Thursday, July 15, 2010

Is Manchester City's Strategy Fair Play?

Another summer, another spending spree by Manchester City. Having already splashed out over £60 million on David Silva, Yaya Toure and Jerome Boateng, it is almost certain that they will complete more big money deals before the new season kicks-off. The press has linked them with virtually all the major transfer targets, most notably the Bosnian striker Edin Dzeko, the exciting but wayward Italian teenager Mario Balotelli, Aston Villa’s willing but limited midfielder James Milner and Lazio’s Serbian left-back Aleksandar Kolarov. Many other names have been mentioned in dispatches, so it is quite possible that the final bill will be even higher than the £118 million shelled out this time last year, with some estimates as high as £175 million.

This would be crazy money for almost any football club, but that’s the point: Manchester City is not just any old football club. Ever since Sheikh Mansour’s Abu Dhabi United Group completed a takeover in September 2008, after buying out former Thailand Prime Minister Thaksin Shinawatra for £210 million, City has been described with much justification as the world’s richest football club. The owners clearly have plans to transform City into a major global force with substantial funds being poured into the playing squad.

A further demonstration of financial strength and commitment to the club came last December, when the owner converted his support, which had previously been in the form or shareholder loans, into £305 million of equity. At the same time, he purchased another £90 million of shares, taking his total investment in the club to around £400 million.

In spite of all this ostentatious flashing of the cash, City are keen to emphasise that this is part of a carefully considered project. Garry Cook, Manchester City’s chief executive, is the man with a plan, which is apparently “to build a successful, sustainable football club for the future.” After an initial period of admittedly significant investment, the intention is that City will become financially self-sufficient.

That’s obviously future music, but how close are City to achieving this ambition right now? Miles away, according to their last set of accounts (up to 31 May 2009), which covered the first season with the Abu Dhabi United Group at the helm. The enormous loss before tax of £93 million was incorrectly reported in some quarters as the largest ever loss made by an English football club, but it has only been surpassed by Chelsea’s world record loss of £140 million in 2004/05, when Roman Abramovich was really pushing the boat out.

To be fair to the new owners, Manchester City have rarely been profitable and have consistently reported losses. In fact, if we look at the financials for the last five years, the only season they made a profit was 2005/06, which was almost entirely due to player sales, ironically largely because of Shaun Wright-Phillips’ transfer to Chelsea. Although revenue has grown by £26 million in this period to £87 million, expenses have ballooned by £92 million to a staggering £161 million. Moreover, nearly the entire rise in revenue is attributable to improvements in the Premier League television deal, while the other revenue streams have hardly grown at all.

The main reason for the cost growth is very clear. As the accounts drily noted, the increase is “primarily driven by increased playing staff remuneration.” Over the last five years, wages have increased by almost 120% from £38 million to £83 million. In the same period, revenue has only grown by 43%, leading to a huge rise in the important wages to turnover ratio to a perilous 95%, way above UEFA’s recommended maximum level of 70%. Only Birmingham have a worse wages to turnover ratio in the Premier League (99%), while Manchester United and Arsenal lead the way with 44% and 46% respectively.

The increase in salaries arises from a combination of City paying top dollar to their stars plus a large increase in headcount. City had six players in the latest list of the top 50 highest football salaries published by Portuguese agency Futebol Finance, which is the same number as Real Madrid and only behind Barcelona and Chelsea. Robinho’s contract is apparently worth £160,000 a week, but that pales into relative insignificance compared to the £221,000 reportedly agreed with Yaya Toure (if you can believe that). The club has also been on a recruitment drive, as staff numbers have grown by nearly 50% from 204 (100 football, 104 admin) in 2005 to 302 (156 football, 146 admin) last year.

So, the wage bill has been growing exponentially (49% in 2008, 52% in 2009), but there’s no end in sight, as the latest figures did not include the eight star signings made last summer (Carlos Tevez, Emmanuel Adebayor, Gareth Barry, Kolo Toure, Joleon Lescott, Roque Santa Cruz, Patrick Vieira and Sylvinho). Some of those players have been given contracts of £160,000 a week, but it’s unlikely that they are all earning that much, so let’s assume an average of £100,000, which is huge money by most standards, but probably not unreasonable for City. That would mean annual wages of £5.2 million, which would imply an increase of around £40 million in the wage bill.

