28th November 2016

Blog

 

4th December 2017

If you take a quick look at our ‘in the news’ page, you will see many recent additions to our growing list of media exposure surrounding the weekend’s outstanding English Premier League fixture (Arsenal vs. Manchester United) and its status as the first billion pound game in English football.

As interest in the story went global (Australia, the Far East, Middle East, Europe, the UK and beyond), the fact remains that the Premier League and its representative agencies were nowhere to be seen. One might have thought that such a momentous point in the English game’s history would have been noted, if not highly publicised, as another example of success in the seemingly unstoppable growth in Premier League club revenues.

Indeed, as we worked through our media commitments during the week leading up to the game, we were expecting to be usurped by what has been a very efficient and effective PR and marketing function for football’s upper tier. What surprised us was the roaring silence and lack of activity.

Historically, the Premier League’s principal success criterion has been the level of revenue, – something that is frequently repeated across the football world. Indeed the annual report on Premier League clubs conducted by a certain firm of accountants inevitably waxes lyrical about the health of the game based on revenue growth, the increasing value of TV rights etc. The record never really changes as the numbers get bigger every year. However, as we continue to point out, examining the iceberg above the surface but ignoring the depths beneath the waves hides a multitude of truths, and so it is for football.

For the two clubs with combined annual revenues of just over £1bn, the fixture hid a number of potentially worrying economic trends. Both clubs have incurred economic (where all the charges of conducting business are taken into account including a charge for capital – see methodology) losses in each of the last four years with only one achieving an economic profit in the last seven years – Man. Utd in 2013.

The two clubs have accumulated revenues of £5.14bn since 2011 and yet have managed to generate accumulated economic losses of £240m over the same period, of which £154.51m resides in North London.

The Premier League table on the morning of 2nd December highlighted the general advantage that the high-revenue, free-spending and low economic return-generating clubs have over their more-financially prudent adversaries. It pays to have a generous benefactor, but the destruction of value is still eye-watering.

 

Recently, the fixture lists have thrown up some real gems from an economic perspective. In the EFL, we had the ‘Game of Woes’ on 18th November 2017 whereby the two most economically-challenged former Premier League clubs (QPR and Aston Villa) took part in a Championship game with combined economic losses of £311m over the most recent 5-yr period. This serves as a good example of the downside of top-flight football where ambition has stretched beyond financial and economic sensibility. Despite the presence of ‘generous benefactors’, both clubs have ended up in severe financial and economic difficulty with QPR incurring a £40m fine from the EFL as a direct result of its financial behaviour.

Next weekend we have the “Manchester Derby” game which is the most valuable game in the Premier League to-date when viewed on a combined club revenue basis (£1.054bn, although Man City’s revenue of £473.4m is over a 13-month period). If you think Arsenal’s economic track record is poor, then look out for our Matchday Metrics service to find out just how far and away Manchester City’s economic performance has been relative to the rest of the clubs in the division. In this case, it helps to have a state-backed ‘generous benefactor’.

So, what are we to make of the senior division’s “administrative silence” regarding the first billion pound game? Perhaps it has come around to our way of thinking and has realised that it is not just about the revenue? Or it may be the case that combining club revenue numbers is an ‘irrelevance’. If so, have we seen the last of annual revenue ranking tables and reports? Will the combined annual revenue number for the Premier League (which we think will be about £4.38bn for 2017 – up from £3.61bn last year) for the division be consigned to oblivion? Probably not.

One thing is certain – we’ll be ready once again for the most valuable game in the fixture list next weekend.

vysyble

 


 

 

 

 

 

 

 

 

 

 

 

25th November 2017

For several weeks, if not months, the future of Newcastle United has been the subject of huge conjecture across the media, within the city and the football world.  Given that one of us is a Newcastle United fan, this time and rather unusually, it is not due to the immediate prospects of the team or whether Rafa Benitez is likely to stay for period long enough to build a team to rival Real Madrid. No, this time it is whether the club will be sold and if so for what price and more importantly for the fans, how much will Mr Benitez receive to build the team following the successful conclusion of an acquisition.

In The Guardian (21st November 2017 – “Ashley seeks improvement in Staveley’s near £300m bid for Newcastle United”- Louise Taylor), it was reported that Mr Ashley “had hoped to a make a greater profit by selling for a sum somewhat closer to £400m”. In a further development Jason Mellor, writing in The Daily Star (22nd November 2017), reports that Mr Ashley is seeking closer to £350m. So the “value” between the various parties seems to be between £290m at the lower end and £400m at the upper end of proceedings.

Valuation

As is so often the case, there has been no shortage of advice with regards to how a football club should be valued.  One commentator from a UK university business school recently sought to value Newcastle United based on the price paid for a stake in Southampton  FC – a club with a very different profile, fan-base, economic track record, marketing potential and so on. Indeed, such an approach is a “relative valuation” – unfortunately a very common position yet it is the intellectual equivalent of valuing a pair of “hand-made Jermyn Street shoes” on the same basis as a pair of ‘wellies’.  It is an all-too-relaxed view but perhaps it is easier than actually having to think, consider and find answers to the inevitable trade-offs that come with such a transaction.

