Friday, 18 May 2012

Manchester United Q3 2012 results: getting hard to square the circle

Since United had its bond issue in early 2010, the club has reported increased year-on-year revenues every single quarter. This revenue growth has more than offset rampant wage inflation. Meanwhile of course the club has clocked up Champions League finals and Championships. This season the performance on and off the pitch has stalled somewhat. The numbers for the next quarter (which runs from April to June) will be worse again.

For the Glazers, the clever trick of football success on a limited budget with high and seemingly ever increasing profits may well coming to an end. Will they spend at the expense of those profits? If they don't, will the success and hence the profits still be achievable?

It's getting harder to square the circle.

Revenue and EBITDA - both down a little
The poor performances in Europe and the domestic cups can be seen in these quarterly figures. Matchday income fell 13% compared to last year as the club played seven home games compared to last season's nine. Of the seven played, two were in the Europa League in front of smaller gates paying lower prices.

Media income fell 19% compared to 2010/11 despite the higher share of the UEFA CL "market pool" this year. The explanation is simply the exit from the Champions League. The impact will be far more severe in the current quarter of course when there will be no CL media income at all compared to the previous year's run to the final.

Commercial income was again the star, with the new contracts signed since last year; DHL, Epson etc and a step up in Nike income and income recognition boosting revenue by 15% compared to 2010/11.

In total, revenue fell 5.8% year-on-year in the quarter and revenue growth for the nine month period was 6.1% (down from 11.9% in the first half of the year). United may be a commercial powerhouse, but old fashioned football success and failure can still have a major impact.

Staff costs only rose 1% compared to last year, reflecting lower bonuses (presumably linked to qualification for the CL knock-out stages). The wage bill for the year to date is still 10% higher than last season, although the fourth quarter will not see any of last season's bonuses.

The major fall in operating expenses (down 16.3%) is largely due to the lack of domestic home cup games. The club accounts for the gate sharing for such games as an expense and this season there were no such games.

With revenue down 5.8% and costs only down 4.7%, EBITDA fell 8.4% and for the first nine months of the year was only up 3.3%. There will be a larger fall in Q4.

These falls shouldn't be overplayed, with United still making cash profits before transfers of £85m in the first nine months of the season. That is more than any other English club has made over any twelve month period. The worry for the Glazers, is that the profits are stagnating this year at a time when investment is needed to keep up with City and others, and none of that is good if you hope to float your club on a stock exchange.

Below EBITDA - not much of note
The club made a small £2m profit on player sales during the quarter (Gibson and Ravel Morrison). The amortisation charge (how transfers are "charged" in accounts) was basically unchanged at £9.7m for the three months. To put this in context, the c. £40m annual amortisation charge compares to a figure of £83.8m at free spending City in the last reported season (2010/11).

There was a £4.3m "exceptional" charge during the quarter which the club says related to "professional advisory fees" and the need to top up the Football League pension fund. I suspect the "fees" element accounts for the great majority of this £4.3m and relates to advice on the mooted IPO.

The interest charge is spread evenly over each quarter even though bond interest is paid twice a year in February and August. The club recorded a "gain" of £6.5m as the pound rose against the US dollar, reducing the sterling value of the club's dollar denominated bonds.

Taking all these charges and credits into account, pre-tax profit for the quarter was £2.8m, down from £7.4m last year.

Cash - a lot less money than there used to be
As I always say in these pieces, I do not consider the profit and loss account described above to be particularly informative when looking at football clubs below the EBITDA figure. The cash flow statement is often more informative. Cash flow includes real spending on transfers which are after all cash transactions (the amortisation charge is a significant simplification by contrast). For United, lumpy bond interest payments and bond buybacks are also a fact of life that constrain what the club can spend.

Despite their advantages, cash figures come with a warning however. Football is a seasonal business with season ticket revenue collected in the summer, boosting cash balances. The end of the season also see large TV payments from the Premier League and UEFA. Furthermore, prepayments on sponsorship contracts can lead to large positive and negative swings in cash and at United there are large interest payments in the first and third quarters of each financial year. It should be remembered that United are the only football club to publish quarterly figures (a requirement of the bond issue), all other club accounts are struck at the seasonal high point for cash in the summer.

You can see the volatility in United's quarterly cash flow in the chart below which shows how cash builds up in the fourth quarter and runs down through the rest of the year:

Manchester United is not like other football clubs of course, because it has £420m of outstanding bonds. Since the bonds were issued in February 2010, the club has periodically gone into the market and repurchased them (usually paying more than the issue price). These buybacks make financial sense (the bonds cost c. 8.5% whilst cash at the bank barely yields 1.5%) but risk depriving the club of cash needed for investment. It is a choice made by the Glazers and their management team. 

There were no buybacks in the third quarter of the 2011/12 financial year, but since 2010, the club has spent over £92m on them. You can see their impact on the "gross" debt which has fallen by the amount bought back (plus currency fluctuations) and on the cash balance below:

Since June 2011, the club has spent £71m on buybacks and interest payments which together with the other seasonal cash outflows described above has pushed the club's cash reserves down to a low of £25.6m at the 31st March.

As described above, there will be the usual rebound in the club's cash position in the current quarter, although the precise amount is very hard to estimate. Judging from previous years and taking into account the lower profits caused by the CL exit, I estimate the cash position will improve to c. £75m by the end of June.

Will they spend?
The big question supporters want answering is not about buybacks or EBITDA, it's about spending to keep the club competitive after a season when the squad was found wanting at home, but especially in Europe. I can't give an answer to whether the club will spend, only the Glazers can, but the very issue raises big questions over their strategy for running the club.

Since the takeover, Fergie's genius has allowed United to consistently win trophies (with a couple of rebuilding dips on the way) whilst keeping the club's wage spending to turnover ratio very low (45.7% so far in 2011/12 for example) and whilst spending very little on transfers (average net spend of  £16m per season). This combination of controlled wages and low transfer spending is vital for two reasons. Firstly it theoretically boosts the value of the club (if you look at valuation based on EBITDA). Secondly, it frees up profits to service the enormous debts taken on to buy the club. Since the takeover, 18% of revenue has gone on interest. This has been "affordable" because the club hasn't ever really had to "pay up" in either wages or transfers.

Since 2005 the challenge of achieving this financial balancing act has been aided by a number of factors. In the years immediately after the takeover, the 40%+ ticket price rises were crucial. The Ronaldo windfall in 2009 and, to be fair, the rapid growth in Commercial income in the last two years have also been significant pluses. Now however, the trick is becoming more difficult to pull off.

Bond buybacks and interest have eroded the club's previously huge cash balance. There has been spending (£47m last summer) but not on crucial areas of the pitch (United haven't bought a central midfielder since Ronaldo departed). Major transfers cost money twice over, both driving up wages and demanding immediate cash. Wage inflation and transfer inflation across football remain endemic and the advent of FFP appears not to be having any impact on this.

If United are to strengthen, money will be needed and that means no more bond buybacks. It probably means lower profitability, in at least the short-term, with negative implications for the valuation achievable at any IPO. The alternative may well be under investment and the club going further backwards relative to its main competitors.

The Glazers know their structure hampers the club. There was heavy briefing of journalists in the run up to the aborted IPO process last year, suggesting debt would be paid down from the IPO proceeds to make United more "competitive". If the IPO can't be delivered however, the club is stuck with its debt and the owners will have to accept lower profits or further relative decline. Can they square this circle?