"Get your Yaya's out"

Similarly, the 2008/09 accounts do not include a full year’s salary for those players bought that season, especially those that arrived in the January transfer window (Wayne Bridge, Craig Bellamy, Nigel De Jong and Shay Given). Assuming that these players are on lower salaries with an average of, say, £70,000 a week, that would mean an additional £8 million (seven months of annual salary of £3.6 million for 4 players).

Furthermore, this year’s salaries will almost certainly include a severance payment to former manager Mark Hughes plus the cost of hiring Roberto Mancini as his replacement. Let’s call that another £3 million.

Clearly, some players have also left the club’s payroll in this time (Elano, Gelson Fernandes, Richard Dunne, Daniel Sturridge), but their wages would have been nowhere near as high as the new recruits, so will not have had that dramatic an impact.

So, we can anticipate a wage bill next year of over £130 million, which would take the club above Manchester United and Arsenal, only just behind Chelsea. And that figure does not include any of the players bought in 2010. As the annual report said, “the financial impact of these latest acquisitions will be seen in next year’s financial statements.” You can say that again.

In the last four years, Manchester City’s net transfer expenditure has been well over £300 million, which represents a tremendous change from the previous three years, when they were clearly a selling club (net receipts of £28 million). After last summer’s heavy buying, City let is be known that they would not spend so freely next time, but it now looks as if they have returned to the transfer market for a third bite of the cherry.

In fact, the accounts suggest that the cost last year was even higher than the reported transfer figures, as they said that the net expenditure on last summer’s transactions was £117 million, while the analysis above is only £99.5 million (and that includes £7 million for Adam Johnson’s purchase in January). The figures also exclude very large contingent liabilities of £23m, which is “payable upon the achievement of certain conditions contained within player and transfer contracts”, e.g. number of appearances, international caps, etc.

On the other hand, City would expect to recoup a good portion of their transfer expenditure this summer. Valeri Bojinov’s sale to Parma has already secured £5 million, but the club would hope to raise at least £50 million from other sales. Possible departures include Robinho, Craig Bellamy, Jo, Stephen Ireland, Nedum Onuoha, Javier Garrido and Felipe Caicedo. This would be a double whammy, as it would also restrain the burgeoning payroll. However, during all this wheeler dealing, they will have to bear in mind the new regulations on squad sizes (limited to 25 players) and home-grown players (minimum of eight in the first-team squad).

"Adebayor - say no more"

Unfortunately we now need to get a little technical in order to understand the concept of amortisation, which is how accountants reduce the value of assets over time. In this case, we mean footballers. At the end of a player’s contract, accountants consider that a player has no value, as he is allowed to leave the club on a free transfer. It’s probably easier to comprehend with an example. City signed Yaya Toure for £30 million on a five-year deal, so the annual amortisation is £6 million.

In Manchester City’s accounts, amortisation expenses have significantly increased over the last three years from £6 million in 2007 to £39 million in 2009, reflecting the continued investment in the club’s playing squad. It is difficult to know how much this will be going forward, as we do not know which players will leave, but my guess is that it will be at least £20 million higher, which would take it up to £59 million next year. To place that into context, that would be the highest amortisation figure in the Premier League, way above Chelsea at £49 million.

"Robinho - time to go?"

And guess what’s happened to the administrative expenses? Got it in one: they’ve also massively increased, doubling over the last five years from £20 million to £39 million. This reflects the significant investment made to improve the club’s training facilities (new gymnasium and improved pitches), offices and other infrastructure, which were in need of a major overhaul.

Manchester City’s financials provoke a sense of déjà vu, as they almost exactly mirror what happened at Chelsea, which will inevitably mean several years of large losses. Actually, you don’t have to be a genius to work that out, as the club kindly spells it out in the annual report, “It is therefore to be expected that there will be further significant operating losses reported in future financial periods as we accelerate the timeframe for generating success.” Chelsea kept telling us that they were on course to break-even, but they are still nowhere near self-sufficiency. Although they have been reducing their losses year after year, in 2009 they still came in at a loss well over £40 million. In fact, as we have seen, Manchester City’s losses are still on an upward trend and next year they could well establish a new record loss of around £150 million, as huge increases in wages (£50 million) and player amortisation (£20 million) are offset by improved TV revenue (£10 million) and commercial revenue (£10 million). We shall see.