There are two broad approaches to valuation:

  1. The business is worth what someone will pay for it
  • Used in the main by investment bankers and other analysts to estimate the potential price of an asset by examining the pricing of “comparable” assets relative to a common variable such as earnings, cash flows, book value, sales, etc
  • Uses P/E and other heuristics “rules of thumb” to “value” (figure out what someone might pay for) the business
  • Says little or nothing about what the intrinsic value of the business is
  1. The business is worth the present value of its future cash flows
  • The “Investor” perspective
  • “Fundamental” or “Intrinsic” value

The uses and misuses of relative valuation (“heuristic” valuation)

Prices are, in effect, “standardized” by using a common variable such as earnings, cash flows, book value or revenues, eg:

Earnings Multiples:

  • Price/Earnings Ratio (PE) and variants
  • Value/EBIT
  • Value/EBITDA
  • Value/Cash Flow

Book Value Multiples:

  • Price/Book Value(of Equity) (PBV)
  • Value/ Book Value of Assets
  • Value/Replacement Cost (Tobin’s Q)

Revenue multiples:

  • Price/Sales per Share (PS)
  • Value/Sales

Industry Specific multiples:

  • Price/subscriber, etc

Relative valuations might give some idea of “what similar businesses or assets are selling for.” However, because they are incomplete measures of performance, there is a danger that they tell us little about “what the asset or business is worth.”

Thus;

Belief: Price-Earnings Multiples determine value

Reality: Price-Earnings Multiples are a function of value

Arguably the investment community’s favourite valuation metric is the price-earnings (P/E) multiple.  A measure of what investors will pay for a share, the multiple equals the stock price (P) divided by a company’s earnings (E).

Investors incorporate it in a deceptively simple valuation formula:

Shareholder value per share = (earnings per share (EPS)) x (P/E). 

Since we know last year’s EPS or next year’s consensus EPS estimate, we need only to determine the appropriate P/E.  However, since we have the denominator (earnings or E), the only unknown is the appropriate share price, or P. Therefore, we are left with a useless tautology: to estimate value, we require an estimate of value.  This flawed logic underscores the fundamental point:  the price earnings multiple does not determine value; rather, it derives from value.  It is an economic cul-de-sac.   

Not wishing to labour a point, one can get to the same answer by the following:

Price = Age of the CEO multiplied by Price divided by Age of the CEO

OR

Price = Number of potted plants in reception multiplied by Price divided by number of potted plants in reception

It would be wrong to draw the conclusion that waiting for the CEO to grow older or putting more potted plants in reception will lead to a higher share price, wouldn’t it? 

The business is worth the present value of its future cash flow

Aswath Damodaran, Professor of Finance at the Stern School of Business at New York University (Kerschner Family Chair in Finance Education) states:

“The value of any asset is a function of the cash flows generated by that asset, the life of the asset, the expected growth in the cash flows and the riskiness associated with the cash flows”

Value Creation and Enhancement: Back to the Future – 1999

This is the basis of a fundamental cash flow approach to valuation.  However, regular readers of our material will know that for a variety of reasons, most notably the inclusion of all of the costs of doing business, that the application of economic profit is fundamental to our research.  It is perfectly consistent with the above quote from Damodaran to use forecasted economic profit to establish a business valuation for the reasons outlined below:

In other words, the Enterprise Value of an organisation is the present value of its future cash flows. Enterprise Value is also equivalent to Invested Capital plus the present value of the future stream of economic profit.  Therefore, the present value of future cash flows = Invested Capital plus the future stream of economic profit (often known or referred to as the “warranted market value added”) – see below:

For those who want to read even more on this subject, the paper “Valuing Companies by Cash Flow Discounting: Ten Methods and Nine Theories,” by Pablo Fernandez (IESE Business School, University of Navarra), is both excellent and worthy of further investigation.

The Economic Performance of Newcastle United FC

So if we are going to prepare a valuation based on the forecast economic performance of Newcastle United – it might be a good idea to place on record the club’s recent performance.

Newcastle United’s Economic Performance 2012-2016 (latest accounts). In three out of the most recent five years of accounts, the club has produced an economic surplus. The accumulated EP over the period is £16.9m ie an average of £3.38m per year. Over the last three years it is an average of £7.98m. NOPAT = Net Operating Profit After Tax  (not No, Pet…).

 

From our work on the rest of the Premier League, the above track record is pretty good.  Most clubs within the Premier League fail to produce any kind of economic surplus – in fact across all of the clubs within the Premier League going back to 2009 there is only a one in four chance of a club producing a positive economic return. In the last five years, Newcastle United have produced a positive return on three occasions.

How much does economic profit have to grow to justify a purchase price of £300m (purchase price in this instance being the equity and the debt)?

At this point, we need to be very clear – we have not seen the latest numbers for the club. We are using the latest published annual accounts dated 30th June 2016, although it is highly likely that the economic performance declined in the year to 30th June 2017 as the club was relegated to the Championship. Clearly, any entity that conducts due diligence on the club will have access to the latest and unpublished accounts.

We are trying to prepare a fundamental valuation of club over the next 10 years, which we will discount back (pounds in the future are worth less than pounds now) at an assumed cost of equity.

Our assumptions are;

  1. Invested Capital – £192.05m (drawn from the annual accounts dated 30th June 2016)
  2. Average EP over the last three years – £7.98m
  3. Assumed cost of equity (Ke) = 9%
  4. Growth in EP; year 1 to year 5 = 2% per annum
  5. Growth in EP; year 6 to year 10 = 2% per annum
  6. Growth factor in terminal value = 1% per annum

The terminal value is designed to take account of any wealth or value creation, which might occur beyond the analysis period, in this case after the 10th year.

How much does economic profit have to grow to justify a valuation of £400m?

