Tuesday, 21 February 2012

Manchester United Q2 2011/12 results - the amazing, expanding wage bill

The second quarter of Red Football's financial year (September to December) is the least exciting. The transfer window is firmly shut, the season ticket selling season is over, it's the dull group stage of the Champions League. Nothing is won before Christmas and from a financial point of view, not much happens...

That is largely the case with these figures for the three months to 31st December 2011 (and therefore the first half of 2011/12 too). Having said that, there are some surprises.

The trends seen in the first quarter figures were present again in Q2. Matchday income was up 3.8% compared to last year despite exactly the same number of home games. The club put through an average price increase of 2.5% this season and the additional revenue has come from better corporate hospitality sales, a real credit to the Old Trafford corporate sales team at what is obviously a very difficult time economically.

Media income rose an impressive 9.8%, but this increase is somewhat deceptive. United benefit this season from a higher share of the English "market pool" than in 2010/11 because of winning the league last season. Furthermore, the club recognises some of the Champions League media income evenly over the number of games played in the competition. With United being knocked out at the group stages, there is a paradoxically higher amount of revenue recognised in the first six months than last season (when income was spread over ten games across the whole season, not six in the first six months).

In the second half of the season, there will be no Champions League income of course and the meagre pickings from the Europa League (a maximum of about €5m if the final is reached) will depend of course on progress in that competition.

Commercial income continues to grow very fast (up 13.4% during the quarter vs last year and up 17.7% over the six months). Much of this growth comes from the c. £10m per annum DHL training kit deal. The club has also recently signed new deals with Bulgarian and Bangladeshi telecom operators. This strategy of finding a local telecom partner in a myriad of markets will eventually reach a natural end of course, but I must confess to having been too cautious on United's commercial growth. The "brand" has stretched far further than most observers (including this one) felt was possible.

In total, revenue growth of 12% in the first six months of the year is very impressive, even if the impact of the early Champions League exit is yet to be felt.

Costs - terrifying
It's a good thing that United's top-line is growing so well, because so is the cost base, and particularly the wage bill. After the 12.2% year-on-year growth in staff costs in Q1, they rose 17.2% in Q2. This increase is before any end of season bonuses obviously, so can only be put down to significantly more expensive deals for key players. When you consider that Garry Neville, VDS, O'Shea, Brown, Obertan and Scholes (his return is not included in these figures) all left the club in the summer with younger (and you would imagine cheaper) players coming in, the wage inflation is even more extraordinary.

Historically, there has been a very, very strong correlation (r squared of 0.98) between media income and wages at United. What has happened this season is effectively a breakdown in that relationship.There is no big new TV deal to drive player salaries up. Endemic wage inflation is THE financial problem in football, it is what Financial Fair Play is designed to deal with. These figures show it remains a huge issue in 2011/12.

Non-staff cash costs rose an equally punchy 14% in Q2 vs. last year. Some of this must be the club's swanky new corporate offices in Stratton Street in central London. Unlike at the old Pall Mall office, the club has the confidence in Stratton Street to have their name listed in reception.

EBITDA and below
With revenue up 8.7% and costs up 16.3% during Q2 vs 2010/11, EBITDA was virtually static (up 0.4%) and the margin was down from 48% to 44.4%. For the first half as a whole, EBITDA was up 7.7%. United remain very profitable, but the negative "jaws" between cost and revenue growth (costs are rising faster than income) is a worry in any business.

Below EBITDA, depreciation and player amortisation were virtually static. The club made its usual small profit on player sales and there was a totally unexplained £2m exceptional charge.

Interest and various marks to market
The interest charge in the profit and loss account was down 11% compared to Q2 last year. This reflects the increasing number of bonds the company has bought in during the last two years. It should be noted that actual bond cash interest payments are made twice a year in February and August.

Under International Accounting Standards, Red Football must recognise the initial discount on bonds over their life, any premium paid when buying bonds, any "mark to market" increase or fall in the sterling value of the US$ bonds and must also mark any swaps to market too. I don't consider any of these (largely non-cash) charges to be material to the health of the business.

Cash and debt

The second quarter is not a big one for seasonal cash flow (pre-payments of season tickets and sponsorships unwind over the quarter). Operating cash flow was slightly negative (-£2.7m) as these working capital positions unwound. As stated above the main bond interest payments fall outside this quarter and there was little transfer cash flow outside the window.The club bought another £5.2m of bonds during the quarter to take the total to £92.8m (almost 20% of the bonds issued in 2010).

