28th November 2016

Blog

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

 


 

9th May 2017

With the French presidential election out of the way and with a perceptible ‘phew’ permeating through certain corridors of power, the focus returns to the British general election. As polarising as these things tend to be, the usual positions have been adopted in the areas of taxation, education, the NHS et al. However, this time around there is one key exception – energy pricing.

Certain sections of the press would have us believe that the energy supply companies are rolling in money, making insane profits and generally sticking up two fingers to the British consumer whilst raising prices at will. Indeed, such is the apparent indignation of the British consumer that the Conservative Party has taken on the mantle of the nation’s champion in such matters and has been standing up for the rights of the great British public to access affordable energy. Their solution is to concoct an idea that could have come straight out of the Socialist Guide to Economics in the form of a price cap.

The reality, as we have highlighted in our free report Lights Out, is that the Big Six energy companies are not rolling in money nor are they making insane profits. In fact, the financial position of the Big Six has been deteriorating for some time with EDF and E. ON in particularly poor shape with emergency cash raises (EDF £3.5bn and E. ON £1.2bn) taking place within the last three months. Our own calculations on the economic performance of the Big Six show annual economic losses north of £26bn per year as of 2016 – this means that approx. £72m is lost EVERY DAY by the energy suppliers.

The standout offender is the French company EDF which is in the process of decommissioning several French nuclear power stations at an estimated cost of £19bn. No doubt the French taxpayer will foot the bill given EDF’s extensive debts (£26.2bn as of the last accounts release) and the company’s cumulative economic losses (as per our calculations) of £58bn since 2008. Some analysts, however, believe that the cost of decommissioning will turn out to be far greater and one which may be the final nail in le cercueil. It is rather unfortunate that the dash for cheap energy 40-50 years ago in the form of nuclear power has turned out to be a very expensive problem when the stations run past their sell-by date.

The ménage à trois of a restricted market, cartel-like pricing and consumer indignation has driven Conservative policy makers to believe that a pricing cap is the panacea to our energy ills. What has been surprising given the current furore is that the financial performance of the companies concerned has not been examined because this is where the real problems lie.

In Lights Out we made it very clear that the Big Six cannot continue to operate in this manner ad infinitum. Deteriorating financial performance on this scale will soon mean the Big Six becoming a very average-sized Five or even Four, probably via a huge corporate failure or two. Don’t forget, though, that we are dependent on these companies and their morals can sometimes be a little off-key – E. ON refused to incur a £330m tax charge in late 2016 by NOT refuelling several nuclear power stations in Germany. In turn, this led to a spike in consumer pricing due to the resultant energy supply shortfall. A sort of morally-challenged win-win.

The only feasible option for the suppliers is to keep raising prices to stave off the inevitable economic failure. They have no choice. However, the government of the day seems reluctant to recognise this. Market reform is long overdue but as it is likely that the colour blue is going to be more prevalent in the next parliament, a steer towards nationalisation is not going to happen. Yet energy supply is a key state requirement but it is dominated by six companies which provide little if any financial confidence. The abacus-tapping Whitehall Mandarins must be getting very hot under the collar as the price of Hinkley Point starts to rise in tandem with the increasing economic losses of its primary contractor – EDF.

Therefore, given a dysfunctional market dynamic despite the promise of free and open competition together with a certain amount of apathy in terms of change with the British consumer, the mix is not only combustible but also has the capacity to be highly damaging if left to fester. Hence, the Conservatives borrow a socialist principle and take the moral high ground. A more robust and pragmatic approach would be to develop a coherent energy policy that considers a capacity growth capability with suitable and sustainable investment opportunities and returns. Perhaps then we will get the energy supply market that we wanted in the first place without having to subsidise companies whereby four of the Big Six are worth less than they were seven years ago.

vysyble

 

 

 

Previous Entries

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

12th January 2017 – Shopping 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.