"The Capitalist Tool" + "the Red Knights" = total journalistic confusion

"The Capitalist Tool" is not Joel Glazer's nickname from his time at college, but the motto of US business magazine Forbes.  Last week Forbes, enthusiastic cheerleaders for the unfettered free market, published its annual list of the world's most valuable football clubs (they do a similar exercise for NFL franchises).  No doubt you will have seen that United top the list with an estimated valuation of $1.84bn (£1.19bn).  This estimate caused much confusion among journalists, many of whom saw the numbers quoted as being very bad news for the Red Knights consortium that is hoping to bid for United.  This article from the Telegraph was typical:

The Red Knights, a group of wealthy businessmen, are attempting to raise funds to launch a takeover bid at Old Trafford, but the Forbes figures suggest they must raise well in excess of £1 billion if they are to make a viable offer for the club.

Unlike some football money surveys (yes I'm talking to you Deloittes), the Forbes one has some financial logic to it.  This is how it is constructed.....

They take EBITDA before profits and losses on player trading - this is what they call "Operating Income".  For United they have a figure of $150m which is roughly consistent with Red Football's pre-exceptional EBITDA for the year to 30 June 2009 of £92.1m (the average exchange rate for that period was $1.603 which actually gives a dollar number of $147.6m but its pretty close).

EBITDA is a very common measure of profits used for valuing companies, perhaps the most common.  It has some disadvantageous when applied to football clubs because it takes no account of transfer spending (something no club can avoid in the long-term if they don't want a team of pensioners and a cost that can sink a club - see Pompey and Leeds for example), but as I say, its a commonly used number.

When you value a business using a multiple of EBITDA (which is profits before interest), the number you end up with is a measure of the "enterprise value" (or "EV") of the company.  Enterprise value is "capital structure neutral", it measures the value of the debt and the equity of the company (see Wikipedia's perfectly sensible article on enterprise value for more details).  Forbes confirm this is their approach in the footnotes to their survey:

Value of team based on past transactions and current stadium deals (unless new stadium is pending) without deduction for debt (other than stadium debt).

Other than this footnote, Forbes give no further information on how they arrive at their chosen "multiple" of EBITDA which drives their club valuations.  United's multiple is 12.2x, whilst Real Madrid's is only 10.2x which is odd.  Forbes say they use "past transactions", but the Glazers' paid almost 17x for United in 2005, and Real Madrid is of course structurally unbuyable which means its "value" is something of an oxymoron, can something you can never buy or sell have a value?

The JP Morgan research report on United helpfully included the EBITDA multiples paid (or offered) for stakes in ten European clubs (including the Glazers buying United).  The multiples ranged from a low of 12.2x implied by the Rhone offer to buy 40% of Liverpool to the 18.9x paid by Roman Abramovich when he bought Chelsea.  His presence on the list, as well as football finance geniuses like Hicks and Gillett shows the problems with valuing big clubs.  There are so few precedents and all too often the price is crazy and irrational.  There is no efficient market for assets like Manchester United, the number of individuals who could afford the club is tiny. Anyway, Forbes' 12.2x used to value United looks perfectly sensible as United's profits are hardly depressed, indeed JP Morgan show last year being the peak for a few years to come.

So Forbes value United at £1.19bn.  Where journalists such as Mark Ogden at the Telegraph get confused is that they forget that this includes United's debt.  Forbes says there is $844m (£518m) of debt which I assume is the bank debt on the balance sheet last June.  This obviously excludes the PIKs, but that really doesn't matter.  The £1.19bn is their estimate of the value of the whole business.  The debt figure you use just drives the equity value (the value of the Glazers' shares in United).

Which brings us to the Red Knights.  Articles such as this one by the ever sensible BBC Sports Editor David Bond (ex-Daily Telegraph himself) suggest the Red Knights will offer around £1.2bn.  Let's be totally clear here, this number is the enterprise value of United, it is completely comparable with the Forbes valuation.  David Bond goes on to suggest that the Red Knights intend to keep United's bonds in place in the short-term (something I wrote about recently).  So if the offer was c. £1.2bn and they kept £534m of bonds, the Red Knights would need to raise around £700m to fund their offer.

Hopefully you can see how the confusion has arisen between the £700m described in the paragraph above and the £1.2bn Forbes valuation.  If the Glazers sold Manchester United to the Red Knights at Forbes' valuation, the Red Knights would pay them around £700m in cash, the Glazers would have to pay off the PIKs, leaving them with around £500m for their (and our trouble).  And the rest of us would go back to worrying about Rafael Da Silva's immaturity vs. his undoubted natural talent.

