Tuesday, February 9, 2010

Greed Is Good


Last week, BBC Radio 5 Live was kind enough to provide a platform to Manchester United Chief Executive David Gill to make a party political broadcast on behalf of the club’s much-maligned owners, the Glazer family. This is a fairly regular occurrence on the “Sportsweek” show, even though I imagine that most of the nation would be happier to “get the ball out” (to quote Jimmy Hill), rather than listening to another tetchy “do you know who I am?” performance from Gill. His self-serving attempts to persuade the listeners that United is a “very well-run club” displayed his trademark combination of smug arrogance and patronising condescension that can only be matched by Premier League Chief Executive Richard “see no evil, hear no evil” Scudamore. When interviewer Garry Richardson had the temerity to question the state of United’s financials, Gill dismissed him with the haughty, “You’re not an accountant, Garry” - as if that’s the worst insult imaginable.

Of course, a man paid £1.8m a year to spout the Glazer ideology is hardly likely to openly criticise his employers, but we could have done without a jumped-up bean counter talking down to us, particularly as some of his comments were misleading at best. When the club’s takeover was first suggested, Gill was vehemently against it and remained that way right up until it was a done deal, when he changed opinion with a body swerve of which Ryan Giggs would be proud. Ever since then he has been an outspoken apologist for the Glazers, even crediting them with playing a major role in the team’s success, “We’ve got the stability of the family owning the club. Long-term decisions can be taken and that’s been proved with the results we’ve achieved over the last two or three years”.

"Radio, Radio"

On the face of it, Gill has a point regarding the financials, as the club reported record revenue of £278.5m in 2009 with EBITDA of £91.3m. He also probably felt that he could afford a bit of a swagger with the club achieving post-tax profits of £6.4m, especially given that they had suffered losses in each of the previous two years, though you might point out that profit in only one year out of three is not really a lot to crow about. To be fair, you’re only as good as your last game and you cannot argue with this year’s performance – right?

Well, yes, actually you can, as the results were entirely driven by the £80m profit made on the sale of Cristiano Ronaldo to Real Madrid. In 2009, Manchester United’s holding company, Red Football Joint Venture Limited (crazy name, crazy inter-company structure) recorded £81m profit on disposal of players compared to “just” £21m in the prior year. Without this £60m growth, United’s accounts would have shown a significant loss – for the third year in a row. The fact that the club only made a profit by selling their best player has to be a cause for concern for the fans, who will worry that more players will be sold in the future in order to balance the books.

"Who's the beardy weirdy?"

At least the Glazers have been successful in boosting the club’s revenues (by £66m since 2007), though much of that increase is simply the club’s share of the Premier League’s collective contract with Sky. Moreover, the growth in turnover has been entirely absorbed by the rise in operating expenses (also £66m), so none of it has fed through to the bottom line (“revenue is vanity, profit is sanity”). When analysing the costs, what is particularly striking is that the number of players has slightly fallen over this period (from 63 to 62), while the administration headcount has ballooned by an amazing 50% to 243. That’s a good use of the club’s resources?

In the 5 Live puff, Gill proudly boasted that “We have well over £100m in the bank”, but again it’s worth looking behind the headline figure for why they have so much. First, because they have cashed the £80m Ronaldo cheque and not used any of it to improve the playing squad; second, because the new sponsors, Aon, paid £36m of their £80m four-year deal upfront. Why would any company pay nearly 50% of the total cost more than a year before they were able to replace AIG’s name on the shirts? Almost certainly, they would only agree to this stipulation if the overall cost were reduced. So, the real question is why United were so desperate to bring in cash early?

"Double Glazing salesmen"

The fact is that Manchester United only make profits until they make interest payments, as their enormous debts to the banks and hedge funds soak up all the profits from the playing side. Shockingly, the total interest paid in 2009 was a gobsmacking £68m: that’s £42m on bank loans and £26m on the so-called payment in kind loans (the money owed to the hedge funds at an eye-watering 14.25%). An almost unbelievable £220m of interest has been shelled out over the last three years. A spokesman for the Glazer family claimed that “the club have a £50m surplus to work with once the interest payments have been made”, which is correct in cash terms, as only the £42m on bank loans is actually paid out, but it’s still true that the interest is only covered two times by the profit, which is moving into distinctly dodgy territory.

