Thursday, 28 January 2010

How we know they're planning to take out cash..... the final piece of evidence

I'd like to apologise for the dweeby, technical, accounting nature of this post.  Hopefully it will make sense the way I describe it below.  If not please don't hesitate to contact me and I'll try to explain what I mean.  Despite it being technical, I thinks it's important.

The digging around that I and others have done since the bond prospectus was published on 11th January shows conclusively that the Glazers will be able to take huge sums out of United now the old bank debt has been replaced with bonds.

What's obviously harder to prove is that they intend to exercise these rights and to what extent.  We know for certain that they intend to take the Ronaldo money out, it's mentioned on pages 27, 44 and 130 of the prospectus.  We know they are going to grab Carrington, sell it and make the club that built it from its own funds pay to use it, that's on pages 78, 79 and 156 amongst others.

But maybe that's it. Maybe just because they've got the right to take 50% of the cash profits they won't exercise that right.  What sort of smoking gun would you need to find to the prospectus to make a convincing case that not only can the Glazers pillage Manchester United to the tune of hundreds of millions of pounds, but that they intend to?

I think you'd need to find something like this:

This small print appears on pages 43 of the prospectus with the same routing of money also described on page 44 and is defined on page 158 as the "Closing Funds Flow".

For clarity, taking this small print together with other bits of the prospectus, this is what will happen to the £504m of proceeds from the bond issue:

£504m raised
of which:

£15m paid in costs to the banks that organised the bond issue
£489m left in MU Finance
of this £489m:
"approximately £400m" is passed to Manchester United Ltd (the rest goes straight to Red Football Ltd to pay off bank debt).
Manchester United Ltd lends the £400m to Red Football Joint Venture Ltd (the parent company of Red Football and the company with the famous PIKs).  The loan is indefinite and interest free.
Red Football Joint Venture Ltd pushes the £400m back into its subsidiary Red Football Ltd (the company with the bank debt) by making a "capital contribution".

Red Football Ltd uses the £400m it has just received (together with more of Manchester United's cash, to pay off the rest of the bank debt and some of the losses on the interest rate derivative).

Now when I first read this clause it didn't seem very important.  I didn't know why they were doing all this money moving, I guessed (wrongly) that it was something to do with tax.  When I had some free time I asked an expert, a senior accountant at one of the big 4 firms in Manchester (thanks mate).  Being a qualified professional he worked it out pretty quickly.  And when he told me the answer it all made sense.  Let me try to explain:

Under English company law, there are restrictions on companies paying dividends.  It is not generally possible to pay dividends from what are called "non-distributable reserves" without a complex and costly "capital reorganisation".  Without boring you with the detail, a company's net worth (it's "shareholders funds") are divided into different "reserves".  A company (even if it has the cash) cannot easily pay dividends from its "share premium reserve".

This is what the various "reserves" that make up Red Football Ltd's net worth ("shareholders funds") looked like at 30th September 2009:

So despite having a net surplus of over £450m, Red Football Ltd can't really pay dividends because it all sits in the "share premium reserve".  If it had a positive number in the "profit and loss reserve" it could pay dividends up to this amount, but this number is negative (the product of over four years of losses).

So how do companies in this position get around this problem?

One way is for the company's owner to make a "capital contribution".  The owner just pumps money into the company (no new shares are created).  Intuitively you can see why this money from the parent and placed in a separate "Capital contribution reserve" can be paid back to the parent in dividends, it is after all the parent's money.

So suddenly, the £400m flow around the Red Football group makes perfect sense.  The new reserve created by this inflow into Red Football's account allows the company to pay dividends to its parent Red Football Joint Venture Ltd.  It has no other possible purpose (and let me add, this is a normal method of creating "distributable reserves" and is perfectly legal and normal).

And the most important thing about this accounting cash shuffling is this, it creates £400m of dividend paying capacity.  Not just the £70m identified upfront in the prospectus, or the extra £25m dividend they can pay that is hidden on page 130 of the prospectus.  £400m.

Still not 100% certain the Glazers are planning to asset strip our club for years to come?

Some simple questions: why bother creating the accounting room to grab £400m and and pay it out to the owners?  
If asset stripping is a scare story with no foundation, why have thy deliberately made it possible?

If you were a benevolent owner who put the interests of the club first, would you create the accounting mechanism to pay out £400m?
You don't need to be a knowledgeable accountant like my mate to know the answers......