Our assumptions are;

  1. Invested Capital – £192.05m (drawn from the annual accounts dated 30th June 2016)
  2. Average EP over the last three years – £7.98m
  3. Assumed cost of equity (Ke) = 9%
  4. Growth in EP; year 1 to year 5 = 10% per annum
  5. Growth in EP; year 6 to year 10 = 10% per annum
  6. Growth factor in terminal value = 2% per annum

Incorporating those assumptions into our model produces an enterprise value of £400.8m.

Therefore, to reach a valuation of £400m, the growth in EP over the years 1 through to 10 has to be 5 times greater than the £300m valuation and the terminal value growth assumption has to be twice that of the £300m  calculation.  

We will leave the reader to decide whether the assumptions underpinning a £400m valuation are “achievable.”

For those fans who believe that the club can afford a £100m “transfer spree” in January – there is this sobering thought.  The club’s cost of capital is probably around 7.5% and if the club was to spend £100m the incremental capital charge would be £7.5m – given that the average EP over the last three years is £7.98m – the capital charge together with the inevitable increase in wages would almost certainly push the club into negative economic territory.

Conclusion

In general, analysts use simplistic and inferior multiple-based methods (“easier than thinking”)

Stock valuation methodologies tend to fall into one of three categories:

  1. Earnings or cash flow multiples including: price-to-earnings ratios; relative price-to-earnings ratios where the benchmark is other firms in the industry; earnings before interest, tax, depreciation, and amortisation (EBITDA) multiples; and revenue multiples
  2. Asset multiples, which are often market-to-book ratios, where “book” refers to either equity (i.e., net asset) book value or total asset book value
  3. Multi-period DCF models typically use projected free cash flows, or economic profits, which are derived from comprehensive financial forecasts of firm performance along with estimated discount rates.

Analysts tend to use methodologies 1 and 2 outlined above – these are relative valuations.

No doubt there will be some who will say that “City Analysts” are correct but we are reminded of the quote from the great sage of Omaha, Warren Buffet;

From our perspective, what the above tells us is that a £300m acquisition price for Newcastle United is certainly a stretch but it can just about be defended when viewed through an optimistic lens.  At £400m, the assumptions used to justify such a commitment are bordering on the incredible whereby EP has to grow at a rate 5 times greater than the EP assumption underpinning the £300m price tag. Furthermore, this particular line of thought seems to be based on an in-going assumption that there is an “investor premium” involved when acquiring a Premier League football club.

Finally, another health warning – we are using numbers relating to June 2016 and we have not had sight of the latest financial information – until this information becomes available we are loathe to produce a “fair value” assessment of what we would be prepared to pay (assuming that we had the money) for the great club that is Newcastle United FC.

vysyble

 


 

 

 

 

 

 

 

 

 

 

 

16th October 2017

Introduction

It is not our intention to write a ‘blog’ every time a club from the Premier League publishes their latest accounts.  However, in this case we will make an exception – the fortunes of Arsenal regularly crop up as a discussion point when we deliver presentations as part of our work with clients.  Arsenal may not have won the Premier League since the 2003-4 season but after Manchester United, it is the club where the most questions regarding the club’s economic position are forthcoming.

With several well-known “celebrity” fans – Piers Morgan is a regular commentator (and latterly a critic of the club’s manager, Arsene Wenger) – plus Idris Elba, Colin Firth, Joan Collins, Barbara Windsor, Alan Parker, Sam Mendes, Rory McGrath, Nick Hornby and Roger Waters ranking amongst the long-list of high-profile personalities who have pledged allegiance to the North London club, it is not entirely surprising that interest in the club is so high.

The ‘Bank of England’

If we go back almost 100 years to the 1920s, with the club under the innovative stewardship of Herbert Chapman, Arsenal developed a reputation for big spending and for even bigger gate receipts. It wasn’t long before the club became known colloquially as the ‘Bank of England’.  In the minds of the public, this reputation is seemingly an enduring one – even today when people, irrespective of their football allegiance, ask us about our work they often begin with the following assumptive question;

“Well, surely Arsenal must be the best performing club financially….” 

Through the revenue lens

Indeed, when one looks in isolation at the club’s revenue performance over the period 2012-17, one can only be impressed.  The club has produced an absolute increase in revenue of £181m or 74% and furthermore, at a compound rate of growth 11.8% per annum.

Fig. 1. Arsenal’s revenue growth profile.

 

Our clients in the commercial sphere would undoubtedly envy such performance and when viewed through this lens the club’s “Bank of England” reputation would appear to be in safe and secure territory.

However, the great Roberto Goizueta – CEO of Coca-Cola between August 1980 and October 1997 (and surely a candidate for the most outstanding businessman of the 20th Century in producing returns for shareholders over his tenure of close to 7,100%) once said;

“The curse of all curses is the revenue line”

Goizueta was referring to the difficulties managers, owners and executives have in saying “no” to revenue even when it is clearly value-destroying as well as highlighting the dangers of judging the economic health of an organisation purely from the revenue line.  Sadly, and despite the great man’s wise counsel, the myth that all revenue is value-enhancing perpetuates to this day. It is something that is experienced almost daily in business consulting.

Economic Profit – a more demanding measure of performance

We prefer the use of economic profit defined as net operating profit after tax less a charge for ALL of the capital used by the organization.  Furthermore, when working with clients, we advocate looking at economic profit over time.

Set out below is a graphic showing the revenue and economic performance over the period 2012 through to 2017:

Fig.2. Over the period 2012-17, revenues equalled £1.9bn. However, there is an improvement in economic performance with the club posting a relatively minor loss of £4.4m in 2017 although over the six years of analysis, the club has produced a total economic loss of £133.8m without any incidence of a surplus.

 

What is going on here? Despite impressive revenue growth and whilst there is a significant improvement in 2017, the club has not produced a positive economic profit over the last six years.

