Arsenal: An Oasis Of Fiscal Sanity In An Orgy Of Excess – Part I
ByReal Madrid’s spectacular exit out of the Champions League at the hands of Olympique Lyon, on top of the on-going fan protests at Manchester United , has me pondering the question of club ownership models.
There’s no denying that football, unlike most consumer products, enjoys a socio-cultural significance that transcends the purely commercial. It would be absurdly reductionist therefore, to simply dismiss ownership concerns with the usual “free market” paradigm that badly run clubs will go bust while the cream will rise to the top.
Supporters are significant stake holders in the game and some mechanism has to be evolved that’ll give them a chance of saving clubs from poor management. I take this aspect of fan participation as a given and as extremely important.
What I’m not clear about at all is the management model that best serves the objective of fan participation. In this 3 part article series, I’ll outline my understanding of the issue and the reasons for my quandary, and invite readers to debate the subject
The question is this: Is there a management structure whereby fans, represented by some collective body, can realistically reign in the plans of a club’s board to play fast and loose with debt?
Given that the primary sources of revenue at clubs are media rights, commercial activity (sponsorship, merchandise etc.), match day revenue (tickets and hospitality); the demand for top talent, and the resultant transfer fee and wage inflation- often cited as the key causes of unsustainability – are natural consequences.
I personally think it isn’t the wages and transfers per se that are the problem. It is the use of excessive debt to finance the show.
The attractiveness of debt in funding ventures is illustrated in the table below (I have ignored tax to simplify the illustration). It can amplify both profits and losses dramatically for the equity holder.
- Debt 10 14 10 14
- Equity 10 6 10 6
- Total Capital 20 20 20 20
- Revenues 25 25 18 18
- Revenues/Assets 125.00% 125.00% 90.00% 90.00%
- Interest @ 10% p.a. -1 -1.4 -1 -1.4
- Debt Repayment -10 -14 -10 -14
- Net Return on Equity 4 3.6 -3 -3.4
- % Return on Equity 40.00% 60.00% -30.00% -56.67%
KEY: The cluster in column 2 indicates the amplified profit while the cluster in column 3 indicates the amplified loss.
This means that when the going is good it’s party time for the equity holder. However, this being a double edged sword, in troubled times the margin for error is dangerously low. The more leveraged you are the more amplified your losses are due to even small drops in revenue.
At an extreme, this leads to bankruptcy where your debts exceed the value of your assets. The key fact is that it doesn’t take much for the show to begin unwinding. When the larger economy gets into trouble, as it has globally today, two things happen; your revenues fall and lenders become wary of renewing your loans if you’re already highly leveraged.
At a minimum, they’ll insist you pay a higher interest rate which given the already falling revenues affects cash flow and threatens your solvency (the ability to pay bills in a timely fashion). This typically, is Act 1 in most unwindings.
Timing, therefore, is everything; If you’re caught short by circumstances- typically a bust of some sort- then you’re inevitably toast.
In this article series, I take a look at two clubs with very different ownership structures to see if either affords better restraints against debt accumulation; Manchester United and Real Madrid.
Manchester United
My sense is that in concert with the global boom following the dot-com era , the Premiership’s global popularity excited people a bit too much.
It is my view that most leveraged and debt heavy takeovers of clubs – Manchester United, West Ham, Portsmouth – were attempts to get in early on the game with borrowed cash that was then cheaply available and in abundance. The plan was to then whip the business into shape extracting ever more revenues, and finally selling out at a profit enjoying a lovely return on equity after the debts funding the takeover have been cleared.
The industry parlance for this is “LBO”, short for Leveraged Buyout. The Glazers followed this blue print to a tee before the “credit crisis” threw a spanner into their works.
As evidence to back this view I offer up some extracts from the following links:
Key Extract:
The Glazers bought the club for £810m, a fortune pocketed greedily by enough shareholders in what was then Manchester United plc. The Glazers paid £270m themselves, borrowing the other £540m from banks and hedge funds.
In the four years up to the latest accounts to 30 June 2009, United became liable to pay more than £325m in interest alone, yet the interest they have not paid, plus fees, has increased the debt the Glazers loaded on to United to £700m.
2) Extracting ever more revenue out of the asset
Key extract:
…independent Manchester United Supporters Trust (MUST), which claimed that since 2005 season-ticket prices have soared by between 50% and 60%. MUST also claimed the club was acting unfairly by “forcing” season-ticket holders to buy tickets for all home cup ties. It alleged the club was making fans sign a “blank cheque” for home cup matches.
3) Rolling out a fresh bond issue to refinance £500m of the loans.
