

What’s missing from that description is how much each term loan was.  This document (the “term sheet” for the loans from 2006) tells us how much they each were in 2006, since when Term Loan A has been gradually paid down to bring the total to £501m:

Term loan	Amount	“Margin” over LIBOR
A	£75.0m	2.125%
B	£150.0m	2.625%
C	£150.0m	3.000%
D	£150.0m	5.500%
Total	£525.0m	3.482%

The “margin”, is the extra interest charged above “LIBOR” which is the “London Interbank Offered Rate”, a benchmark wholesale interest rate.  Because LIBOR goes up and down with market interest rates, the actual rates charged on these loans will fluctuate over time.  LIBOR today (6 month LIBOR) is 0.94%.  So the interest rate on these facilities if they were in place today would be 3.482% + 0.94% = 4.422%.  On £501.7m of debt, that would cost £22m a year in interest.

The expensive swap

At this point, regular followers of United’s financial affairs are probably thinking something like: “What the hell are you talking about Anders?  The interest charge shown in last year’s accounts was over £40m....” and they’d be right too.  The interest payable on bank loans and overdrafts in the Red Football accounts was £42.1m.  So what’s going on?  The answer is “the swap”.  An interest rate swap is a derivative contract that “swaps” one rate for another.  In the case of Red Football, the company entered into a contract to swap the variable LIBOR element of the bank interest rate for a fixed rate of 5.0775% on £450m of the bank loans.  So instead of paying 3.992% on this £450m, Red Football was paying 3.4282% + 5.0775% = 8.56%.  On the rest of the loans, Red Football paid the lower floating rate.  So half of the interest paid by the club last year was because of the losses on the swap contract.

With the bond in place, Red Football has ditched the swap at a very significant cost.  The swap ran until the end of 2013, and to close it and get rid of it now (as it is losing money) is going to cost £38.6m.  The cost represents the difference between current swap rates (around 2.2%) and the old swap rate of 5.0775% multiplied by the £450m value for three years.  The club is paying £11m of this up front and then around £5m each year for five years.

If the bank debt was still in place, Red Football could still close off the swap at the same cost, and could even lock in the 2.2% available now.  This would fix the annual interest cost at £28.5m per annum.

  

The very expensive bonds

Unlike the bank debt, the bonds pay a fixed interest rate (or “coupon”).  The coupon on the 425m US$ bonds is 8.375% and the coupon on the 250m £ bonds is 8.5%.  At the current exchange rate, the interest cost of the bonds is £44.8m.  That’s more than twice the interest cost of the bank debt at today’s interest rates.

  

The real reason for the bond issue

So what on earth is David Gill talking about when he says the bond is “a better instrument” than the bank debt?  United could have exited from the swap (at the same cost), entered into a new swap to lock in current low interest rates, and only have to pay £28.5m in interest a  year vs. £45m on the bonds. The club would also have saved the £15m cost of the bond issue and would only have £500m of bank loans outstanding rather than £534m of bonds outstanding.

So why could the Glazers possibly want to swap cheaper bank debt for more expensive bond debt?  David Gill gives us clues when he says “There are no covenants if you meet interest payments every quarter - you are very much left to your own devices........while we didn't reduce overall debt we now have more flexibility”.

Under the bank debt covenants, 40% of any cash over £1m had to be used to pay down debt and there were strict targets to meet to reduce the ratio of debt to profits each year.  It was very hard for the Glazers to pay themselves dividends under the bank covenants.  You can see all the details in the term sheet.

The bond sweeps away all these restrictions, and brings in all the rights to dividends that I have described elsewhere.  The bond unlocks the Ronaldo money and the early Aon payments.  This cash can now be paid to the Glazers.

So no David, the bond issue isn’t “like remortgaging your house”.  Unless when David Gill remortgages his house he signs up for a higher mortgage rate than he’s already paying and agrees to let a gang of burglars in to steal his silver......

LUHG

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 2^nd 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.

LUHG

One for the lawyers

Quizz time.

Question 1:       Which of the following events is MOST LIKELY to happen?

Question 2:       Which of the following events was NOT identified as a “Risk Factor” in MU Finance plc’s bond prospectus?

a)                  United being relegated from the Premier League in the next seven years

b)                  A terrorist attack on Old Trafford

c)                   A substantial organised boycott of season tickets and executive tickets by thousands of United fans this summer

I think the answer to both is c).  If a US court is asked the same questions and agrees with me, then things could potentially get very expensive for the Glazer family.