Often the best way to discern organisational performance at a more detailed level is to analyse the movement across the constituent parts of the economic profit calculation; in this case revenue, costs including taxation, NOPAT, the charge for capital and the resulting economic outcome between the beginning and the end of the analysis period.

Fig.3. The increase in revenue is £181m whilst costs have increased by £175m. The capital charge has increased by £5m which means that there is an overall increase in economic profit of £1m. Evidently, and more importantly, revenue and costs are broadly in line.

 

What this evidently illustrates is that the impressive growth in revenue, which amounts to £181m between 2012 and 2017, has been closely matched by an increase in expenditure with costs rising by £175m over the period.  This demonstrates the danger of judging organisational performance on revenues alone as, in this case, we can clearly see that almost all the impressive revenue growth has been taken in expenses.

Arsenal is not alone

Fig.4. Whilst revenues for the Premier League have increased by £1.6bn, so too have expenses. The charge for capital has also increased by 55% from £221m to £342m. The total economic loss in 2015-16 is £320m, an increase of £128m (66%) from the 2008-9 value.

 

The graphic above shows the total revenue, total expenses (including tax), the charge for capital and the resulting econmic profit for all clubs within the Premier League in the 2008-9 and 2015-16 seasons.  The expenses line has been reversed to ease comparison and again this shows that overall the impressive  growth in the revenue line (£1.6bn) has been matched by an equivalent increase in expenditure – the movement in the revenue and expenses lines are almost identical.

Just to be completely clear and whilst one doesn’t want to labour the point – all of the huge growth (85%) in revenue (£1.6bn) has been expensed – presumably player wages and the fees of their agents are a large part of this.

Some commentators think we are being alarmist in delivering this outline – well so be it.

How Arsenal compares against Tottenham Hotspur and Manchester United

Set out below is the economic performance for each club over the period 2012 through to 2017:

Fig. 5. Arsenal’s economic performance has been one of steady if shallow decline since 2010.

 

Overall, Arsenal’s North London neighbours Tottenham Hotspur (under the excellent stewardship of Mr Levy) is in economic surplus. Over the five years from 2012 through to 2016 (the numbers for 2017 have not been released just yet) the club produced an economic surplus of £58.4m.  By contrast, Arsenal’s economic loss over the last six years ie 2012-17, is £133.8m despite the club’s significant economic improvement in 2017.

Over the same period, Manchester United posted an economic loss of £80.9m which, given the size of its balance sheet and the geographic spread of its revenue base, is not remotely terminal but nonetheless it will need to be managed going forward (and we have every confidence that it will be).

In terms of economic efficiency, when we look at the relationship between economic profit and revenue, we can see just how far Arsenal is behind both its North London rivals and its traditional Mancunian adversary.

Fig. 6. A near £8 per £100 of revenue differential exists between the North London neighbours. Will Tottenham Hotspur’s next set of accounts widen the gap even further?

 

Conclusion

Nobody is pretending that Arsenal’s economic position is terminal but perhaps this work does shed some light on the Mr Wenger’s apparent reluctance to spend aggressively in the transfer market over recent years.  Furthermore, there is evidence in the most recent numbers that economic performance is improving.

All that said, from our other work we have seen that in the first year of a new TV deal, economic performance across the entire Premier League does improve (although there are still a significant number of clubs generating economic losses), usually for a solitary season before normal service is resumed and the trend reverts into more challenging economic territory in the subsequent years of the TV contract cycle.

Whilst Tottenham Hotspur have not yet released its 2017 numbers, the gap between its 5-year track record of economic profit and Arsenal’s 6-year total (of economic profit) stands at £192.3m –  a sum that is more than enough to purchase two decent central defenders or perhaps the more productive half of a certain Lionel Messi?

Against this background (and again stressing that the position is certainly not terminal), the club’s reputation as English football’s “Bank of England” perhaps needs a re-visit?

vysyble

 


 

 

 

 

 

 

 

 

 

 

 

25th September 2017

This time around we have a few updates and a couple of observations for you.

Further interest in the application of Economic Profit to football has been kindly provided by Professor Stefan Szymanski from the University of Michigan. Some of you will know Stefan as one of the co-authors of ‘Soccernomics’ as well as a respected authority around the subject of sporting economics. It is on the Soccernomics website that we now have our guest blog entry – ‘Football’s Economic Back-Pass’ – which explains everything you wanted to know about Economic Profit but were afraid to ask by illustrating the economic performance of the English Premier League clubs. We are genuinely delighted and grateful to have been given such a highly-regarded platform other than our own to express our ideas and findings.

If you have been following our Twitter account recently (@seetrends), you will have seen several tweets released for selected games in the English Premier League whereby we give a quick snapshot of the economic position of both teams prior to kick-off. It provides for an interesting talking point and puts the concept of Economic Profit along with other relevant financial measures such as revenue, staff costs and transfer activity directly in front of fans on matchdays. The reaction has been overwhelmingly positive and so we intend to officially launch the service, to be known as ‘Matchday Metrics’, later this week.

We have put the final touches in place to our latest report ‘Over the Line’ which examines the economic costs associated with promotion and relegation into and out of the Premier League. We aim to release the report on 10th October.

The report highlights some fascinating points about the true cost of promotion out of the Championship division as well as the impact of Premier League economic dynamics on promoted clubs and their overall economic performance and vulnerabilities.