The press have focused on the c. £100m fall in the club's cash balance, but £86m of this fall took place in Q1. In Q2 the cash outflow was only £14m.

The cash outflow and bond buybacks left gross debt at £439m and cash at £50.9m. Net debt has therefore risen slightly from £368m at the end of September to £388m at the end of December.

Credit has to go to the club for once again boosting revenues in a tough economic climate. United (along with Real, Barcelona and Bayern) is one of the commercial giants of modern football. Much though it pains me to say it, the Glazers have overseen extraordinary commercial growth (this year Commercial income will be more than 2.5x the level the plc achieved in their best year). The second half will see weaker media income as the CL exit bites, a timely reminder that on-pitch success is never guaranteed.

Despite United's excellent revenue growth, the dynamics of football finance remain awful (hello Rangers, hello Pompey). Any business which sees core cost growth of 16% year-on-year is going to struggle to meaningfully grow profits. Profit growth is not crucial for a football club, but it is for the owners who are no doubt still eyeing an IPO and want to tell a story of rising profits, not just revenue growth. I remain confident that FFP will eventually calm player wage inflation but such restraint is not visible in these figures.

Finally, for all the booming income and soaring wages, there can be no doubt whatsoever that the £116m Ronaldo/Aon windfall received on 30th June 2009 has gone to deal with the debts laden on the club. In the thirty months from that date 31st December 2011, the club spent the following on debt service and investment.

In almost all football clubs, surplus cash is reinvested. At Manchester United it is still far more likely to be spent dealing with debts that the club should never have had.


Wednesday, 8 February 2012

Income up, costs down - Chelsea getting in shape for FFP

Chelsea have a rather irritating habit of issuing an anodyne press release trumpeting their financial results (this year on 31st January), several days before the real accounts become available at Companies House (today). Normally, the detailed figures hide a whole host of nasties not in the release. This year however, the accounts show real progress in the club's aim to meet UEFA's new Financial Fair Play rules.

Rising income and falling costs - the holy grail of football finance
Football clubs find it incredibly hard not to pass increases in revenue straight on to players, managers and agents in the form of higher staff costs. It is the achilles heal of the financial side of the sport. These results from Chelsea show revenue rising by 8% and pre-exceptional costs falling by 5%, including a 2.6% fall in wages. That is a remarkable achievement. To put it into context, in the last five years there has only been one other occasion when the wage bill at any of the old "big 4", City or Spurs has fallen year-on-year.

Readers who think "oh cutting the wage bill is easy, CFC let loads of old, expensive players go", should remember that United did the same last summer when VDS, Neville, O'Shea, Brown, Hargreaves and Scholes (temporarily) all left, yet we can see from MUFC's Q1 results that wage costs are still up on last year (by 12.2%). The trick is not just offloading players, it is preventing endemic wage inflation amongst the remaining squad, especially when TV money is increasing as it was in 2010/11.

The only cautionary point to make about Chelsea's wage control in these figures is that Fernando Torres and David Luiz will only be in these numbers for six months. On an annualised basis they would add c. £4m to these salary figures (although there have been offsetting cost reductions from the sales of Alex, Anelka etc).

Chelsea's revenue (excluding the digital JV) rose £16.5m or 8% in 2010/11. Chelsea unhelpfully do not give the usual "matchday/media/commercial" split other clubs provide. We know from UEFA figures that CFC received £10.3m in CL TV income in 2010/11 vs. 2009/10. We also know from Premier League figures that CFC's receipts from the league rose £4.9m. 

Using these PL and UEFA figures, Deloitte's estimated segmental split for last season and adjusting for one fewer home game in 2010/11 vs. 2009/10 and we can get quite a good estimate for the club's segmental revenue performance for 2010/11:

The table above shows quite an encouraging growth in commercial income, especially in difficult economic conditions, although at c. £60m pa, CFC's commercial revenue is far behind that of MUFC (£103m) or Real Madrid (£127m).

Decent revenue growth and tight cost control meant that Chelsea made positive EBITDA (before profit on player sales and exceptionals) for only the second time since Abramovich bought the club (the other occasion was a £1m profit in 2007/08). The c. £4m EBITDA in 2010/11 is not huge (Arsenal made £47m from non-property activities) but being able to cover cash costs (pre-transfers) from earned income is a key first step in achieving financial sustainability, . The contrast with City's £71m EBITDA loss is stark.

Below EBITDA - messy
Unfortunately neither the profit and loss account nor UEFA's FFP "breakeven" calculation finishes at the EBITDA line.