There are no less than fifteen pages of “Risk Factors” in the MU Finance bond prospectus.  Such is the norm with modern debt and equity issues in our (and particularly America’s) litigious culture.  The Risk Factors cover a huge range of potential pitfalls from player injuries, through the nature of English insolvency law to the terrorist attacks I mentioned above.

The purpose of the Risk Factor segment is both to alert potential bond holders to things than could go wrong, but also (and perhaps more importantly) to protect the issuer of the bonds (MU Finance plc and its parent company Red Football Ltd) from any potential litigation from bond holders in the event of something going materially wrong at United.  The reason that the list is so long (other than the fact that football is inherently a risky business) is that if any substantial risks are not disclosed and then come to pass, the issuer can be sued by people who bought the bonds.  In US courts, not only can investors sue for the amount invested, but also for punitive damages in cases where business risks were not adequately disclosed.  Such punitive damages can be several multiples of the original amount invested.

Investor litigation is rare in the UK, but in the United States is a well established practice (check out the Stanford Law School’s “Securities Class Action Clearing House” for many, many examples).  Although things have calmed down since the wave of post-dot.com bubble litigation and then the aftermath of the credit crunch in 2008, US investors in both bonds and equities frequently turn to the courts when they feel a company that has sold them securities has not shared all the relevant information it has with them.  Red Football of course chose to sell bonds into the US (to “qualified institutional buyers” under the 1933 Securities Act), making the identification of risks very important.  The bond prospectus not only lists numerous risk factors, it also makes the following statement:

“The risks and uncertainties we describe below [in the Risk Factors section] are not the only ones we face. Additional risks and uncertainties of which we are not aware or that we currently believe are immaterial may also adversely affect our business, financial condition or results of operations.” (page 28 of pdf version)

So the prospectus attempts to list all material risks Red Football is aware of but doesn’t mention supporter opposition to the club’s ownership.  This raises the question whether the risk of action by supporters was considered “immaterial” and was therefore deliberately not mentioned, or whether Red Football’s management aware of it.

Opposition to the Glazers runs deep and is long standing.  Years of ticket price rises, the lack of transfer activity last summer and news that total debt had passed the £700m mark had already increased supporters’ concerns by the end of 2009.  The publication of the prospectus itself was always going to anger supporters as it revealed for the first time all the cash extracted from the club by the Glazers and their intention to take much, much more in the future.

I am not suggesting that the famous Chatmaster’s “green and gold” idea should have been foreseeable, nor the formation of the Red Knights group, merely that when a sizeable proportion of your customer base is already very unhappy about the way things are, when you know you are about to reveal further the gory details and when you are failing to sell out the ground on a growing number of occasions, then a “customer” backlash is a material risk.

A red I know is friends with a (football ignorant) bond manager who had bought bonds in the issue.  When the red asked him if he was worried about a boycott, the bond manager was startled and asked him what he was talking about.  When he heard the answer he didn’t like it.  As the saying goes, I’m no lawyer, but I have seen hundreds of securities offering documents over the years and have a fair idea what constitutes a material risk and what doesn’t for United’s “business, financial condition or results of operations”.  If I was a bondholder and in the next few months supporters’ groups call a boycott with a significant number of season ticket and executive ticket holders taking part, I’d have a lot of questions to ask about why the risk of such an event was not disclosed.  Why even the existence of opposition to the owners was not disclosed.  But before I asked those questions I’d call my lawyers and I’d make sure they were in America.

Interesting times.

LUHG

Mortgages, filings and security

There's been some excitement in the last day or so about the filing of two security documents by Manchester United Limited relating to the recent bond issue. Bloomberg covered the story here:

http://www.bloomberg.com/apps/news?pid=20601077&sid=aCM7m6uGb2eQ

and various wire services and blogs have now run with it.

You can download the two documents here:
MU Ltd mortgage
MU Ltd debenture

The first thing to say about this is that there is nothing really new in this. All the club's property was mortgaged after the takeover (with these arrangements amended after the August 2006 refinancing). The new documents are merely the latest arrangements now the bonds are in place. Bloomberg say:

"Manchester United, the 18-time English soccer champion, included its stadium and training ground as security in its 504 million-pound ($785 million) bond sale, according to documents filed with U.K. regulators."