Longer-term, there is no doubt that Manchester City have a lot of potential. Despite their years in the doldrums, they are already the sixth highest English club in terms of revenue and are rich in tradition, having won the old Football League twice, the FA Cup four times and the European Cup Winners’ Cup once. As the marketing men would say, they have a great brand (the “people’s club” in Manchester) with a solid fan base, which even stayed loyal when the club was relegated to the third tier of English football in 1998, and now they’re playing in a spanking new stadium in the most lucrative league in the world.

Of course, the main driver for revenue growth at English football clubs these days is television and City are no exception with broadcasting income of £48 million representing 55% of their turnover. It increased by 11% in 2009, largely due to the money earned from reaching the UEFA Cup quarter-final, but by far the largest component was the central distribution of £40 million from the Premier League. This was the reason for the substantial £19 million increase in 2008, as a new three-year Premier League deal commenced. We already know that City will receive £50 million from the Premier League this year, the £10 million improvement derived from higher merit payments (after finishing fifth) and more matches shown live on television. Next season, they should receive a further £10 million increase, as the new Premier League 2010-13 deal kicks in, following the much higher sale of overseas rights.

However, City’s broadcasting revenue is still a long way behind the so-called Big Four, as they also benefit from the riches of the Champions League. In 2008/09, this was worth between £20 million and £33 million, but last season’s pot increased by almost 30%, so qualification is now worth at least £25 million, assuming a team gets out of the group stage. In fact, reaching the Champions League would increase revenue across all three streams, including higher gate receipts and better deals with sponsors.

"The Bank of Abu Dhabi"

Commercial revenue actually fell £2 million in 2009 to £23 million, because City decided to stop hosting other events like summer music concerts and the Ricky Hatton fight. The better news is that City have signed new marketing deals with Etihad and Umbro, replacing Thomas Cook and Le Coq Sportif as shirt sponsor and supplier. These contracts are reportedly for much more money, so Etihad’s deal is worth £25 million over the next three seasons, compared to Thomas Cook’s £2.3 million annual payment, while Umbro have entered into a ten-year strategic partnership for more than £50 million.

The owners plan to maximise the commercial potential for the City brand, so you would expect them to boost this revenue, especially in the Middle East. There is certainly room for improvement, when you look at how much Manchester United’s marketing machine earns – over £50 million more than City. Their continental counterparts like Bayern Munich and Barcelona earn even more from their commercial operations, so there is definitely a great opportunity here.

Despite a small increase in 2009, match day revenue is also relatively low. The Deloittes Money League gives a figure of £21 million, having re-classified some revenue from commercial, which is around half that achieved by Spurs, even though City’s average attendance is nearly 8,000 higher. In fact, crowds have been on the rise at Eastlands over the last three seasons, increasing from 40,000 to 43,700, though this is still only utilising 92% of the stadium’s 47,700 capacity, which does not look great when you see that Manchester United fill 99% of the far larger Old Trafford (76,200 capacity). At the moment, City’s gate receipts barely cover Yaya Toure’s salary, something that City fans might like to consider when shouting “we pay your wages” to the team. The club has increased its ticket prices by an average 5% for next season, but they are still a lot lower than many other clubs.

"Don't look back in anger"

However, the club is restricted in its ability to greatly increase its match day revenue by the fact that it does not own the City of Manchester Stadium, which is rented from the council on a 250-year lease. On the plus side, City only had to pay £30 million to convert the stadium into a football ground after the 2002 Commonwealth Games, but this arrangement is a double-edged sword. First, City had to hand over Maine Road to the council; second, the rental payments are based on a formula that allows the club to retain receipts up to the 34,000 capacity of their old ground. This effectively means that City do not get the benefit of higher attendances, as it just means more rent paid to the council. The club plans to expand the capacity to 60,000, including more corporate hospitality facilities, but they would probably prefer to buy the stadium, so they could remove the rent expenses, increase revenue and sell naming rights.