On the plus side, Chelsea made a profit on player sales of £18.4m, boosting EBITDA to £22.4m. After that, things get worse quite fast.

Chelsea are still hampered by a very significant amortisation charge (the way transfers spending is recognised across the life of a player's contract). This charge has fallen in recent years, something that is key for meeting FFP, reflecting a reining back of the very aggressive transfer spending of the early Abramovich years. The charge rose in 2010/11 however, and this rise only includes six months of amortisation from the c. £75m spent on Torres and Luiz in the January 2011 transfer window (see chart below):

At around £40-45m, the amortisation charge nowhere close to being covered by EBITDA. Once depreciation is added too, the club made on operating (EBIT) loss of £26m (inc player sales), a loss but a great improvement on last year's £71m.

Exceptionals (again)
In the last four years, CFC have reported "exceptional" costs relating to firing their manager on no less than three occasions. Nothing very exceptional there.... In 2010/11 there were £41.9m of exceptional charges. These split as follows:

Termination of Ancellotti + back room staff contracts/compensation to Porto for AVB: £28m
Impairment of player registrations: £7.4m
Payments to HMRC for unpaid NI on "image rights": £6.4m

Now these costs are individually "one-off" in nature, but Chelsea's managerial merry go round has cost the club no less than £64m in compensation to various parties over the last four years. That is equivalent to 25% of the club's matchday revenue over that period, a staggering waste.

Adding the exceptional charge, a small interest bill and the share of profit from the media JV takes the £26m EBIT loss to a pre-tax loss of £67.4m. Ignore the exceptionals and the loss would be £25.6m. This compares to £70.4m in 2009/10. There is definite progress being made.

Cash flow and Roman's support
With £34.3m of the £41.9m of exceptional charges being real cash payments (the impairment is a non-cash charge), Chelsea's operating cash flow was weak in 2010/11, with an cash outflow before investment of £5.5m, but this is still an improvement on 2009/10, reflecting the far better underlying EBITDA performance and strong working capital inflows.

In 2009/10, Chelsea had negative net cash transfer spend. That all changed of course in January 2011 with the (panic?) purchases of Torres and Luiz. These accounts show £112m of "intangible asset" additions on the balance sheet and a  gross cash spend of £85m. As I have explained before on this blog, cash flows from transfers are very volatile but the pattern is clear. Chelsea are spending again (at least for now).

Even adding in £24m from player sales, the accounts show net cash spending on transfers of £60.6m. Add in capex and there is a £72m cash outflow before financing. This hole is filled as it is every year by loans from Abramovich's parent company Fordstam Limited. In the past, such loans are converted to equity after a while and no doubt the same will happen again.

Some FFP maths
So how close are Chelsea to meeting the FFP rules? On the assumption that UEFA ignores exceptional items (and I believe it is reasonable to make that assumption, especially in the early years of the new rules), the club has made good progress.

I have assumed that within Chelsea's cost base is c. £8m of spending on youth development and c. £1m of spending on community development. These items are effectively "deductible" under FFP. 

The table above shows that based on these assumptions about spending on youth and community activities, Chelsea have closed their "break-even" deficit quite substantially over the last three seasons. Revenue is up and costs are down. This calculation is before any player wages based on pre-June 2010 contracts are excluded under the Annex XI exemption, which will reduce the loss further.

Most big clubs should be able to generate profits on player sales (academy products have zero "book cost"). Assuming Chelsea can match the £18.4m profit achieved in 2010/11, the core deficit is only around £8m. That is well within the the €45m (c. £38m) allowable loss over the first two years of the new rules.

As discussed above, the main risk to this happy position is a big rise in the amortisation charge (i.e. a further splurge of transfer spending). Five years ago the amortisation charge was £70m. A return to that level would blow a big hole in the FFP calculation.

The other, ever present, risk if of course that the club will abandon it's cost control in an attempt to stay competitive on the pitch. I have written before how "six into four doesn't go" when it comes to Champions League places. Chelsea can only meet FFP with the sort of squad cost they have now by being in the Champions League. The stakes are high.

Concluding thoughts
Ignoring the exceptional charges (and Chelsea will pray UEFA do just that), these are impressive figures. To continue to meet FFP and to ween the club off Abramovich's cash, Chelsea will need to repeat the trick of holding down wages whilst achieving top four finishes. That is no easy task when every other club's wage bill is rising and when the squad needs a significant overhaul.

The other long-term option of course is boosting matchday income from the current c. £65m pa to an Emirates Stadium like £90-100m. Maybe Nine Elms/Olympia/Earls Court etc is the answer.