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|
|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.