As a comparison to the average annual interest costs of over £70m, the club paid a £7m dividend the year before the Glazers arrived. Even allowing for the significant growth in turnover, it is clear that the dividend payments would be nowhere near as high as the mountain of interest currently being paid. Even worse, the club had to admit in the last accounts that they took a £35m hit on the interest hedging derivatives, which were only required in the first place because of the scale of the debt. At least the club is getting good value for money from all those extra accountants – not.

"Can't Buy Me Love"

This has been the situation ever since the Glazer family bought the club in 2005 in a £810m leveraged buy-out that loaded debt onto the club. They paid £270m themselves, but borrowed the remaining £540m from banks and hedge funds. Before the men from Florida arrived, Manchester United was a thriving business, free of debt, with plenty of cash to invest, but the Glazers effectively mortgaged the club to the hilt. Even after years of unprecedented success on the sporting front, the original £540m of debt has grown to today’s staggering figure of £716m – after hundreds of millions of interest payments. The debt even increased by £17m last year, despite the company returning to profit! As Harry Philp from Hermes Sports Partners commented, “That debt is a ticking time bomb that they have to pay off”.

The largest rise came in the PIK loans, which increased by £27m to £202m. Payment in kind is actually a bit of a misnomer, as it implies that the loan is paid off with goods rather than cash. In fact, no annual payment of any description is made with the interest simply added onto the loan. So, the debt continues to grow. In fact, it snowballs, as the interest rate is extremely high (14.25% in this case), because the lender gets nothing back until the whole loan is repaid. Ultimately the Glazer family is responsible for these loans, though it would be misleading to say that this is not an issue for the club, and they are clearly anxious to pay off this tranche of debt. Even without the PIKs, Manchester United would be a business £514m in hock. The Glazers have saddled the company with debt close to twice the annual turnover and over five times the underlying profits, a ratio that would classify the debt as “junk” according to Paul Marshall, the co-founder of the Marshall Wace hedge fund. Add in the PIKs and you go beyond junk to Latin American classifications.

"The Masque of the Red Death"

So who benefits from this financial strategy? Certainly not the fans (“customers”), who have seen ticket prices rise by 50% since the takeover. No, the beneficiaries have been the Glazer family and an army of professional advisors. Unlike almost any other owners in the Premier League, the Glazers are not putting money into the club, but taking it out. On top of the estimated £260m that has been leeched out of the club to service the debt since 2005, what really rankles is the amount of money that the Glazers have paid themselves for a “job well done”, also known as constructing this debt nightmare, which adds up to a barely credible £23m in the past three years.

This includes £13m in professional fees (£10m for management and administration, £2.9m for consultancy) plus £10m of loans at favourable rates (that’s £1.667m for each of Malcolm Glazer’s six children, who happen to be directors of Red Football Limited). It has only been legal for a director to borrow money over £5,000 from his company since the Companies Act was revised in 2006. As Keith Harris of Seymour Pierce stated, “You would not expect directors to be borrowing money at a company of United's size and, although it is now allowed legally, it is generally still frowned upon because it does not create a good impression of the directors' governance of the company”. Talk about milking the club for all it’s worth. No wonder the fans “Love United, Hate Glazer”.

"Exit poll"

The bankers, lawyers and accountants have also been rubbing their hands with glee during the last few years, when it has been estimated that they have racked up an outrageous £80m in fees. We know that £24m was wasted (sorry, spent) on the 2006 refinancing, while another £15m was incurred for the recent bond issue. If you were a Cockney Red, would you prefer the hard-earned money you gave the club to be spent on, say, Kak√°, or some slimeball in a pinstripe suit?