This is wrong because Carrington is actually explicitly excluded from the mortgage. As I described here, Carrington is not part of the security because the Glazers want the ability to take it from the club (for no cost) and then sell it. Ironically, it would be better for the club if it was part of the mortgage security as it would be more protected from such an action. I say more protected because Old Trafford itself can be sold under certain circumstances. I don't for a minute think this is their "Plan A", its more a fallback arrangement if things go wrong, but its instructive that provisions to do a sale and leaseback (where its called a "Specified Asset Sale and Leaseback") were included in the bond document - it shows what sort of "custodians" of our club they really are.

In the centenary year of our stadium (which the club are actively promoting of course), the news is not that the Glazers have mortgaged our heritage, they did that five years ago, its that they have deliberately reserved the right to sell Old Trafford if things don't go their way....

LUHG

The Empire strikes back.....

So here we go, released from the legal restrictions during the bond roadshow, David Gill and the club hierarchy are coming out fighting against all the criticism they have received. Tomorrow morning, Gill will do an "exclusive" interview on Radio 5.

Football Focus on BBC1 this morning had a piece on the gold and green protests and spoke to MUST, Keith Harris (banker not ventriloquist) and a rather ill informed academic. The club was obviously given the chance to take part but instead sent the BBC this statement:

"Manchester United is the most profitable football club in the world, last year, on a record turnover of £278m, the club made a record cash profit of £91m. Interest payments were £41m and wages accounted for less than half of the turnover.

"The recent bond issue has been very successful and provides the club with certainty in its interest payments, as well as great flexibility with the removal of bank covenants.

"The cash from the sale of Cristiano Ronaldo is available for Sir Alex to spend and it will be spent on players who are available for purchase and who the manager thinks can improve the squad, not to prove to pundits that it exists."

From: http://news.bbc.co.uk/sport1/hi/football/teams/m/man_utd/8488910.stm

Let's take a look at this statement bit by bit:

"The recent bond issue has been very successful" - They have indeed raised £504m, £4m above the initial target.  That is a successful bond issue.  Well done all.

[The bond issue] "provides the club with certainty in its interest payments" - This is also true.  From now until February 2017, the club will have to pay a fixed £44m per year (unless it chooses to redeem some bonds). The 8.72% they are paying on the £504m is indeed certain.  It is also higher than the actual interest rates on the bank debt they are replacing and is even higher than the fixed rate (5.0775%) that the management chose to lock into in 2007 and is now costing the club £35m to unwind.  But yes, they get certainty.

[The bond issue gives] "great flexibility with the removal of bank covenants" - hmmm.  Let's be very clear about this.  The bond does indeed remove the bank covenants and replaces them with bond covenants.  These are a lot less onerous than bank covenants.  They allow Red Football Ltd flexibility to do the following:

1. Pay an immediate dividend to Red Football Joint Venture Ltd of £70m (page 130 note 13).
2. Pay an additional dividend to Red Football Joint Venture Ltd of £25m whenever they wish (page 130 note 14).
3. Transfer Carrington (for free) to another Glazer company, sell it and let the new owners lease it back to the club (page 78 and onto 79 "Real Property").
4. Pay £6m a year to the Glazers in management fees (page 100).
5. Pay £3m a year in "general corporate expenses" to Glazer companies (page 129 note 10b).
6. If EBITDA is at least twice the interest bill, pay 50% of the net cash profits of the club to parent companies in dividends (page 127 note c(i)).

So who benefits from the "flexibility"?  The football club or the Glazers personally?

"The cash from the sale of Cristiano Ronaldo is available for Sir Alex to spend and it will be spent on players who are available for purchase and who the manager thinks can improve the squad, not to prove to pundits that it exists." - Now I don't want to use rude words in a family blog, but this is a bit much.....

Look at this table from page 44 of the prospectus.

At the end of September 2009, Red Football Ltd had £146.6m in cash (that's the first column entitled "Actual").  Why so much?  Firstly because £80m of Ronaldo money was in the bank and secondly because Aon, our new sponsors paid £35.9m of their £80m four year deal up front.  So that's a bonus inflow of £115.9m in the £146.6m.

