Wednesday, October 28, 2009


Last week was a frustrating experience for Arsenal fans, as their youthful team casually threw away leads twice against seemingly inferior opposition: first conceding an injury time equalizer to AZ Alkmaar in the Champions League; then relinquishing a two goal advantage after they had been cruising in their local derby against West Ham in the Premier League. Here we go again was the refrain, closely followed by the usual question of why the club does not invest some money in more experienced players to provide a stronger spine to the dazzling, but fragile, young tyros.

It surely cannot be due to lack of funds, if you believe the media’s take on the club’s recent annual (financial) results, where Arsenal announced a 24% increase in pre-tax profit to £46 mln. This included income of £313 mln, which is the largest annual turnover ever reported by a British football club. Gate and match day revenue exceeded £100 mln for the first time, largely because the team reached the semi-finals of both the Champions League and the FA Cup, which also contributed additional broadcasting revenue.

"How much is my transfer budget?"

Outstanding, but, as is so often the case, we need to look beyond the headlines. In this case, the impact of property development on Arsenal’s financials cannot be over-stated. Over £88 mln of the record-breaking turnover came from the sales of apartments at the Highbury Square development, accounting for almost all of the increase in pre-tax profit (£9 mln). Without this property revenue stream, Arsenal’s turnover is reduced to £225 mln, which is still very respectable, but is well behind the £256 mln recorded by Manchester United.

In addition, it has to be recognised that the Highbury Square development, which was intended to contribute over £100 mln profit to Arsene Wenger’s transfer budget, has now become a giant millstone around the club’s neck, directly impacting the manager’s spending capacity. Otherwise, why would the club have recently accepted a low-ball offer from real estate group London & Stamford Property for some of the flats? Even after the reduction in property valuations following the credit crunch, experts estimated the market value to be £500 per square foot, but Arsenal were happy to take a knock-down price of £400 – a 20% discount worth around £10 mln.

"Money's too tight to mention"

This shows how concerned the Arsenal Board is about the level of debt, which was still around £300 mln at the time of the accounts. To place that £300 mln debt into perspective, it’s about 1.3x the group’s annual football income, which looks pretty good compared to most people’s ratio of mortgage to salary, which would be at least 3x (assuming no sub-prime dodgy deals). Furthermore, borrowing money to purchase an asset (the Emirates Stadium) that will considerably increase future revenue generation is not exactly a gross misuse of company funds.

Even though this is significantly less than Manchester United’s gigantic £650 mln debt and effectively much lower than Liverpool’s £300 mln debt (as they have not yet funded their proposed new stadium), it’s obviously still enough to worry Arsenal’s money men. The other “Big Four” team, Chelsea’s debt is probably not an issue, unless their benevolent Russian oligarch has a change of heart, because from time to time he simply converts their debt into equity, as an example reducing it from £700 mln to £300 mln last year.

Arsenal’s debt has actually been cut by £20 mln over the last twelve months, mainly as a result of the loan repayments that reduced the balance on the Highbury Square facility from £134 mln to £124 mln. Subsequent to the year end, this loan has been substantially further reduced to £47 mln. The other good news is that they have refinanced the remaining loan into a new facility, pushing back the repayment from April to December 2010. Although this came at an additional cost with the margin increasing to 2.5% above LIBOR (previously the two loan tranches had margins of 1.3% and 1.7%), the huge pressure of finding a £120 mln loan repayment by April has now been removed. This still leaves the long-term stadium financing of around £245 mln, which is covered by a 21 year loan at a fixed rate of 5.3%, the agreement obviously having been struck before today’s historically low interest rates. Including the capital repayment of £5 mln, the total annual cost of servicing the bonds is £20 mln, excluding any property development financing.

"This used to be a football club"

Arsenal do appear to be managing their business with the requisite degree of prudence, but what are the major risks that could impact their financial performance? Well, the most significant issue still concerns property development, first through the sale of the remaining apartments (around a third of the original 655) at Highbury Square, but also the question of what to do with the Queensland Road site. When presenting the results, Arsenal’s new Chief Executive Ivan Gazidis was confident enough to state, “We anticipate it is likely we will make a profit out of that (Highbury Square) development, which will then be available to the football side”. However, the accounts strike a more cautious note, “conditions remain very tough and uncertain for our property business and this will likely continue to impact both of our main property development projects over the next year”, which is not surprising, given the difficult conditions in the mortgage lending sector.

