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, Kaká, 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.


  1. Read your stuff about my beloved Everton on a club website and have now read all your articles on Man U, RS, Villa and Spurs. Excellent work, ta very much.

  2. My pleasure (and a lot of research) !

  3. Well written! But wouldn't not spending mean not winning which will in turn mean losing out on revenue and thus losing cash(which is what the glazers want)? If the club is in such a sad position how can you explain the 1.5bil offer that the glazers rejected? Or even a red knights offer of 1bn would have given them a hefty profit right? So why are they not selling? Because there are many buyers in the market for a money generating machine like united which has still survived after making those huge payments! Please will you clear up if there was not debt will united be great financially? I don't think fan ownership is working either because you can see that barcelona are about to take out a 125mil loan. And real madrid is approximately 300+mil in debt. What model do you think will work best for united? I also recently read that united's revenue is more than 70mil less than madrid's? Also how much effect do you think gordon brown's 50% foreigner tax policy and the weak pound has had on english clubs? And one final question to you- as of now (i.e without the glazers taking out the said money they are allowed to take out) is united in a good financial condition?

  4. Hi, Interesting argument, but you are totally ignoring the fact that one of the main reasons Red Football JV makes a loss is because it has to amortise goodwill to the level of about £35m a year. As I'm sure you know goodwill is not a cash event it is purely an accounting tool used to increase the value of the balance sheet to reflect the premium the Glazers paid for United. The amortisation of that goodwill therefore artificially reduces the actual profits of the business. So many people focus on the holding company because losses make headlines, but the true trading company is Manchester United Limited which made nearly £50m before the sale of Ronaldo. I think if those wishing to comment on the financial situation were less selective about the information they air then people would get a cleaer picture of things. Cheers

  5. @Anoynmous (10:21),

    I take your point re the goodwill and believe that this is how United will try to pass UEFA's Financial Fair Play regulations, i.e. exclude that from the break-even calculation.

    However, not sure that I agree with the rest of your argument. If people only focus on the trading company, isn't that being selective? In business, organisations will always set up intricate inter-company structures, normally with an objective to reduce tax, so you often have to review financials at the holding company level to obtain a true picture. I should know, as I've done this myself a few times in the past in a previous job.

  6. Just stumbled across this article. Looks like a cut and paste from andersred. Amazing level of vituperation. I'll comment on a couple of things.

    When the Glazers bought the Bucs in 1995 they were a national joke having had 13 straight losing seasons. Under the Glazers they have a winning record, even after last season, and have won a Superbowl. '07 and '08 were both winning seasons. At the start of '09 they fired their coach, John Gruden, and installed a new head coach and General Manager. They then cut 6 of Gruden's overpaid, under-producing veterans and started building through the draft (that's what small market teams do in the States). The result is a season or two of frustration for the fans and then, hopefully the return to winning ways. In many ways it's a tribute to the Glazers that the fans were so upset by a losing season - before them that was the expectation.

    Moving to United, My first observation is that the initial financial structure was quite typical for a leveraged buyout as was the 2006 refinancing. Keeping the mezzanine layer for as long as they have is a little unusual, but seems to be a function of the financial system's meltdown rather than anything else. (As a side note, it's worth remembering that the PIK has been pretty tax efficient - on an after-tax basis it's costing a little less than 10% which is not bad for the mezzanine layer.)

    to be continued

  7. Continuing on the PIK, the righteous indignation that free cash flow generated by the company might be used to pay down that layer of financing is naive at best and, in reality, mostly self serving. (What was the Claude Raines line in Casablanca - I'm shocked, shocked to find that gambling is going on in here.) What did you and the other commentators expect?

    Now let's look at the plc's dividend policy. From 2000-2004 the plc consistently paid around 35% of after-tax profit as dividends (don't ask andersred, go and look at the accounts). The £7 million you referred to was the partial dividend paid just before the take-over became final - you really wouldn't expect the shareholders to be given a complete dividend as well as the substantial premium being paid for their shares. Had United continued as a plc and generated the same operating cash flow as actually occurred, the dividend payments over the last 4 years would have amounted to £45-£55 million (depending on how the Ronaldo cash was treated). Puts the 'barely credible' £23 million in at least some perspective (over 4, not 3, years). It's also worth bearing in mind that £13 million of that was inter company transfers for professional services - there's no evidence that the money went into anybody's pockets.

