Friday, 15 October 2010

United’s 2009/10 results: Understanding the cash flow

Apologies in advance for the slightly technical nature of this post. It is an analysis of the cash flow dynamics in United's business. It is not trying to make a political point, rather to help those without a financial background get their heads around what is happening and what the outlook is for the next few years. Please email me if you require any clarification on the more technical aspects and I'll endeavour to reply.

The club had a lot of debt (£522m) and a lot of cash in the bank (£164m) at the 30th June. The source of the debt is obvious, the original takeover and the subsequent refinancings in 2006 and most recently in January 2010 when the "Senior Secured Notes" (aka "bonds") were issued. The cash in the bank has come from several sources which I describe below.

The reason all this is important (even if it is quite technical) is because not all the cash reported is "available", some of it will be needed to pay costs during the season when less cash flows in. In addition, the Glazers have large and growing "entitlements" to take dividends out of the club. They have not done so as yet, but supporters should be aware what impact taking up these rights would have on the bank balance. Finally, most agree the ageing squad will need investment in the coming years, probably more than the £31m spent in the 2009/10 season. By understanding the cash dynamics, people can reach their own conclusions about whether high investment and dividend payments are compatible.

Where has this £163m come from?

The "seasonal" effect and the need for a "buffer"
Football clubs receive a lot of money in the summer from season tickets and seasonal hospitality sales but "recognise" this income in the profit and loss account as games are played. In addition, a high proportion of TV money is paid at the end of the season. At the 30th June, the amount received from season ticket and executive sales for the 2010/11 season was £52m (interestingly £2m lower than the previous year). Clubs' costs are incurred more evenly over the year (over 70% of costs are wages). This means that there is a substantial seasonal difference between when cash is received (mainly in the April to June quarter) and when profits are recognised (more evenly but with the October to December quarter with the most home games being the most important).

With the results just published, we can see for the first time how these seasonal effects impact on cash flow over each quarter of the financial year (the club has only had to report quarterly since the bond issue). The  seasonality can be seen in the pie charts below which compare how EBITDA is split and how operating cash flow (EBITDA + changes in working capital) is split. The difference is very, very pronounced, with over 70% of cash (remember this is before transfers, interest and spending on the stadium) coming in the final three months of the year, three months that only generate 19% of the year's operating profit.

So United has its highest cash balance at the end of the financial year in June. In fact the cash balance actually fell in each of the first three quarters of the year, reaching a low point of being down £55m on the year at the end of March (note the cash draw down excluding changes in borrowing was a still significant £38.5m at the end of Q3):

This seasonality explains why United have a history of holding substantial cash balances at the end of each season and has occasionally had to use its "Revolving Credit Facility" ("RCF"), a sort of overdraft facility. Since the bond issue in January, the club's current RCF is £75m which is available to cover short-term cash requirements. The bond prospectus gives some details about the RCF, including that it costs c. 3-4.5% above LIBOR (currently around 1%). More importantly, the RCF has a five day "clean down" to £25m each year. This means the club has to reduce the drawn balance of the facility to a maximum of £25m for at least five days a year. This is to ensure the facility is used for short term borrowing, not long term investment.

The table below shows the season end cash balance over the last few years (and also what percentage of turnover that represented at the time).

As the table shows, large cash balances are the norm for United (except when there is a one off hit to cash such as Lazio failing to pay for Stam in 2002 or the building work on the quadrants in 2006). From 2003 to 2009 (and excluding the quadrant impacted 2006), United had balances averaging £48m at its year end. So what changed in 2009 and 2010?

Cash Boost No.1 The Aon and other commercial upfront payments.
United negotiated a strange but useful pre-payment when it did the sponsorship deal with Aon in June 2009. Aon agreed to pay £35.9m (45%) of the £80m four year deal upfront and a year before the sponsorship started. This boosted the 2008/09 and 2009/10 cash balances, indeed it represents 24% of the 2008/09 closing balance and 22% of the 2009/10 balance. Such prepayments along with season ticket money received for the following season are called "deferred income" in the accounts. Deferred income from commercial contracts totalled £65.7m at 30th June 2010, up £8.2m on the previous year. So United is sitting on £65.7m of cash from various sponsors and partners for sponsorship that has yet to happen. That represents 40% of the club's cash balance at 30th June 2010.