The Arsenal Board faces an enormous decision over the Queensland Road site. They have already had to book an impairment charge to cover the increase in costs following the project delays and the decrease in market valuation, but the site has now finally received planning permission. Will they use the cash retained in the business to finance future developments? Or, after the trials and tribulations of Highbury Square, will it be a case of “once bitten, twice shy”? If so, they may just sell the site to a real estate developer, instead of pretending that AFC stands for Arsenal Football Construction. This decision may play a crucial role in determining whether the transfer purse strings will be loosened – or not.

"Subtle Emirates advertising"

Ironically, much of Arsenal’s performance off the pitch is linked to their performance on the pitch. As it should be, you might think, but it may be worthwhile stating the obvious, namely that the club’s income is affected by the performance and popularity of the team. This is unlikely to be an issue for season tickets, at least in the short-term, as the club currently has over 40,000 supporters on the waiting list, though I would note that the club did freeze ticket prices this season.

Most important is the team’s participation in the UEFA Champions League. Even though Chairman Peter Hill-Wood told the recent AGM that the club only budgets to qualify for the Champions League three seasons out of four, the reality is that it would be a financial calamity if Arsenal were to drop out of the four qualifying places available in England. Arsenal do not separately break out the revenue earned from UEFA’s central distribution, but Deloittes quoted £18 mln in their review of the 2008 accounts (excluding match day revenue), while Alex Fynn, co-author of “Arsenal: The Making of a Modern Superclub”, estimates the current worth to be £40 mln. What is certain is that the total pool available to UEFA has increased by 25% this year to €1.05 bln.

"Now that's what I call branding"

What may not be appreciated is that UEFA share out the Champions League sponsorship and television income according to a complicated formula, which rewards clubs according to the size of the television market in their home country. As England is a large nation with many people watching “footy on the telly”, the English clubs receive a higher proportion of the revenue than their European rivals. Moreover, most of the money is divvied up at the Group Stage, which is why it’s of supreme importance to at least get this far. More prize money is available if you progress to the quarter-finals, semi-finals or the final itself, but the majority has already been distributed before then. The position where you finish in your domestic league is important too, as this also impacts the way the revenue is carved out, e.g. the side qualifying second receives less money than the side qualifying first. Therefore, scraping into the Champions League by qualifying fourth has a financial impact, as well as increasing the stress levels of supporters.

In fact, coming fourth has a double whammy, because UEFA has adjusted the qualifying procedure for the Champions League, in order to guarantee that clubs from lower ranked leagues have participants in the group phase of the competition. This means that clubs from the “big five” European leagues now face theoretically stronger opposition in the matches to qualify for the Group Stage, so face a bigger risk of missing out. Hence, Arsenal could be faced by the likes of Valencia instead of the winners of the Bulgarian league.

"New shirt sponsor"

Arsenal’s accounts state that the club derives a significant amount of revenue (£48 mln) from commercial activities, but any risk is lessened by the long-term nature of the arrangements with its partners, so that naming rights and shirt sponsorship contracts with Emirates Airlines only expire in 2021 and 2014 respectively, and the kit sponsorship deal with Nike only runs out in 2011. However, in their annual Football Review, Deloittes pointed out that in 2008 commercial revenue represented only 21% of total income and was much smaller than Chelsea (£17 mln less) and Manchester United (£20 mln less). To further place this into context, Arsenal’s commercial revenue is less than half of what is earned by Real Madrid – the real purpose of the Galacticos project. Therefore, Arsenal’s long-term commercial contracts are something of a double-edged sword: although they may bring some certainty to future revenue, it does mean that Arsenal have fallen behind other clubs in this sphere, as seen by the £80 mln shirt sponsorship deal that Liverpool signed with Standard Chartered last month.

This has to be one of the drivers for the appointment of former Major League Soccer (MLS) Deputy Commissioner Ivan Gazidis as the new Chief Executive. The Board clearly hopes that Gazidis and his team will help boost future growth. The problem here is that this will inevitably involve things like growing the brand, increasing the global reach and the continuing “Arsenalisation” of the stadium. Although Gazidis seems like a sound chap, I sincerely hope that he does not morph into a Peter Kenyon or Garry Cook with their constant references to “the project”. It will be interesting to see whether Gazidis tries to pressurise Wenger into undertaking lucrative pre-season tours to the Far East or the States, like Chelski and Franchise Utd, instead of the usual, cosy trip to Austria.