The second "As adjusted" column shows the impact of the bond issue (as if it had happened in September because those are the most recent figures).  See how the cash mysteriously falls from £146.6m to £116.6m. This is explained on page 43 of the prospectus.  The bond cash needs to be topped up with club cash to pay off all the old debt, plus some of the losses on the interest rate derivative and the £15m in fees the bond deal cost.  So there goes £30m.

Then look at little note 1 below the table,  "we may, without restriction, make a distribution or loan of up to £70.0 million to our immediate parent company, Red Football Joint Venture Limited, that may, in turn, use the proceeds of that loan for general corporate purposes, including repaying existing indebtedness."

They "may" do that.  If they did that of course, no less than £100m would have gone out of the club.  Have they done it as of today 30th January 2010?  No.  Why not?  Because the settlement date for buyers of the bonds (the date they pay for them) was yesterday the 29th January.  It wouldn't have been possible to pass the money up to Red Football by today because they need to do the "Closing Funds Flow" whereby money moves around group companies.  So today it is true the money is there.  You can guarantee it won't be around for long.

Will they pay up the £70m?  We won't know for certain until the accounts for the year to 30 June 2010 are published next year.  But with the PIK time bomb ticking under the Glazer family (and their other businesses struggling in the US) the answer is obvious.  My bet of a pint to anyone who wants to gamble on the money staying in the club is still there.

So what of buying players?  Even if the cash goes as I described, the club can still buy, with even more debt. The Glazers can take the money from Ronaldo as set out above but out of the kindness of their hearts they've fixed a new £75m bank facility for the club.  Now of course cash is cash whether its Aon cash, cash paid by TV companies over the rest of the season, Ronnie cash or cash drawn down under the £75m facility.  Maybe they have put the Ronaldo money in a separate account called "Look, look it's the Ronaldo fee account" so they can show journalists the bank statement.  It doesn't matter of course,  sell the best player in the world for £80m and push at least £100m of cash out in fees, dividends, derivative payments etc and you end up in exactly the same position.

So if you happen to hear David Gill on the radio tomorrow, remember this, the money IS there this weekend, but the whole design of the bond issue is structured to mean it and a whole lot more will walk out of Old Trafford in the weeks, months and years to come.

LUHG

Red Football Joint Venture breaks a covenant

Hot(ish) news this evening.

The Red Football Joint Venture Ltd ("RFJV") accounts for the year to June 2009 became available from Companies House today. You can get them free here.

RFJV really only serves two purposes in the Glazer structure, to hold 100% of the shares in Red Football Limited and to be party to the famous PIKs (which are secured on the shares RFJV owns).

So with new accounts from RFJV, it's all about the PIKs. They were up to £202.1m at the end of June 2009 as expected.

The new news was this in note 18 on page 30 (my underlining):

The interest rate on the PIKs is going up from August 2010! To 16.25%!

Now all the Red Football companies are audited by PricewaterhouseCoopers LLP, probably the most highly thought of accountancy firm in the world. It is inconceivable that the auditors would not have insisted on this change in PIK interest rates being mentioned in the 2008 accounts if it was always going to take place in August 2010. Which means, "something has happened" during the period since the last accounts to push up the rate.

What could that be?

It has to be a breach of a covenant by RFJV, nothing else has altered.

This evening a source confirmed to me that RFJV had indeed breached it's net debt to EBITDA covenant during the year to June 2009. Not by much, debt/EBITDA was 6.2x and the covenant was 6.0x. But this small miss will (based on the June 2009 value of the PIKs rolled on to August) cost £4m in extra interest in the first year.

Three conclusions must be drawn:

1) It seems very likely that the demand for huge upfront payments to secure United's new shirt deal (which Aon agreed to) and the insistence that Real pay for Ronaldo in one tranche were an attempt to get the ratio below 6.0x (through boosting cash and reducing net debt) by the June 2009 year end.

2) The requirement to suck cash out of United to redeem the PIKs is even greater than we thought.

3) The Glazers are not quite the financial geniuses they would have us believe.

LUHG

Half a billion £s.....

This is a research paper on the detailed covenants contained in the Red Football bond prospectus which was published on 11th January 2010. The paper can be downloaded in pdf form here.

