What Stan Kroenke’s takeover of Arsenal might tell us

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

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

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

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

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

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

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

Comparing the valuation to Liverpool

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

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

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

Arsenal’s depressed profits and the shirt deal opportunity

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

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

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

Reading across

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

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

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

The world's "richest club" sues one of its fans - but where's the damage?

The Telegraph has today revealed what many involved in opposing the Glazers have known for a while, Manchester United is taking a single fan to court over the leaking of the names of 400 corporate hospitality clients last April. The supporter in question was arrested during a police investigation into the leak, but was released without charge. The club itself has failed to track down the source of the leak (not surprising given that the majority of staff at Old Trafford detest the owners and there must therefore have been a lot of suspects).

The Telegraph report that United's High Court writ says that the leak caused "loss and damage" to its business. This does not tally at all with the club's public statements on executive and hospitality sales.

In its third quarter 2010 presentation to bond holders published on 28th May 2010 (available here), the club said:

"Season ticket & seasonal hospitality sales processes initiated. Trends consistent with prior years."

Almost two months later on the 23rd July last year, the BBC website quoted United's official spokesman as saying that:

"Executive sales are exactly in line with last year"

So publicly and to bond holders, the club has been adamant that all was well with executive sales.

Why then are they suing this supporter?

How much money is the club claiming it has lost through this leak?

Obviously it has not lost enough money to make it worth mentioning to the holders of its bonds... Or was it trying to play down the impact of protests and direct action on its business?

Whatever the answer, this litigation smells horribly of action being taken out of spite and that makes me ashamed of my club. 

LUHG

How much of United's profits are reinvested?

A few people commenting on my recent posts about net transfer spending under the Glazers have asked how investment levels as a percentage of profits compare between the Glazer era and the plc.

Here's the answer:

Whether looking at net or gross investment, the Glazers are ploughing a significantly lower proportion of the club's profits back into Manchester United.

Where could all that money be going? Oh yes.....

Welcome to Glazernomics!

LUHG

Update on David Gill's misleading comments to Parliament

Paul Kelso, the Telegraph's steely Chief Sports Reporter has challenged United on David Gill's misleading comments to the Select Committee. The response he got was:

"they say David Gill referred to net spend excluding the Ronaldo cash (in bank). Glazers: £27.2m a year vs. £16.3m 99-05"

Two things strike me about that statement.

Firstly, since when does "net spend on players" mean "net spend on players except the sale of Cristiano Ronaldo"? Why exclude such a huge item from the calculation?  Why not start excluding major sales from the plc era (Beckham's for example)? The answer of course is that excluding the Ronaldo money makes the numbers look better. But spin and truth are not synonymous....

Which brings me on to my second thought. The weird "ex-Cristiano" calculation may be what David Gill meant to say, but it is absolutely not what he actually said, as anyone can see from the video. How ironic to mislead during a rant about how well the club communicates....

LUHG

How not to communicate with Parliament and supporters

I had the pleasure of attending the Department of Culture, Media and Sport Select Committee hearing into "Football Governance" at the House of Commons this morning. The first witnesses were David Gill (CEO of Manchester United), Peter Coates and Tony Scholes (Chairman and CEO of Stoke City), and Niall Quinn (Chairman of Sunderland).

During questioning from Labour MP David Cairns about the impact debt had had on United, David Gill made an extraordinary statement (you can watch for yourself at 11.02:58 on this video):

"our net spend on players since the owners taken over [sic] was greater than in the five or six years before that"

Now that statement is not correct.

In the five years prior to the Glazer takeover (2001-2005), United spent a net £89.4m on players. From 2006-2010, the club spent a net £56.0m on players. You can see the full figures in this table:

I didn't make these figures up, they come from ten separate cash flow tables from the Manchester United plc and Manchester United Limited accounts filed at Companies House. I have chopped out the individual sections and you can see the originals below:

Pre-takeover cash flows

Post takeover cash flows

David Gill went on to explain at some length why he felt no need to engage with MUST or IMUSA and dismissed those fans concerned about the club's finances as "domestic" (outrageous!). He said the club was very good at communicating with its supporters and cited social media in Saudi Arabia as an example (let's hope they don't mention democracy).....

I think he needs to work on his communication strategy and he could start by giving Parliament the correct information.

LUHG

“A distant subsidiary” – Who is Peter Pannu trying to kid?

Background
Last week Bloomberg and the various other media ran reports that Birmingham International Holdings Limited (“BIH”), the direct parent company of Birmingham City PLC (“BC”) which is itself the sole parent of Birmingham City Football Club PLC (“BCFC”) had some financial problems.

Statements published to the Hong Kong Stock Exchange by BIH relating to its interim results to 31^st December showed that the Chairman, Carson Yeung, was having to take out a HK$150m (c. £12m) personal loan (secured on his own Hong Kong properties), and that BIH was raising HK$310m (c. £25m) through a placing of new shares to keep the business going.