Since we published our last blog entry ‘Crystal Balls-Up’ on 12th September 2017 regarding the somewhat questionable Board decisions made at Selhurst Park, another six goals have been shipped without reply. The club’s next game is away to Manchester United followed by a home game with Chelsea. It is entirely conceivable that the club could go 8 games without scoring. We hope that the balance sheet is in good shape as ‘Over the Line’ demonstrates that anything other than prudent fiscal management during a Premier League tenure condemns relegated clubs to a prolonged period in the second tier and sometimes beyond.

There has been increasing unease within football circles about the overall financial health of Sunderland AFC. Certainly, our calculations show that the club is not in the best of economic positions and will remain so unless there is a significant change in direction and a major capital injection. We have already offered comment about the club’s economic performance in previous reports and blogs and it is a great shame to see such a rich footballing heritage in a difficult spot. If the situation deteriorates further then the club may have to face administration which in turn will entail a probable points deduction.

In our view, the club made the fatal mistake of trying to compete with the big boys on very modest revenues with an underlying and deteriorating economic performance. Sometimes relegation can be beneficial in that it offers a chance to regroup. However, Sunderland appeared to fear relegation so much that it eventually ended up destroying the balance sheet in a long, drawn out and futile survival process. The chart below demonstrates the length to which the club went to preserve its Premier League status in matching Manchester City’s economic inefficiency with much shallower pockets.

The FPI Values are a measure of economic efficiency (see Methodology). To convert the FPI Value into a comparative economic profit or loss per £100 simply subtract 100 from the FPI Value ie Sunderland’s economic loss per £100 of revenue is 66.40 – £100 = -£33.60. This is a large sum to lose over such a long time on what has been a relatively low revenue level by Premier League standards (the same argument could be made of Manchester City despite the larger sums involved but the deeper pockets of its UAE-based ownership ‘sways’ the argument in City’s favour).

Now that the club is indeed relegated, the future looks bleaker than it has for many years whereas if the club had accepted relegation earlier and managed the balance sheet accordingly, there would have been the much better prospect of promotion back into the Premier League and probably sooner rather than later.

Finally, a comment or two on Manchester United’s full year numbers which were released last week. The revenue rise is impressive and represents one of the largest revenue rises for an English club in many a year. However, the rise in costs, especially in staff, is notable. Thus the club has returned, according to our first set of calculations, an economic loss of £16.3m which is not a disaster by any means. In fact, we view the club as a well-run operation as it does not heavily rely on broadcast revenues (although the share of revenue has increased from 27% to 33%).

What is intriguing, though, is that once again and despite the much-vaunted rise in money into the Premier League clubs due to the £5.1bn domestic TV contract and revenues from additional international media rights, the biggest club in the land did not achieve an economic profit. In our report ‘We’re So Rich..’ we demonstrated that the top 7 clubs by revenue are less-than-consistent when it comes to profit generation. When economic profits do appear, they are usually to be found within the ‘other’ 13 clubs. However, given the inflationary course of the transfer market over the last 2-3 years and the evident inflationary track in player wages, do we dare to even think that the words of optimism touted earlier this year from certain quarters about the future financial health of the Premier League are over-done?

Admittedly, one swallow does not make a summer but we await the other 19 club balance sheets with renewed interest.

vysyble

 


 

 

 

 

 

 

 

 

 

 

 

12th September 2017

The ‘right fit’ is a commonly-used term in the recruitment industry. It denotes a mutual understanding of expectations, culture, abilities, demands and ambition. It points to a shared view, a meeting of minds and a pact of direction. It also builds upon the vision of success. The ‘right fit’ is the individual tasked with delivering the payload of success.

Presumably, the board at Crystal Palace deliberated long and hard before appointing Frank De Boer earlier this year. Previously linked with Everton before his former team mate Ronald Koeman took the role as well as with Southampton as Koeman’s replacement, the ex-Inter Milan manager’s reputation was still flying relatively high given his successful tenure at Ajax. It is easy to see how the seduction of passing football can potentially sway those all-important executive decisions.

A change in emphasis, style, and culture – all things that the leadership apparently bought into. Furthermore, one might quite reasonably expect that the board must have expected and planned for a period of transition: a period of potentially below-par performance whilst the team and the players absorb and adapt to the new playing philosophy. Such a phase might see the club in the lower reaches of the Premier League before performances improve and longer-term success became more apparent.

Unfortunately, it only took the board 77 days to lose its nerve and curtail the journey towards the promised, cultured land of total football despite the team playing well on Sunday.

That’s not to say that De Boer was indeed the answer. It depends on what the board had in mind as the question in the first place. A tiring of relegation scraps? A desire for something other than route one? A hankering for a ‘big name’ to enhance the club’s reputation? Who knows….

We suspect that the decision to jettison the Dutchman was driven by a sharp realisation that change brings with it a range of costs and risk, the biggest being the economic fallout arising from a potential relegation.  As we will reveal in more detail in our new report ‘Over the Line’ (released 10th October), despite the cushion of parachute payments, the cost of relegation is significant and highly damaging under certain circumstances.

Crystal Palace is currently in its 5th season in the Premier League since promotion in 2013. As almost two thirds of promoted clubs are relegated by the third season, the club has done well to last the course so far. However, we believe that the club is in danger of becoming ‘economically exhausted’. What do we mean by this? Since the promotion season, the club’s efficiency in generating economic profits has declined year-on-year, from an economic profit in 2013 of £19.01m to an economic loss of £8.98m in 2016. Therefore, each successive season in the Premier League is becoming more of a financial burden as value creation is challenged.

It is also notable that Crystal Palace is the only club to have gained promotion into the Premier League and achieved an economic profit in the same season since 2009 so the financial expertise is certainly present in-house.