ANALYSIS OF THE GLAZER BOND DOCUMENTS SHOWS MANCHESTER UNITED WILL HAEMORRHAGE OVER HALF A BILLION £ IN CASH IN THE NEXT SEVEN YEARS

Summary

The small print of Red Football Ltd’s bond prospectus shows that the Glazers have structured the issue to allow them to take at least £20m of dividends out of the club every year. An additional, so far unnoticed, clause allows a further £25m to be paid out in dividends at any time. Add these payments to the £70m already known about, the Carrington deal and “management fees” and at least £220m of the club’s cash will flow directly to the Glazers between 2010 to 2017.

With interest on the bonds and the extra cost of leasing our training ground back, the total that will be sucked out of the club between now and 2017 will exceed half a billion pounds, to add to the huge cost already imposed by the Glazers.

Only £70m to pay off the PIKs[i]?

Since the bond issue details came out many analysts have been wondering how the family were going to deal with the rest of the PIKs.

The PIKs are held by Red Football Joint Venture Ltd and are secured on that company’s shares in Red Football Ltd (and thus the club). If they are not repaid by 2017, the Glazers will almost certainly lose all their shares in Red Football Ltd.

Paying off the PIKs is the top priority for the Glazers. The fact that the interest rolls up at 14.25% also makes it essential for them to try to repay them as early as possible (the PIKs will total around £207m by the end of March, will be over £300m by the summer of 2012 and almost £600m by 2017).

So taking £70m out of the club (which they couldn’t do under the old bank loan agreement) is a start, but it is never going to be enough. If they paid £70m off in March 2010, there would still be £332m to pay by August 2017[ii].

This cannot be the strategy for the PIKs. They NEED to pay off more or they will still lose the club to the hedge funds. There must be something else going on.

The small print in the prospectus

Other than paying off the PIKs with their own money (something they have shown no inclination to do for the last five years), their only solution is to get more money out of the club. Payments to parent companies and directors are restricted by the terms of the bond issue, so we need to examine the prospectus’s small print that covers the “covenants” Red Football Ltd has to adhere to.

There are two key covenants, relating to this area; Restricted Payments[iii] and Incurrence of Indebtedness and issuance of preferred stock[iv]. They are both very dense, almost unintelligible sets of rules about what Red Football Ltd can do whilst the bonds remain outstanding. The first one, Restricted Payments, puts limits on Red Football Ltd and its subsidiaries paying cash to the parent companies (like Red Football Joint Venture Ltd). The £70m we all know about is explicitly allowed in clause 13[v]. But it turns out there is a clause just below it that hasn’t got any publicity. Clause 14 says they can also pay up another £25m whenever they want[vi].

And that’s not all. On top of this £95m, there are rules in clauses i to vii about other dividends that the owners can take out of the club[vii]. To summarise, if the club’s interest is still covered twice by EBITDA (as described in the “Incurrence of Indebtedness and issuance of preferred stock” covenant referred to above[viii]), Red Football Ltd can pay dividends worth 50% of the net cash profits of the club (technically the “Consolidated Net Income” or “CNI”[ix]). CNI excludes losses or profits on player transfers and the amortization of goodwill and player contracts.

To give you an idea of what we’re talking about, this is the calculation for Consolidated Net Income for the year to September 2009 and shows what would have been extractable in fees, dividends and interest if the bonds had been in place during the year.

	Clause[x]	£'000
Net Income year to 30 June 2009		25,587
Less profit on player trading	3	(80,724)
Less profit on sale of fixed assets	4	(23)
Add back exceptional	4	837
Add back non-cash tax	5	22,917
Add back amortisation of goodwill	7	35,388
Add back amortisation of player registrations	7	37,641
Less mgt fees in excess of consultancy fees[xi]		(3,100)
Add back higher EBITDA run rate*		6,654
Consolidated Net Income year to 30 Sep 2009		45,177
Permitted dividend**		22,589
Management fees***		6,000
General corporate overheads of parent entities****		3,000
Interest on bonds*****		47,500
Total		79,089
EBITDA (adjusted year to Sep 2009)******		100,780
% diverted*******		79%

* Additional £6.7m of EBITDA shown in most up to date accounts (year to Sept 2009) vs. year to June 2009

** permitted 50% distribution

*** See page 152 of Prospectus (166 of pdf)

**** See section below “Carrington, personal loans, “management fees” and expenses”

***** Assuming coupon of 9.5% on £500m issue

****** From Prospectus page 12 (26 of pdf)

******* Note this is a proforma number as if the bond issue had been in place in year to Sep 2009

So in the latest twelve month period for which we have figures, the Glazers could have paid themselves 50% of Consolidated Net Income (about £22.6m) in dividends. No doubt they believe they can continue to push up profits from here (I’m more sceptical), but even if profits are only flat every year until the bonds are redeemed, that’s another c. £23m or so they can take out each year.