Today the press is full of vehement denials by the BCFC board that anything is wrong. Peter Pannu (BCFC’s acting Chairman) said on the club’s official site (my emphasis):

"It is important to note that BCFC (the club) is a separate corporate entity from BIHL (a listed company in Hong Kong). Although a distant subsidiary, BCFC's accounts are separate and it operates on its own financial basis.

"BCFC is in credit with their bankers and there is no financial impediment to its operations. We will have no problem securing UEFA licence approval for which the club had already filed the papers.

"As for BIHL, the financial support by a major shareholder is a common occurrence and there is no cause for concern or any direct links to BCFC's wellbeing."

This is a completely ridiculous and totally misleading statement that insults the intelligence of Birmingham City's fans.

"Material uncertainty"
BIH’s interim accounts show a “material uncertainty” that the group (i.e. including subsidiary BCFC) can continue as a “going concern”, in other words there is a major risk of insolvency. That is the source of press stories last week.

BC and BCFC’s full year accounts (published in October 2010) both contain exactly the same “material uncertainty” as BIH’s accounts (see pages 7 and 13 respectively). In note 1 of the BCFC accounts (page 13) more details of the club’s cash needs are given:

“The forecasts show that the Group [i.e. Birmingham City Football Club] needs funding of around £7.5m from its parent company [BIH] in the short term in order for the Group to continue to operate within its agreed bank facilities..... The sensitised forecasts [that BCFC stays in the PL but at a lower than hoped level] shows a further requirement for funding of up to £3m in June 2011.”

The BCFC accounts then go on to talk about the placing of new shares in BIH (also page 13) and say that:

“The directors of the parent company [BIH] have confirmed that £7.5m of the funds to be received from the placing are expected to be transferred to the Group by the end of November 2010 and have also confirmed that additional funds of up to £3m will be made available to the Group from the placing proceeds noted above later in the year as and if required.”

So BCFC is entirely reliant on funding from BIH to stay within its banking facilities. This money is needed even if BCFC fight off relegation and no forecasts have been presented to the auditors on the basis that BCFC (currently in 18^th place but with games in hand) go down. 


Far from being a “distant subsidiary” of BIH, BCFC is entirely reliant on it for financing as is described in detail in UK Companies House filings from October. Peter Pannu is significantly misleading supporters by claiming the financial fortunes of BCFC are not tied to those of BIH. If BIH fails, so does BCFC.

Where things stand in March 2011

The comments by the auditors in the BC and BCFC accounts were from October, so perhaps Birmingham City fans should heed Pannu’s words that there are no “financial impediments” at the club? Well what the BIH statement to the Hong Kong Stock Exchange on 3^rd March 2011 tells us is that things have not got any better since October:

1. It is not clear whether Carson Yeung has actually taken out a personal loan secured on his Hong Kong property. The 3rd March statement by BIH say that he will “apply [for] a credit facility”. The BIH accounts in October 2010 said the same thing (page 56). Does the loan exist?

2. The placing referred to in the BCFC accounts as the source of funds to keep the club within its banking facilities has still not taken place. Although the BCFC accounts said the money would be transferred to the club “by the end of November 2010”, on 25th February 2011, BIH announced the placing would be extended until 25th March 2011. Only 29% (around £7.2m) of the placing is “underwritten” (i.e. guaranteed by the broker leading the placing), the majority may or may not be raised.

3. BCFC represents 94.5% of BIH’s turnover in the six months to 31st December 2010. BIH has no other material businesses.

4. BIH has announced and then aborted two deals to buy businesses apparently owned by Carson Yeung since it bought BIH. BIH has also announced two property deals with Mr Yeung to acquire land he owns or is intending to buy in China. The largest of these two property deals includes the payment by BIH of £5.6m in cash to Mr Yeung (see page 4 of BIH circular published on 19th January). No information is given as to where BIH will obtain this cash.

5. At 31st December 2010, the BIH balance sheet showed a cash balance of only HK$ 18.5m (c. £1.5m). In addition to its HK$ 125m (c. £10m) of debts (all related to BCFC), the club also owes a further HK$ 128.3m (c. £10m) in stage payments on previous transfers.


Unknowns
Carson Yeung may or may not be a wealthy man, we have no way of knowing.

Mr Yeung (who has already lent the club £15m) may or may not have borrowed £12m to support Birmingham City. Whether the loan has been taken out is not clear.

Mr Yeung may have property assets in mainland China which he intends to sell to Birmingham City’s parent company, but the ownership of the land is not properly disclosed. The source of any cash consideration for these deals is not clear.

If one of these deals takes place (the purchase of development land in the Liaobin Economic Zone, Panjin City, Liaoning Province, PRC announced on 19th January 2011), unnamed "guarantors" may end up holding convertible preference shares allowing them to become majority owners of BIH and hence Birmingham City Football, but again disclosure is inadequate.

Birmingham City’s parent company may be about to raise around £25m in new shares through a placing to help the club, but the placing is four months late and only a third of the money is guaranteed.

The Premier League may be on top of all this. But maybe not....

If I was a Birmingham City supporter I'd want answers rather than patronising bullshit from Mr Pannu.

LUHG