From the latest set of Premier League club accounts (2016), the club runs the second-highest wage bill-to-revenue ratio in the division – 79% of a revenue total of £101.82m is spent on wages and associated costs. For comparison, Leicester City spent 62% of a revenue total of £128.72m on wages, won the title and still spent £210k less than Crystal Palace on staff costs (£80.35m vs £80.56m).

From our perspective, the high wage-to-revenue ratio, the high reliance on TV money – approx. 78% of revenue – and the level of activity in the transfer market (net summer spend of £7.51m in 2016 and £32.3m in 2017) suggests that the pressure is certainly on financially given the latest transfer outlay. The revenue uplift anticipated in the forthcoming 2017 Premier League club accounts may not be enough, though, to bring about the financial transformation that many expect.

The last major revenue uplift for the Premier League in 2013 when the domestic TV revenue values rose 70% to £1.006bn per year did not produce a “profits bonanza.” Half the clubs produced an economic profit although only Tottenham Hotspur and Everton, from the top 7, were in the black. The division was a whisker away from a rare economic breakeven:  a good economic performance, but not quite enough. Close, but no cigar etc. The challenged economic profit trend for the division has persisted since 2009.

We are not expecting a seismic shift by the Premier League clubs into the black for the 2016-17 season either on the back of the latest TV deals. The overall net summer transfer outlay increased by 47% from 2015-16 to £635.6m. Add in wages and agent-related fees and the picture in our view becomes much less rosy.

Relegation for Crystal Palace could precipitate a fall in TV revenue and performance/merit payments from an anticipated £100m in the current season down to circa £7-8m (even after today’s EFL announcement regarding the new 5-year deal with Sky) without a cup run. The parachute payment gives back £40m in the first year so the shortfall is approx. £52m from the Premier League revenue level although this does not consider potential changes in matchday revenue, sponsorship monies and other commercial activities. Nevertheless, the board would be forced to drastically reduce the wage bill to a more manageable level. Bearing in mind that the average economic loss in the first season back in the Championship is £26.74 per £100 of revenue according to our Football Profitability Index calculations and you get a sense of the potential financial carnage that awaits.

Therefore, the board has backtracked very quickly. It may well have been close to a total meltdown rather than total football although four games played, four games lost and no goals scored is poor by anyone’s standards. Even Derby County’s miserable 2007-8 season started with two goals and a point. They eventually ended up scoring 20 for the season and accumulating 11 hard-fought but futile points.

There are 18 games to go between now and the opening of the January transfer window. Autumn will blend into winter and the struggles will intensify. ‘Six pointers’ will shape the membership of the bottom three and fates will start to be sealed. Cash balances will drain and finance directors will start to sweat and plan for a not-so-prosperous Championship future.

Clubs outside of the top 7 that continually spend beyond their means to try and stay in the Premier League are found out sooner or later (Blackburn, Bolton, QPR, Aston Villa, Sunderland et al). As Burnley, Norwich City and Hull City will tell you, there is a much better chance of going back up if the balance sheet is in good shape on the way down.

However, 5 seasons of Premier League competition with decreasing financial width suggests that Crystal Palace may be operating at its financial limit. Even if the club were to survive this season in the Premier League, the anticipated damage to the balance sheet might be a step too far with further limitations for next season, all depending of course on the benevolence of the owners.

In our view, the big mistake is trying to change the footballing philosophy of the club at precisely the wrong time. There are 13 clubs fighting for survival every season in the Premier League. The pressure is as much financially-orientated as it is about the football. Our findings show that the poorer the state of the balance sheet, the more likely is relegation. The board should have evaluated its current and future economic risk first before taking the decision to embark on a new course.

Should relegation occur, the Championship may provide the perfect laboratory and the ‘right fit’ to try and test new footballing methods and cultures. Silver linings and all that….

vysyble

 


 

27th July 2017

We last looked at Sky in our blog of 27th December 2016 entitled ‘Reaching for Sky’. We gave a detailed assessment of the value of the business along with a view on the 21st Century Fox share offer. The company has since announced its results earlier this morning for the 12 months ended 30th June 2017 and they make for mixed reading at best.

Unfortunately, the cost of the latest TV / Premier League arrangement is weighing heavily on the group’s economic performance which we have set out below together with comparatives for last year (2016) and for five years ago (2012).

£m

2012

2016

2017

2017 vs. 2016

2017 vs. 2012

Revenue

6,791

11,965

12,916

951

6,125

Net operating profit after tax (NOPAT)

1,030

782

858

76

(172)

Charge for capital

(293)

(946)

(1,066)

(120)

(773)

Economic Profit (EP)

737

(164)

(208)

(44)

(945)

EP per unit of revenue

10.9%

(1.4%)

(1.6%)

(0.2%)

(12.5%)

EP per unit of assets

13.8%

(1.1%)

(1.2%)

(0.1%)

(15.0%)

From the above financials, the economic performance of the business is declining and is a shadow of where it was 5 years ago. The economic loss for the 12 months ended 30th June 2017 totalled £208m, a £44m increase on the previous year’s economic loss of £164m and £945m less than the economic profit of £737m posted in 2012.  This is despite a £6.1bn increase in revenue (2017 vs. 2012) – clearly the cost of each revenue increment is increasingly punitive suggesting huge pressure on margins.  As Warren Buffet said;

“Growth is simply a component – usually a plus, sometimes a minus – in the value equation.”