The Glazers have obviously been well aware of this crippling burden and have attempted to refinance on a number of occasions, but the credit crunch has largely scuppered their efforts, as almost no money has been available on the commercial debt market. The intention was always to pay off the highly onerous PIK notes, which were only meant to be a form of short-term financing, and they did manage to redeem half of this debt in 2006, but had to pay £13m to the hedge funds for the privilege of early redemption.

"Glazed and confused"

The growing concerns over the borrowing arrangements lead to last month’s £500m bond issue. Fundamentally, the Glazers could not secure the desired funding from the banks, either because they were unwilling to loan this amount of money or they would only lend it at exorbitant rates. Additional pressure came from the fact that the cost of servicing the debt was going to increase later this year with the 14.25% rate of interest on the PIK loans rising to a stratospheric 16.25% in August 2010, as the company had gone above the threshold where net debt is not allowed to go above 5 times EBITDA. Breaking this covenant highlights how precarious the club’s balance sheet really is – and also suggests that the management are not, in fact, the financial geniuses they would have us believe. If the situation were to further deteriorate, then the hedge funds could appoint their own directors to the board and potentially seize control of the club.

The bond issue does not remove the debt, but it does allow the Glazers to restructure it, so that they can change the order in which they are allowed to pay it off. Under the terms of the current deal, they can only start paying off the expensive PIK debt after they have repaid the £500m “senior” bank loans arranged through JP Morgan. Hence, the bond issue will be used to clear the bank debt, so they can start to address the increasingly urgent issue of the PIK loans. If they had not managed to refinance, the PIK loans would have grown to £580m by the repayment date of August 2017 – on top of the £500m the club owes to the banks.

"Standing up for the Glazers"

However, this is far from a Premium Bond with the club having to tempt investors with a near double-digit rate of interest. Jonathan Moore from Evolution Securities argued that the bond required a high yield, as “the company has high leverage, limited base case free cash flow (they can’t sell Ronaldo for £80m every season) and pretty leaky covenants. Furthermore, the club’s recent EBITDA has been driven off three excellent seasons on the pitch, but you don’t have to be a Liverpool fan to recognise that football success can be cyclical and this deal seems to be priced for perfection on the pitch”. Maybe this is why Manchester United’s executive management had to slog their way round three continents in two weeks to market the bond.

The effect of the refinancing is to actually make United even more leveraged than it is now, as more cash will be taken out of the club, so that the books will be laden with higher debt levels, although this point is moot, as the Glazers’ debt is effectively the club’s debt anyway. As Duncan Drasado of the Manchester United Supporters Trust said, “The key to the bond issue is that it has opened the door to Manchester United’s vault and now the Glazers can drive in with a fork-lift truck and load up cash”. Sensationalist stuff? Not a bit of it. The bond prospectus lays it all out in black and white with the Glazers able to take out £127m in the first year alone.

"Manchester United - season's video"

Once the restrictive bank covenants have been removed, they are allowed to pay an immediate dividend of £70m to Red Football Joint Venture Limited for “general corporate purposes, including repaying existing indebtedness” plus an additional £25m dividend at any time. On top of this explicit £95m, they are also permitted to pay out dividends up to 50% of net cash profits, as long as the club’s interest is still covered twice by EBITDA, which would have been worth £23m in 2009. Of course, the Glazers will also receive compensation for “management services” - £6m to be precise. However, that does not cover their “general corporate overhead expenses”, which merits a further £3m. That all adds up to a hefty £127m. Cue a hearty rendition of “Money for nothing and your chicks for free”.

After the refinancing, the club’s owners will trouser a whopping £224m over the next seven years (£6+£3+£23 per annum). Adding in the £300m+ interest on the debt, we can see that well over half a billion pounds will be sucked out of the club in the same period. And this does not include any potential sale and leaseback of the Carrington training ground or even the Old Trafford stadium. In fact, the Glazers could actually take out even more cash in dividends, as another result of the bond issue is a “capital contribution” transferring funds from Red Football Joint Venture Limited to its subsidiary Red Football Limited, which is far too technical to fully explain, but effectively means that this money can also be paid out as dividends. Returning to our good friend, David Gill, we can now see that he was absolutely correct in his radio interview when he said that the club had all those millions in the bank, but the real question is for how long, as the bond deal is clearly structured to allow that money to walk out of the door.