Let’s remember that not one penny of these amounts have been investments in the club. They have simply financed the takeover of the Glazers. It is Manchester United that’s liable for the debt, not the Glazers.
Yes, they’ll take a hit on the equity they put in, but they’ve already paid themselves £22.9m in the form of various fees out of the club’s revenues.
The prime example as to how perilous such leverage can be is illustrated in the following statistic
.
“Without the sale of Christiano Ronaldo, Manchester United, who announced pre-tax profits of £48.2m today, would have been reporting a loss of £31.8m.
That it has taken Ronaldo’s sale to generate a profit despite the club performing consistently well both domestically and in Europe in recent years should be cause for grave concern. They have Wayne Rooney who’ll fetch a good valuation in a pinch too; but what then?
Even doing a domestic and European double, year after year, isn’t going to guarantee a healthy level of profitability it seems. Let’s not forget, too, that the world isn’t yet out of the woods economically; can ever growing media and commercial sources of revenue be taken for granted in such an environment?
In my view, the state of football financing and ownership should never be allowed to come to this ever again.
The whole sorry episode is summarised in the following set of questions asked by MUST of David Gill.
My question to our readers is this: On the above evidence, do the Glazers seem to you to be interested long term investors, or financial mavens looking for a quick turnaround on their investment despite being blindsided by the Credit Crisis?
I’m not suggesting they were oblivious of the possibility of crisis; but that they, like many others, may have misjudged the depth and duration of the beast.
I’ll post my views on the circus that is Real Madrid in the next instalment and then sign off with my thoughts on what I think are avenues worth exploring to safeguard fans’ interests.
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Tue 13th September 2011; 19:45, Dortmund
This blog is consistently articulate and analytical in it’s views be it tackles, punditry and now finance. Pleasure to read everyday.
I find your article interesting, and i think any coherent argument on this subject is to be encouraged.
I would point out, however, that the fundamental premise (that football clubs are what we might call ‘quasi-public’ entities, due to the ‘socio-cultural’ nature of football) sadly doesn’t represent any reality in law. Although an ideallist might like the law to see it that way, and most clubs outside the elite group probably view themselves this way, the fact is that a club is a limited company trying to generate profit for its shareholders, and as such is open to any such ‘management model’ seen fit by those in charge of managing the business.
One cannot simply gloss over this.
Saloner.
Interesting topic for a debate – especially when we’re being suffocated by the eulogy of the footballing career of David Beckham – there’s nowhere to hide from it.
Football really has a dilemma because as you so rightly point out, a football club is more than just a business in that it carries more than just the emotions of it’s supporters. It’s part and parcel of any society’s identity and plays a very important role as a unifying hub that people from all walks of life can build a common purpose around.
I can’t remember who said it, but it rings true when you hear the statement “you should watch football, not invest in it”.
From a bare bones business point of view – it’s hard to see how a football club can actually make a tidy profit. For those that do like Arsenal and to an extent Man United, the commercial and off the field activities play a critical role in generating revenue.
Match day revenue is no longer a viable option to stay afloat and if you don’t have the millions of fans around the world like the big clubs do – then it’s just a tall order to keep up with the pace.
Debt then becomes a strange bed fella and unfortunately for football, the board rooms aren’t filled with the sharpest knives in the drawer.
I work in the financial markets and I’m very familiar with the devil that is leverage. It’s a bastard I tell you and as much as you can increase your profit margins significantly, a mental lapse or poor judgement in hedging your position can unleash the mother of all disasters for you.
Good things these computers are you know – at least you can fix stop losses to automatically bail you out when things go pear shaped….LOL.
Unfortunatley, football clubs don’t work like that.
With regards to Man United, the dilly dallying wwith that obscene amount of debt is only viable as long as the club is successful. The deal breaker for me is going to be the retirement of Alex Ferguson.
There is no guarantee that the next manager at Manure will be as successful and therein lies the beginning of the end of the debt madness.
Lady Arsenal….
Great points – as they say, emotion has no place in a board room…and this rings so true for many football clubs.
All you can hope is that the current owners have a so conscience.
Incidentally, Arsenal does have a supporters trust who collectively own 1% of the football club. The Arsenal supporters trust regularly have an audience with the CEO of Arsenal and I think some times a board member, but their relationship and influence into day to day or into strategic management is based on goodwill and a desire to keep a healthy dialogue between the board and the fans.
Membership to the Arsenal supporters trust is open to anyone so technically, as a member, you get to own a piece of Arsenal football club.