That would help contribute towards a brighter future for City, but there is a cloud on the horizon, namely UEFA’s Financial Fair Play initiative, which will ultimately exclude from European competitions those clubs that fail to live within their means. Although City claim that they are “engaging fully with the FA, the Premier League and UEFA” on this matter, it is highly unlikely that they will break-even in the near future. Indeed, UEFA President, Michel Platini, specifically mentioned them, when he announced the new measures, “Manchester City can spend £300 million if they want to, but if they are not breaking-even in three years, they cannot play in European competition.”

But does it really matter if City spend so much? Defenders of the beautiful game have bemoaned the reduced emphasis on traditional methods such as good coaching, intelligent tactics, developing players, hard work and team spirit; all of which can apparently be replaced by whipping out the cheque book and buying your way to success. The argument goes that this policy inflates the market for everyone else, both in terms of transfer fees and wages. It is obvious that clubs apply a premium when City call, no doubt whistling “Santa Claus is coming to town”, as they hear Garry Cook approaching.

"Father Christmas"

This could be particularly tough on the youth players at Manchester City. The club is rightly proud of their performance in developing young players. Indeed, the annual report notes, “Vladimir Weiss became the 27th player since 1998 to graduate from the academy to first team football – an almost unprecedented record of success.” However, does anyone seriously believe that this will continue, now that the club can go out and buy a ready-made international? Although Mancini has spoken of the club’s commitment to the academy, it would be no surprise if the focus lessened with few, if any, players progressing to the first team. As a meaningful comparison, Chelsea’s youngsters have hardly set the world on fire since Abramovich started pumping money into the club (though, in fairness, they did win the FA Youth Cup last season).

After the spectacular collapses at the likes of Portsmouth and Crystal Palace, there is also some concern about the benefactor model, which works just fine until the money runs out. Even when the owner appears to be incredibly well funded, there is always the possibility that his financial status might change (e.g. market crash in Dubai), he loses interest or gets arrested. Indeed, City should be well aware of these dangers after their experience with Thaksin Shinawatra, who faced corruption charges in Thailand, which lead to his money being blocked. This meant that the club could not pay the players and had to ask the former chairman for a loan.

On the face of it, the men from Abu Dhabi are cut from a very different cloth with a long-term strategy, based on diversifying their economic operations and presenting an appealing image to the world. In a message to fans, the new chairman, Khaldoon Al Mubarak, said, “We are genuine people and we want to develop this club in a sustainable manner.” All very reassuring until you realise that in the same conversation, he also stated, “Mark (Hughes) is as good as they get and we are backing him all the way”. That’s the same Mark Hughes, who was unceremoniously sacked a few months later.

"Time's up"

There is also a worry that they’re not really City fans. When they bought the club, Sulaiman Al Fahim claimed that there was nothing special about City, acknowledging that his backers were simply “attracted to the Premier League itself.” To be fair to Sheikh Mansour, he soon cut short Al Fahim’s “loadsamoney” impression, when he realised that this was upsetting a lot of people, e.g. when the club launched its “name your price” offer for Milan’s Kaka.

Maybe this is why some City fans feel uncomfortable with their new wealth, as it looks like they’re trying to emulate the business model followed for so long by their dreaded neighbours: spend big, build a global franchise and attract worldwide support (from Surrey to South Korea).

On the other hand, although this might not be the club they knew and loved, most City fans surely think that if anyone deserved this good fortune, it has to be them, following all their years of being the underdog. After all, they would not be the first club to benefit from a sugar daddy or buy their way to success. Is what they’re doing really that different from Manchester United when they paid huge money for the likes of Rio Ferdinand, Juan Sebastian Veron, Wayne Rooney and Dimitar Berbatov?

In any other business (and football is now surely a business), there would be no problem with investors using vast amounts of their personal wealth to fund ventures. Would anyone have said anything if the owners had spent £1 billion+ to acquire United? The investment in City, which has largely been spent on buying new players, may actually end up costing less than purchasing a ready made club.

"Not provocative in the slightest"

It’s also difficult to see how else they could realistically break the monopoly of the big four without investing substantial sums. It might be unfair to the likes of Everton and Aston Villa, but this could be what it takes in England to break into the Champions League. This is the thrust of Khaldoon’s argument against the UEFA Fair Play rules, “This suggests that the big clubs, which make the most money, must remain the big clubs and that the status quo must remain.”