This cash is great for the club of course, but as time goes on, will have the effect of reducing the club's cash flow compared to its profits. In each of the next four years, the club will book c. £20m of Aon related revenue (and profits as the costs of being sponsored are virtually zero) but will only receive £11m in cash (the other 45% having already been paid). On the Aon contract alone therefore, operating cash flow will be c. £9m a year lower than operating profit each year. Add in the other £29.8m of commercial deferred income and the hit to cash flow could be even greater (although we do not know any details of the other commercial prepayments).

Cash Boost No.2 Ronaldo and other transfers
The existence and potential use of "the Ronaldo money" has been a hot topic ever since he his sale to Real Madrid was announced on 11th June 2009. The £80m received by United days before the end of the 2008/09 financial year represented 53% of that year's closing financial balance. Since that date, the club has spent £44m in cash on players (both new and ongoing payments for players already signed) and received £14m for selling players; a net spend of £31.8m. I think we can safely say therefore that "the Ronaldo money" is still there. It represents 49% of the club's current cash balance.

Cash Boost No.3 Virtually no interest paid between January and June 2010 but some swap costs
Interest on the old bank debt used to be paid quarterly. Interest on the bonds is paid twice a year on 1st February and the 1st August, with the first payment on 1st August 2010. The cash flow statement for the period January to June 2010 therefore includes virtually no interest actually being paid (the interest is charged to the profit and loss account of course). The £15.2m of "interest" in the cash flow statement actually refers to a £12.7m payment on the swap closure and interest on the "Alderley Mortgage" taken out to buy the freight terminal next to Old Trafford. In future years around £45m (depending on exchange rates) will be paid out in cash each year and another c. £5m for swap costs. So in the 30th June 2010 cash balance is a one-off interest rate holiday of c. £10m (c. £22m bond interest which would "normally" be paid in the second half of the year minus the large swap cost).

The outlook for the club's cash position
Movements in cash flow can be divided into a series of categories, some of which are described above. Of primary importance of course are the cash profits (EBITDA) a business makes. I am going to deliberately leave the outlook for profits for another day, and focus on the other dynamics at work further down the cash flow statement. The following table shows the actual cash movements in some detail in 2008/09 and 2009/10 and my comments on the outlook (assuming flat EBITDA).

Thinking about dividends and the squad

United is a great business, and as the table above shows, if profits just remain flat, will still generate around £14m of cash next year (assuming a net £30m is spent on transfers). That £14m is before dividends, and in 2009/10 of course the Glazers did not take any of the £95m in dividends to which they were entitled.
Assuming flat profits, by the end of the financial year 2010/11 the dividend entitlement will have grown by another £28m. In total the entitlement will be £123m. Obviously if all this was paid, the net cash flow in the model above would be a £109m outflow not a £14m inflow. This would take the cash balance at the club down to around £55m, totally swallowing up the one-off benefits of the Aon prepayment and the Ronaldo money. The club's cash balance would be back to where it has been in previous years, the amount needed to cover seasonal fluctuations. If that wasn't enough, the ongoing dividend entitlement (roughly 50% of EBITDA minus interest) would make the club cash negative at current profitability.

Of course the vast majority of supporters don't spend a moment thinking about the year-end cash position of the club, but do spend time wondering what investment will be needed to keep our squad competitive in future years as Giggs, Scholes, Neville, Van de Sar, potentially Ferdinand and probably Hargreaves bow out.
I think the questions supporters need to ask are this:

    Will the Glazers take the £95m (soon to rise to c. £123m) in dividends they are "entitled to"?
and if they do....
    Will there be enough be in the kitty to adequately replace our ageing squad in the year or two ahead?