NashIsArsenal: I’m glad you enjoy our efforts. Thanks for taking the time to express your appreciation; it is fuel to our endeavours.
Lady Arsenal: It is true that clubs are limited companies. In fact, as the final, and third, episode of this series will illustrate, I want them to remain limited companies that seek profits. What I seek though is a structure where fans are in a position to rein in the riskier attempts in seeking such profits. They must have representation on the board with a vote that commands weight.
Please stay tuned in to the coming instalments and do contribute your thoughts in the comments. I think the recent credit crisis has impacted football in a manner that should alert fans to explore ways of having a stake and a voice in their clubs. My article is but a baby step, among many such voices and endeavours, in that direction.
We, at the Arsenal, are blessed with a prudent board and coach. Not all clubs are so blessed; and there’s no guarantee we’ll always this privilege indefinitely either. Hence my wish to start a discussion here on this blog.
Oops! Correction: “…and there’s no guarantee we’ll always this privilege indefinitely either” in my comment above should read:
“and there’s no guarantee we’ll enjoy this privilege indefinitely either”.
Darius, perfectly true.
I’m very heartened to see this supporters’ trust movement taking root. But until such trusts have a vote and voice that command weight, football clubs will be hostage to fortune hunters.
While the obvious – atleast in theory – option seems to have a trust that has a substantial shareholding the coordination problems inherent in the endeavour are damning. Whether there can be a legal solution that defines a supporters’ trust and gives it reasonable powers is something I’m pondering.
I think what with global media reach, a well run club can be profitable if only moderately. I’d also wager that there are enough investors ready to invest in football on the basis that prudent management can enable one to eke a relatively small but steady profit. I fear though that such investors are driven away by the more wild-west types running clubs these days. What prudent investor would want to get into a business where an oil sheikh and a Russian oligarch, to offer but a selection, are indulging their fantasies? But by the time this crisis runs out, and I think the world is in for quite some pain for awhile yet, a lot of this adventurism would have been stopped in its tracks. Sadly, quite a few clubs will have suffered the collateral damage too. Portsmouth was just the first act.
But, that reminds me that I’m typing out most of my envisioned instalments right here in the comments! So, I’ll zip up now.
Very Good article, Saloner & Darius. This blog is growing from strength to strength. I told you, Darius, that your analytical mind will make your blog exceptional. Here we are. The baby is fast out-growing the bath bowl, isn’t it?
The management model that allowed the Glazers to leverage ManU so easily is not in any way beneficial to Football. Besides money, emotion is also invested by quite a large number of people in the football club. This makes a football club slightly different, as a plc, to othe limited companies. Surely a structure should be in place to provide a sort of ‘Check & Balances’.
Good article. The world of football finance is shrouded with mystery so it’s good to get a clear message. Villa’s Randy Lerner is an example of an American owner who hasn’t landed the club with dangerous debt.
Saloner,
I would like to first echo the prior comments and applaud you on an incredibly insightful article. This is obviously something you saw fairly clearly a few years ago when the media were enthralled with the so-called investments being plowed into Man Utd, Liverpool, Portsmouth, West Ham; at the same time the very same media were claiming Arsenal were falling behind because they resisted overtures from the likes of Usamov.
On the broader issue of football and leverage, a flawed foundation of how much leverage to employ is optimal capital structure; basically the ideal proportion of debt-to-equity so as to maximize earnings. Glazer, Hicke, etc. all apply it to some degree. When considered carefully there is a probability of insolvency always factored in to the calculation. What’s more, in the case of football there is incredible variability in revenue (Champions league, Uefa qualification, relegation) in addition to refinancing risk.
The rosy picture all of these leveraged owners all bring up is a world where they will always qualify for Europe and such. In a little noticed comment recently, the Arsenal board impressively noted that it had factored into its cashflow security not making the Champions League one out every four years. Conversely, it looks as if Liverpool will have to sell massively this offseason if they don’t make the Champions league, and are even in greater jeopardy if they are shut out of Europe entirely,
Again, great article.
LRV, Paul Jeffrey and Bomba, I’m glad you found the article a good read. Thanks, also, for taking the time to express your views.
If there’s one thing that can be suggested to be at the root of the current economic troubles it is delusional levels of optimism, or, perhaps a bit more bluntly, delusional greed.
Football clubs have to have some defence against these excesses. What those defences can or should be is a question whose time is here.
Can someone clarify why this really is in the news. I do not even know who she is, or her husband, and does it matter. Why do we normally have to hear about each little detail of some celebrity when truly distinct that the only purpose may very well be give them some media exposer. Personally, who cares, I do not.