In fairness, UEFA have given clubs every opportunity to meet the new guidelines. First, there will be a phased implementation with the first monitoring period being season 2013/14, though this does cover the preceding two reporting periods, 2011/12 and 2012/13. For each successive monitoring period, three reporting periods will be taken into consideration.

UEFA have also stretched the definition of break-even to include an “acceptable deviation”. Billionaire owners will be allowed to absorb aggregate losses of €45 million over three years for the first two monitoring periods, so long as they are willing to cover the club’s losses by making equity contributions. The maximum permitted loss then falls to €30 million from 2015/16 and will be further reduced from 2018/19 (to an unspecified amount). This means that in the transition (weaning-off) period, owners can pump in an average per season of €15 million up to 2015 and then €10 million up to 2018.

"I'm coming for you"

In addition, clubs will still be permitted to borrow for “good” projects like improving the stadium, training facilities, youth and community development. Any costs associated with this investment, like interest on loans to fund the construction or depreciation on the resultant fixed assets, are excluded from the break-even calculation. In other words, an excess of expenses over income may still be allowed if it is solely related to costs that are for the long-term benefit of the club.

At this stage, we should probably clear up a few misconceptions about the Fair Play regulations. Many seem to believe that if a club has no debt, it should be OK, but that is not the issue for UEFA. They are less concerned about clubs taking on debt, but more their ability to service that debt, i.e. pay the interest charges. Some thought that this was the reason that Sheikh Mansour converted his loans into equity, but in reality this makes no difference to UEFA. Obviously, it’s beneficial to the club, as it would be able to start with a clean slate financially if the owner walked away – though it would still have to finance a massive wage bill – and it will also reduce City’s annual interest payment, which is currently £17 million.

It should also be noted that City are not quite debt-free yet, as they still have £49 million of loan notes and bank loans, including £30 million repayable over 25 years at 7.27% and £14 million over 15 years at 7.57%. The debt also includes £43 million provided for future stadium rent, giving gross debt of £92 million. If cash balances of £19 million are taken into consideration, net debt is £73 million. On top of that, the accounts also reveal that City owe other football clubs an amazing £77 million.

"Sheikh - your money maker"

Others are under the assumption that if the owners were to inject £1 billion into the club, that would somehow enable the club to meet the UEFA regulations. Obviously, this would strengthen the balance sheet, but it would not help the profit and loss account. Assuming the funds were used to strengthen the squad, all that would happen is that expenses would increase following a rise in salaries and player amortisation, which would make it more difficult to meet the break-even target.

Another potential loophole often mentioned is for a wealthy owner to pay a ridiculous sum, say £200 million, for sponsorship or use of an executive box. Here, UEFA have said they will test such deals for “fair value”, and if an owner has over-paid for services, the income will be adjusted down to market value. Of course, this is open to interpretation and there are plenty of high-paying deals that could be used as a comparative. It would also be difficult to argue against a club securing many deals at, say £5 million, which could add up to a tidy sum.

However, here’s the thing: Manchester City do not have to worry about any of that, as there is a section in the new guidelines that may well allow them to pass UEFA’s break-even test with flying colours.

As a rule, revenue from non-football operations is excluded from the break-even calculation, but clause B. (k) in Annex X allows you to included revenue from “Operations based at, or in close proximity to, a club’s stadium and training facilities such as a hotel, restaurant, conference centre, business premises (for rental), health-care centre, other sports teams.”

"Cooking up a story"

That sounds almost exactly like the £1 billion development that City are planning for the area around Eastlands stadium. Described as a world class sports and leisure complex, it will include a training facility, luxury hotel and restaurant and should provide a very healthy revenue stream. Bingo! Job done.

Of course, I may be a touch over-cynical here. An alternative scenario would have Manchester City cutting back on their investment after they reach the Champions League, replacing expensive imports with cheaper players developed by their academy, and reaching break-even that way.

This all makes sense if you believe Khaldoon, when he explained that the owners had two reasons for investing in Manchester City, “There is a pure football, emotional side to it and a big business side too. Sheikh Mansour is a huge football fan, but we can also create a franchise, a business which will create value over the years and reap a long term return.”

At the moment, the normal rules of business do not apply to City, but strange as it seems, they just might pass UEFA’s Financial Fair Play rules.