 – Berkshire Hathaway Annual Report, 2000

Sky is clearly creaking under the strain of the latest domestic football TV deal and for us, this is further evidence that the “boom” in TV revenues for clubs has reached or is very close to reaching its peak.  The idea that Sky can afford a further increase in 2019 needs to be seriously questioned. Indeed, many informed commentators have over the past few weeks questioned how sustainable the current domestic football TV arrangement is and this latest set of numbers from Sky will provoke further debate.

This less-than-stellar financial performance should worry every Premier League Chair and Chief Executive not to mention the fans of the game. Why? Read on…

Several days ago, Andy Dunn in the Daily Mirror praised Tottenham Hotspur for not entering the current off-season transfer “madness.” This theme was also echoed by Peter Coates, Chair of Stoke City, in a recent interview with TalkSPORT radio. Furthermore, the 26th July 2017 edition of the Daily Telegraph led with the headline “’Dangerous’ fees pose major threat to game”, a quote taken from an interview with Jose Mourinho, the manager of Manchester United. If that wasn’t enough, Daniel Levy, Chair of Tottenham Hotspur, was quoted as follows at a Nasdaq Q&A in New York:

“We have a duty to manage the club appropriately.  Some of the activity that is going on at the moment is just impossible for it to be sustainable.  Somebody spending £200m more than they’re earning, eventually it catches up with you. And you can’t keep doing it.”

Unsurprisingly, we agree entirely. Against this, the Daily Mail published an interview on 24th July 2017 with Richard Scudamore, the Executive Chairman of the Premier League, whereby he took the line that all was well and that there remained significant interest from potential overseas investors. Indeed, the Premier League has done well to expand its TV deal revenue base into the Far East and China. Given the current inflationary levels in player transfer values (and no doubt wages), there will be further pressure on Mr Scudamore and his commercial team to deliver.

The first satellite transmission agreement back in 1992 totalled some £38m per season and due to the hugely impressive negotiating skills of the Premier League, this has currently risen to £1.7bn per season. Under any lens, this is a staggering growth in revenue – equating to a 16% annual compound increase over the period 1992-2017 in what has been a generally low-inflation economy.

In other words, a pint of lager back in 1992 which then cost £1.44 would now cost £65 if it followed the same growth uplift. According to the Nationwide House Price Index, the average cost of a house in the UK back in 1992 was £51,815 and again following the same rate of growth as the Premier League TV revenue transaction would result in the average house price being £2.3m in 2017.  Similarly, an average family car costing £9,410 in 1992 would, if it followed the same rate of growth, now cost £424,000.

All of this is taking place whilst we as football fans are concerned about the current state of the game’s economics. In any other industry where pricing and asset inflation runs at such rates, it would be easily identified as a bubble and invariably bubbles tend to burst with devastating consequences. The problem is that another 16% compound inflation for three years ie for the 2019-2022 contract round brings the cost of a potential Sky portion of the TV deal to £6.51bn or £2.172bn per season. Sky’s latest numbers where economic losses are increasing despite rising revenue strongly suggests that the deal at this level is a risk to the group and is at risk in itself.

Taking a step back, we at vysyble believe that value is created by investing capital and generating a return greater than the cost of that capital. If one accepts this premise, then the only metric that fulfils or satisfies that statement is economic profit; a measure that includes all the costs of doing business and is defined as:

Economic Profit = Net operating profit after tax less a charge for ALL of the capital used by the organisation.

Peter Drucker, the highly influential and best-selling author on all things management-wise, stated;

Based on something we have known for a long time: what we call profit, is usually not profit at all. Until a business returns a profit greater than its cost of capital, it operates at a loss.  Never mind that it pays taxes as if it had made a genuine profit.  The enterprise still returns less to the economy than it devours in resources…Until then it does not create wealth; it destroys it.

Peter Drucker: The Information that Executives Truly Need Harvard Business Review, January 1995

As an aside, the economic profit metric includes taxation. HMRC does not hold back in seeking redress from football clubs in severe financial difficulty as it is frequently the largest creditor and the most prolific in serving company winding-up petitions. Despite this, the post-tax position is frequently ignored or not even calculated by many analysts and commentators. Financial vanity is one thing but tax is very real, is a clear cost to the business and should be reported as such.

On occasion, when presented with our approach some commentators have made the point that football clubs have a wider ethic beyond an economic objective, that somehow football clubs are not designed or meant to be profitable.  However, such an argument is in danger of confusing the generation of wealth with its allocation.  We would be the first to acknowledge that football clubs have wider community and fan responsibilities – however they cannot meet those obligations over the longer-term without either generating an economic return or in lacking the input from a generous benefactor.

The Executive Chairman of the Premier League gave assurances in his Daily Mail interview of 24th July 2017 that all was well because the ratio of player wages-to-revenue is currently at a ‘comfortable’ level – around 60% – and is lower than it was five years ago. Such an approach ignores the very significant costs of maintaining the invested capital balances of the clubs. Additionally, the clubs were delivering economic losses five years ago, so arguably the point of being ‘comfortable’ is anything but if capital is being destroyed on a constant and regular basis.

We repeat; when all the costs of operation are incorporated into the economic mix, the picture is a very depressing one – not of value creation but of increasing value destruction.  For instance, in the 2015/16 season when we subtract the charge for all the capital on the balance sheets of the clubs from the total NOPAT for all 20 clubs, we see an economic loss of £320.1m as we reported in our financial analysis of Premier League club performance. In other words, and in total, the clubs have in effect given £320.1m to other stakeholders: probably players and agents.  If that complies with their wider “social obligations” then so be it.