In fact, this bond issue is deliberately structured in such a way, that (assuming they can hold profits where they are) this is the minimum sum they can take each year. If there is any rise in profits from better TV deals or higher prices for supporters, half the extra money can be paid out in dividends.

Adding management fees, expenses and the interest on the bonds, every year 79% of the operating profits of the club will be taken out.

Or perhaps we should turn it around the other way and look at it from the fans’ point of view because this outflow is no less than 70% of all United’s matchday revenues. 70 pence from every pound spent by supporters on match tickets, food and drink, programmes, even car parking, and 70 pence from every pound spent on corporate boxes and executive facilities will go straight out of the door in dividends, fees and interest.

Carrington, personal loans, “management fees” and expenses

When thinking about how they plan to pay down the PIKs, we can’t forget Carrington and the direct payments to the family.

I don’t know exactly what Carrington is worth, but we can make an educated guess at £15-20m. All United’s property is valued at around £250m[xii], so estimating around £235m of this being Old Trafford and the balance basically Carrington (and the Cliff) sounds about right. Anyway, the Glazers get the asset free and get to sell it with the club leasing it back. So that’s c. £15m in the Glazers’ pockets and probably an additional cost of at least £1m per year to the club (assuming an 8% yield on Carrington).

We have no idea what the family have spent the £22.9m[xiii] they have taken out in loans and fees and have excluded them from my calculations. Under the terms of the bond issue they can however charge the club £6m pa for “management services”. This has been widely reported in the media.

There is however a final indignity hidden in the Restricted Payments covenant (clause (10)(b) of the section setting out payment which are allowed). This shows that Red Football Ltd is entitled to make up to £3m of payments to parent companies to cover their “general corporate overhead expenses” including “…..payments in respect of services provided by directors, officers or employees…..”.

You might imagine that such expenses should be covered by the £6m “management fees” already being charged, but no.

Adding it all up

The net result of all this is very depressing. The bond documents embed the rights of the Glazers (merely if they maintain current profits) to take over £30m in dividends, fees and expenses out of the club every year.

Adding in Carrington and the “hidden” £25m one off dividend, they can easily reduce what we have always been told are “their” PIKs down to around £84m this year (see table below).

Total permitted cash to RFJV	£m	PIKs £m
End March 2010		191
add early redemption fees (3%)		194
From bonds	70	124
Carrington proceeds (estimated)	15	109
Extra allowed dividend	25	84
Total after refinancing	110	84

With the annual dividend and management fees, they will have paid off “their” PIKs including rolled up interest by 2015 (if they just hold profits flat) or even 2014 (if they manage to grow them 5% pa)[xiv].

Total possible cash to RFJV (annually)	£m
2009 base 50% CNI	23
Management fees	6
General corporate overhead expenses	3
Total annual dividends on 09 profits	32
Assumed yield on bonds	9.5%
PIK rate	14.25%
PIKs repaid in	2015

In total between the completion of the bond issue and 2017 (assuming the bonds yield 9.5%), this is the bill the club will have footed:

Cash outflow 2010-2017 post refinancing	£m
Cumulative interest to 2017	333
Cumulative dividends to 2017	161
Cumulative fees and expenses to 2017	63
Extra cost of Carrington to 2017	8
Total	565

By 2017, despite having pumped more than half a billion pounds out of Manchester United, the club will still be saddled with the £500m of debts it has today.

These figures are based on the club not having to draw down its £75m revolver or taken on any further borrowing on top of this (there is permission in the document for at least a further £50m[xv]), as the numbers defy all sense already……

Conclusion

Many supporters, commentators and people in the wider football world have been astonished by the revelations concerning the Glazers ownership of Manchester United that have come to light in the last week.

This paper demonstrates that the pillaging of the club over the last four years by the owners is set to continue and indeed accelerate in the years to come. Nobody can be in any doubt; not the fans, the Football Association, the Premier League, UEFA, the government or indeed the manager or players that what is being allowed to happen is nothing less than a violent assault on one of Britain’s best known sporting institutions. There can no longer be any excuses by the football authorities to not immediately and urgently intervene (through rule changes if necessary) to prevent people, who have no interest in football beyond their own greed, from acting in this way.