"Theatre of Dreams or just collateral?"

You would expect the average supporter to be incensed, but what do the experts think of the bond placing? Jim O’Neill, the Head of Global Economic Research at Goldman Sachs slammed the deal, despite his bank being involved in the fund raising, “There’s too much leverage. Trying to use a lot of debt in the belief that a company’s value will improve forever carries all sorts of risks”. Similarly, a financial analyst on Sky News argued that “in the long-term the bond issue is very bad news for the club, because when you look at the details, a large amount of interest and dividends will leave the club”.

Nevertheless, the company announced to the BBC, “The recent bond issue has been very successful and provides the club with certainty in its interest payments, as well as great flexibility with the removal of bank covenants”. Well, yes, they do get the certainty of fixing the annual interest on the bonds at £44m per year, but at around 9% this is much higher than the previous rate. As for the flexibility, that is also true, but we have seen that this only benefits the Glazers and not the club. David Gill further bragged, “The very fact it was twice over-subscribed demonstrates the strength of the offer”, but it seems that the market would beg to differ. The bonds were sold at a yield of 9.125%, representing a large spread of 5.7% over the gilt rate, which reflects United’s financial riskiness. Once the bond issue was completed, the price in the open market sunk like a stone, sharply increasing the yield. This indicates just how much faith the investment community has in the Glazers’ business model with the Financial Times wondering whether it was the “worst debut by a high yield bond this year”.

"Of course I'm happy with my transfer budget"

The big question, of course, is what would happen to the financials if United’s glory days on the pitch come to an end. The club itself states that “maintaining playing success” is one of their four pillars for driving revenue growth with the other three being “leveraging the global brand, developing club media rights and treating fans as customers”. Pass the sick bag, Alice. The bond’s prospectus contained a lengthy list of risk factors, such as uncertainty over whether full houses will continue (already this season, around 16% of corporate boxes have been left unsold) and increasing competition, jeopardising qualification for the Champions League. The tipping point might come when Sir Alex Ferguson finally retires.

Lord Ferg, that renowned Socialist, has remarkably claimed that United’s finances are “of no concern at all”, patiently explaining that the reason that he has not made any marquee signings is that he cannot find any value in the transfer market. Pull the other one, mate, it’s got bells on. Or, more succinctly, bollocks. If so much money is available, why have the club arranged a new revolving credit facility for an additional £75m “to acquire players”? In other words, if the club wants to buy new players, it will have to take on even more, guess what, debt. It’s almost as if the excess cash that Gill so lovingly describes is needed elsewhere.

"Looking for a hiding place?"

Just as he did with Ronaldo, Gill has emphasised that Wayne Rooney has a contract until 2012, but the question is actually where the club will find the money to buy the next Rooney. Nervous fans are already looking across the Atlantic at the Glazers’ NFL franchise, the Tampa Bay Buccaneers, who won the Super Bowl in 2003, but have since endured a miserable spell, finishing bottom of their division this season, partly because the owners are spending a lot less than the salary cap.

Despite Gill’s blustering performance on the BBC, the reality is that United’s sums simply don’t add up. His confidence is not supported by the bond’s prospectus, which baldly stated, “We cannot assure you that our business will generate sufficient cash flow from operations, or that future borrowings will be available to us, in an amount sufficient to enable us to pay our indebtedness”. Come again? Better still is the comment made by Manchester United’s Chief Executive in 2004, when the club rejected Glazer’s first offer, “We’ve seen many examples of debt in football over the years and the difficulties it causes. We know what that means and we think that is inappropriate for this business”. His name? David Gill.