Our Football Profitability Index for the Premier League shows that the clubs have yet to collectively make a single penny in economic profit since 2008. In any other industry, there would be closures, lay-offs and a significant reduction in company market capitalisation values. Only the TV deals keep the wheels of commerce turning with many clubs relying on TV money for 60%+ of their total revenue. The comfort factor in the wage-to-revenue ratio evaporates when we see that wage inflation in the 13 clubs outside of the top 7 is running at 26% over the three year-period from 2013-14 to 2015-16 whilst revenue only increased by 10.15%. In fact, wage inflation is back above levels last seen in 2010-11 for this group of clubs.

Therefore, if the TV money is threatened then the clubs have very little room on the wing to jink past the scything tackles of declining asset values (as clubs reduce money available for transfers) for existing players and the cost of debt servicing (which financed the inflated transfers in the first place). The ‘hit’ to club balance sheets will be truly significant and will be Football’s equivalent of the credit crunch. The current ‘summer of money’ is merely adding fuel to an already-smouldering fire.

We remain firmly of the view that you cannot manage what you cannot see and that until the Premier League administrators, the Premier League clubs and the fans see and understand the true economic dynamic of the game, then and only then will they be able to find the value-maximising way forward for all stakeholders.  Until then, we, as fans, continue to fear for the future of the game.

vysyble

 


 

11th July 2017

It’s been a busy few days with the launch of the second edition of ‘We’re So Rich It’s Unbelievable! – The Illusion of Wealth Within Football’ and the Football Profitability Index data. So far, the media reaction to our work has been highly encouraging and at the time of writing, it is still developing.

In addition, the other heartening factor is the reaction from football fans. The vysyble twitter feed has been populated with comments and questions from fans regarding their respective clubs alongside supportive observations that we have indeed touched upon something that directly affects them – the financial health of the game. After all, it is money from the fans that pays the media subscriptions and the ticket fees.

We’ve also had a few negative comments and observations regarding the basis of our work and the results outcome. This is to be expected but as we make very clear to everyone, how we go about our research and analysis is outlined in detail on the website (www.vysyble.com/methodology). The other thing to remember is that finance is not the precise science that many people tend to think it is and furthermore profit and cash are two very different bedfellows. Numbers can be arbitrary and value and definitions can be vague. However, we take published accounts from the clubs and work through their own numbers to arrive at the economic profit value. We are not financial alchemists!

Our remit is to unpick the underlying financial dynamics at play using economic principles that have been around for longer than Notts County FC and have also been successful in Europe i.e. a Nobel prize or two. In many cases, the results fly in the face of accepted wisdom and the accompanying disbelief factor can be very concentrated indeed. We see this in our client work and football is no different. It is a highly emotive sport laden with cultural overtones; when the narrative is challenged, the feathers start flying – as much as anything because people care so much about the game.

Yesterday evening we were the guests of the very genial and hospitable Mark Saggers and his production team on TalkSPORT Kick Off. The debate was lively, considered and hugely enjoyable. What struck us most of all is that there appears to be a collective nervousness within the game’s fanbase about the future of the Premier League and the possible permutations arising from future media deals.

As was pointed out, the Premier League as a product is a very successful and watchable export and we agree that there is much potential out there for additional revenues from foreign media rights.

However, our research points to the problem of financial inefficiency at club-level. The average fan must be doing a lot of head-scratching to try and work out why, after 25 years of seemingly unstoppable growth in turnover, the clubs still have not mastered the very basic equation of spending slightly less than revenue generated. This is value creation. As we have demonstrated, the reverse is happening on an all-too-constant basis. It therefore becomes almost irrelevant as to where and how the ‘new’ revenue is achieved because the incurred expenditure is, based on past experience, always going to be greater. In any financial context, this makes no sense whatsoever.

We have no issue with the Premier League administrators. Commercially, they have achieved much that is to be commended, if not admired. We do want to engage with them so that they can understand our perspective and analysis. After all, it is difficult to manage something if it is not visible or apparent. And yes, we are aware that the Premier League is almost a self-regulating body that has 20 shareholders ie the clubs. In that respect, we may get short shrift. But it is in everyone’s interests to view the numbers and the pathways involved.

We are also convinced that change is coming whether it be from how audience consumption habits evolve, how the game’s reliance on media revenues are realised or even the structure of competitions and their accompanying rules. Club owners have enjoyed a long run of rising revenue but the source of income may be shifting in ways that may have a detrimental impact on club finances if the model is predicated on a ‘jam tomorrow’ basis.

Will there be pain? Yes. Player contracts are fixed-term assets. Transfer values are moveable numbers. A revenue contraction means player sales. However, if a number of clubs have to sell at the same time then asset/player values will undoubtedly drop significantly. The financial pain is thus magnified. Team performance suffers and well…you know the rest if you are a Portsmouth fan et al.

Hopefully, our research is a wake-up call to some. Our Football Profitability Index points to an increase in economic losses for the 2016-17 season, the financials of which won’t be available until April/May of 2018. If so, it could be a record season for all the wrong reasons.

vysyble

 

 

 

Previous Entries

9th May 2017Illuminating, non? Political energy lacks vision.

2nd March 2017Claudio’s Burden. The price of failure outweighs the price of success.

12th January 2017Shopping for Godot.  A never-ending quest for value in Retail.

27th December 2016Reaching for Sky. Is Rupert Murdoch’s £10.75 per share a fair price?

6th December 2016Auld Lang Syne. A reminder from history of the damage that poor financial planning can cause.

1st December 2016Fork Handles? Four Candles? Tesco’s blurred strategic vision.

27th November 2016Football’s Instant Replay. Financial warning signals for the top English Premier League clubs.