    Rolling along, there's a perception that the team has been starved of cash for transfers under the Glazers. In reality, the team has spent around £198 million on player registrations in the (slightly less than) 5 years under the Glazers. This compares with the £156 million spent in the last 5 years of the plc. (Again, look at the accounts if you find this hard to believe.) It is true that a lot of this expenditure was financed by selling the player the plc had bought in the previous years (only Ferdinand and Rooney survive of that group), but I'm unclear why this is considered to be a bad thing.

    You quote Jim O'Neill and Duncan Drasdo in your article - both closely associated with the 'Red Knights'. O'Neill in particular had a vested interest in trying to stir up unrest in an effort to drive down a possible purchase price. To put his words in context remember that he is the chief economist for Goldman Sachs, a company with an astonishing 91% debt ratio (it's not really astonishing - it's a function of the business they're in - but it does show that debt must be looked at in context). Goldman were one of the leaders in the sales of the toxic securities that almost brought down the financial system; Jim was the economist whose rosy forecasts helped them sell the securities. (Goldman are under investigation in the States for their role in the meltdown - Jim and his fellow senior executives may well face charges.)

    I'll finish by following up on the 'goodwill' discussion above. Along with goodwill, the amortisation of player contracts and asset depreciation are non-cash charges to the income statement. That leaves you with an interesting problem in analysis - either add back all the non-cash charges and work with the free cash flows generated by the company, or add back only the goodwill and recognise that allowance has already been made for player and asset replacement. In practice, free cash flows make a lot more sense for analysis - they make it much easier to see what's going on in the company. The biggest cause of alarm among fans is the idea that reported accounting losses mean that the company is going broke and has no money for transfers; looking at the cash flows makes it clear that this is not the case. As far as the UEFA Financial Fair Play rules are concerned, despite you prognostications, United are fully in compliance with any version that might be arrived at.

  8. Sorry - a big chunk failed to publish.


    Would expect excess cash in the company to be used to pay down the mezzanine.

    Glazers have spent £198 million on players vs. £156 million in the last 5 years of the plc.

    plc paid 35% of after tax profit as dividends (2000-2004). Your £7 million figure is the partial paid immediately before the takeover became final (at a substantial premium). Under the plc the last 5 years' dividends would have totaled £45-£55 million. (Depending on the treatment of the Ronaldo transaction.)

    O'Neill and Drasdo are not exactly unbiased commentators - through their association with the Red Knights they have a vested interest in stirring up fan unrest in an attempt to drive down a possible purchase price.

    O'Neill is chief economist at Goldman Sachs - they have a 91% debt ratio. Jim and his fellow executives were intimately involved in the sale of the toxic securities that nearly brought down the financial system.

  9. Oops - looks like it published after all.

  10. @Anonymous (71:14),

    Thank you for your articulate, well-argued comment, but you will not be surprised to hear that I disagree with most of it.

    Yes, the structure of the initial deal may be no different from any other LBO, but surely that's the point/problem, as a significant part of the purchase price was funded by borrowing, which has resulted in United being saddled with a ton of debt.

    Again, an interesting argument on the PIKs. You appear to be arguing that it's OK that these instruments are "bad", as everyone knows that they are. Actually, I think that most people would have been shocked that the interest rate was 14.25%. I say was, because it seems that the predicted increase to 16.25%, as United broke a financial covenant, has indeed come to pass.

    Let's accept your suggestion that if United had continued as a PLC, then the dividends would have been £45-55m. Surely the comparison then is not just the £23m fees/loans that the Glazer family has taken out, but also the interest payments on the loans with which they burdened the club, which amounted to £332m (09 £69m, 08 £69m, 07 £81m, 06 £113m - source: accounts for Red Football Joint Venture). This is without including the millions spent on professional fees for bankers, lawyers and accountants.

    The main point is not whether the LBO or PIKS are consistent with the normal finance world (they are), but whether this has deprived the club of funds that they could have used elsewhere, e.g. not raising ticket prices or the transfer market.

    This brings us to your comparison of transfer spend, which is overly simplistic for two reasons. First, it does not take into consideration United's significant increase in revenue in the last five years. Second, transfer fees have changed a great deal over the years. As an extreme example, the record £1m that Brian Clough paid for Trevor Francis in 1979 would not get you very far today.

    I take your point about Goldmans, but wasn't part of the problem with the financial system associated with over-leveraging? Now where have I heard that before ...

  11. Tiny pedantic comment. We were in the hunt to sign Van der Vaart, as were Bayern. However, Real were playing hardball and demanding £18m+ which both clubs weren't willing to pay. Real relented with Spurs because they weren't seen as a real rival + it was deadline day. Otherwise a well written article! Must've taken so much time to research!


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