Andersred

18 January 2009

Contact: andersred@btinternet.com

About me

I am a season ticket holder at Old Trafford as well as having been a fund manager based in London with 15 years experience of company financial analysis.

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[i] PIKs are “payment in kind securities”. These were issued by Red Football Joint Venture Ltd (“RFJV”), a parent company of Red Football Ltd in August 2006 and are secured on RFJV’s equity in Red Football Ltd. The PIKs accrue interest at 14.25% per annum which is rolled up into the capital of the securities (a process known as “reverse amortisation”).

Manchester United is not liable for the PIKs, but if the Glazers fail to repay them by August 2017 (by which time they would be worth almost £580m), control of Red Football Ltd would pass to the owners of the PIKs (widely thought to be Citadel Capital Group, Perry Capital and Och Ziff Capital Management Group.

[ii]

Revised PIK capital outstanding is calculated using £175.479m total exposure declared in RFJV’s report and accounts to June 2008 less £2.811m of unamortised financing costs. Interest is added to this net amount for nine months to 31 March 2010 when it is assumed £70m is repaid (less an assumed 3% early redemption fee). The revised sum of £123.2m is then projected forward (reverse compounding at 14.25%) to August 2017.

[iii] See page 112 (page 126 of the pdf version), of the “Preliminary offering memorandum of MU Finance plc”, published on 11 January 2010 (hereafter the “Prospectus”).

[iv] See page number 116 of the Prospectus (page 130 of the pdf version).

[v] See page number 116 of the Prospectus (page 130 of the pdf version).

[vi] The Restricted Payments covenant sets out what constitutes a Restricted Payment in clauses 1-5. It then describes circumstances (sub-clauses (a) to (c)) under which such payment can be made before setting out 14 exemptions from the rules governing Restricted Payments. The last of these covers the extra £25m allowed, the only restriction being that Red Football Ltd has not defaulted on the bonds.

[vii] Pages 113-114 of the Prospectus, (pages 127-128 of the pdf version). The other clauses in this section state that total Restricted Payments cannot exceed the sum of 50% of Consolidated Net Income plus 100% of new equity issued, cash proceeds from certain asset sales and certain sums reflecting any changes in the status of subsidiaries. None of these additional clauses are likely to materially affect the dividend paying capacity of Red Football Ltd. This test applies from the issue date of the bonds onwards and so is a rolling test over time. For the purposes of this paper, I have assumed that dividends are drawn annually under this clause, but they could be taken out over different periods (both shorter and longer).

[viii] Clause (b) on page 113 of the Prospectus (page 127 of the pdf version) makes passing the Fixed Charge Coverage Ratio test a condition of dividend payments. The Fixed Charge Coverage Ratio test amounts to an EBITDA / interest cover test of 2.0x (see pages 116 and 148 / 130 and 162 of pdf). The Fixed Charge Coverage Ratio can be seen to have been met on a proforma basis in the year to September 2009 on page 13 of the Prospectus (page 27 of the pdf). This is true even if adjusted EBITDA is reduced by £3.1m to reflect the higher management fees that will be charged in future vs. the consultancy fees charged on 30 June 2009.

[ix] See page 145 of the Prospectus (page 159 of pdf). Consolidated Net Income can also be calculated as adjusted EBITDA, less depreciation, less interest, less cash taxes.

[x] These numbers show the adjustments to arrive at Consolidated Net Income specified on page 145 of the Prospectus (159 of pdf).

[xi] To calculate the proforma permitted dividend in the year to September 2009, Consolidated Net Income needs to be reduced by the difference between future permitted management fees (£6m) and the actual “consultancy fees” paid during the year and already in the net income calculation (£2.9m).

[xii] See note 8 to financial statements of Red Football Ltd year to June 2009 (page F-12 of the Prospectus / 214 of pdf).

[xiii] See page 86 of the Prospectus (page 100 of pdf version).

[xiv] Methodology as set out in note ii, but £110m is applied to repay PIKs in March 2010 rather than £70m, and ongoing dividends equivalent to 50% of CNI and £6m of management fees are applied to redeem PIKs annually thereafter.

[xv] See clause 14 page 118 of the Prospectus (page 132 of pdf version)

LUHG