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

Soccerex: teak, catsuits and David Gill

How many trade fairs are there that have the guts to have a stand manned by a Hollyoaks actress dressed in a skin tight lycra catsuit?  And if that wasn't too distracting, you could discuss investing your fans’ hard earned money in a teak plantation or you could spend it at the bespoke tailors stand.  Burnley FC had a stand too but they were wearing moustaches not catsuits.

Of course the main business of the day at Soccerex was Matt Lorenzo's interview with David Gill, arranged before the Red Knights' announcement.

As a jilted pen pal of David's, I had a chat with Matt Lorenzo at lunchtime to try to find out what the format would be and whether he would pick me to ask a question in any question and answer session.  At that point even Matt hadn't been told what the format was, but I was confident enough to spend the next three hours trying to formulate the question.

Unfortunately about five minutes before the session started, it was announced that there would be no questions. To be fair to David and Soccerex, this was a private event at which he was an invited guest so they could have whatever format they wanted (not to mention the fact that they allowed the BBC and Sky to record it).

It is frustrating however that the big issues about the Glazers impact on United can NEVER be debated with either the club or its owners.  If everything really is so rosy, what is there to hide?  When so many of your customers are worried, isn't it good business to speak to them?

Although it has given the media some good copy, David's comments on the Red Knights should come as no surprise.  He clearly loves the job of running the club and is very good at it.  He is (as he reminded the audience), an employee and I imagine he wants to keep his job.  I don’t know what he really thinks about the Red Knights, but as we are at such an early stage, it would be inconceivable for him to say anything positive in public even if he was secretly in favour.

I would like to touch on one issue he raised.  How the club would be managed if acquired by Red Knights/fans (I've taken the following quote from the Telegraph because they had a more expensive dictaphone than me):

“The Red Knights’ idea of having 20, 30 or 40 very wealthy people owning and running Manchester United, I just don’t know how it would work in practice,.

“The best clubs, the better run clubs have clear single-decision making that is quick and efficient. I don’t see how if you’ve got a number of very wealthy people being involved [that can happen].

“They don’t become wealthy through luck, those sort of people want to be involved in the decision making, The key clubs, Abramovich at Chelsea, Mansour at Man City, Berlusconi in Milan, even the president, the key decision maker at Madrid is not all those fans, it’s the president.”

Let’s not dwell on the Madrid point, suffice to say most United fans would have liked a vote on the Glazers.  The “single owner = quick decision making” argument is frequently made by both David Gill and Sir Alex Ferguson.  From their point of view, I can see that it does make life easier, but it’s hardly the most important factor when thinking about who should own United.  Is it really worth the £266m the family have cost us?  I bet they don’t even have to dial the numbers themselves.

Some clubs owned by one individual are run very well and some are run very badly.  Think of such visionary leaders as Robert Maxwell, Ken Bates or Vladimir Romanov.  The same goes for clubs with a broader ownership structure, what the Spanish clubs show, is that management can be separated from ownership, the same can be seen in Germany.  Berlusconi is a curious role model for good governance, would Keith Harris really be worse than a man who had to change the law to avoid being convicted on numerous bribery charges?  Holding Manchester City up as a model for anything is of course laughable and I put it down to David’s stressful week.  Not only is it far too early to assess the “project” at the council house (we'll have to wait another three or four managers before we can do that), but Sheikh Mansour appears to have already succumbed to City disease with his decision to keep Gary Cook in place.

I know where David is coming from of course, he is picturing some hellish “Dragons Den” to decide transfers with multi-millionaires quizzing potential signings.  Of course it wouldn’t be like this.  There would be a board of directors (on which the Red Knights would want David to sit as Chief Executive) which would set budgets and so forth.  I imagine the Glazer family do a similar thing now and then, the meeting where they voted to borrow £10m from the club must have been a hoot.

Maybe it would take more than one phonecall to Florida to buy a player under a new ownership structure, but the person at the end of the phone won’t be the same person who is stripping cash out of the club in dividends and fees and charges.

David said the Red Knights would want to be involved in the decision making because that’s how they became wealthy.  Nobody would put a penny into a Red Knights offer if it was a club class version of Ebbsfleet United.  And successful business people well understand the importance of delegating and appointing people with the right skills to do the specialist roles. The owners would elect the board and the board would run the club.

When the only thing the club’s (presumably expensive) PR machine can come up with is “but we’ve got a streamlined decision making process” it does make me wonder whether things may be worse than we thought. Are the supporters really expected to think that the club's ability to tie up the signing of Chris Smalling very quickly outweighs ticket prices rising over 45% in 5 years? 

So goodbye Soccerex in sunny Manchester, the next one is in Rio I think.  Too warm for catsuits there.