"Ground control to Major Tom"

Broadcasting revenue is also hugely important to the club’s turnover, increasing to £73 mln, mainly due to the Arsenal’s progress in the Champions League, which was further boosted by Sterling’s weakness, as UEFA’s revenues are sourced in Euros. Although pay-TV operators are not immune to the turbulent economic conditions, football remains key content for these companies and continues to drive subscriptions, hence the next Premier League contract has already been secured until season 2012/13 with an increase of 5%. All well and good, but again the Spanish clubs lead the way here, as they are allowed to negotiate individual broadcast deals, as opposed to the Premier League collective bargaining, so that Real Madrid earn well over £100 mln a year from television rights.

Enough already with what accountants call the “top line”, what about the costs? Like investment banks, by far the most important expense is wage costs, which have increased to an incredible £104 mln. The annual report proudly states that the wages to turnover ratio of 46% continues to fall within the club’s target range. Hang on a minute, almost half of the club’s revenue goes to the staff? If you ever thought, just for a moment, that footballers were over-paid, here’s your confirmation.

"The good old days"

Not only the players, when you see that Ken Friar received total remuneration of £1.4 mln last year. I appreciate that he took on some Managing Director duties before the arrival of Ivan Gazidis, but that’s pretty good for a man who started out at Arsenal as a tea boy. Former Managing Director Keith Edelman also received a very generous “golden goodbye” of £1.7 mln as compensation for his loss of office, despite the fact that he was reported to have resigned.

Unfortunately, the pressure on staff costs is unlikely to change in the near future, even though owners would dearly love to introduce some form of salary cap, as there remains enormous competition between clubs for the best players. Actually, the situation is likely to get worse for the Premier League clubs, following: (a) the introduction of the 50% income tax rate (witness Andrei Arshavin’s frequent complaints); and (b) the depreciation of the Pound against the Euro. Just look at this summer when Ronaldo, Kaka and Benzema all took their skills to sunny, tax-friendly Spain instead of the “best league in the world”.

"Welcome to Highbury"

Some commentators have claimed that Arsene Wenger has transfer funds available to him of up to £80 mln, but I just can’t see it myself. Straight off the bat, once the property development financing is cleared, the club has to find £20 mln to pay off the stadium loan every year for the next 21 years. Assuming that the football business continues to produce annual profit of £30 mln, that leaves just £10 mln per annum. Of course, this presupposes continued qualification for the Champions League Group Stage, which is no longer a certainty after the rise of Manchester City (and, to a lesser extent, Spurs and Aston Villa).

Of course, Arsene Wenger is renowned for his ability to also generate revenue from the transfers of players that he has developed. In particular, last year’s accounts include a profit of £23 mln from the sale of player registrations. They also exclude the £42 mln received this summer from the City slickers for Emmanuel Adebayor and Kolo Toure, though the net money available is almost certainly less, as many Arsenal players have received increases in their contracts in the last few months. The accounts actually state that the net income resulting from these transfers is only £27 mln, presumably because the purchase of Thomas Vermaelen and others is also included.

"The Arsenal board"

What about the profit generated from property development? First of all, it’s very unclear whether there will actually be much profit accruing from this activity, but there may also be an intention to use any gains for a potential Queensland Road development. In fact, the accounts include a get-out clause along these very lines: “The use of property profits which may be transferred to the football segment is not determined until such time as those profits are realised and transferred in cash to the club – accordingly, there is no current commitment to use any such profits and cash anywhere within the Group at any specific time for any specific purpose”. So, there is absolutely no guarantee that any property profits will be made available for football transfers.

In short, only the Board and (presumably) Arsene Wenger know for sure how much money is genuinely available in the transfer pot and any external estimate can only be speculation. Wenger himself has said that, “there is money to spend, but at the moment I am very happy with the squad I have”. This may well be accurate and Wenger may genuinely want to build a team from scratch without breaking the bank, but somehow it does not ring true. I just cannot imagine that if funds were genuinely available, then we would not have seen the arrival of the experienced players that the team has so palpably needed for the last four years.

"Eton rifles"

Until the distractions of the property arm of the business cease, the paradox of Arsenal being described as one of the richest clubs in the world (3rd according to Forbes magazine, 6th per the Deloitte Annual Review) and yet apparently having no money available for transfers will surely continue. Any long-suffering fan expecting Arsene Wenger to stride into a press conference to the sound of “Hey, Big Spender” any time soon is likely to be sorely disappointed.

No comments:

Post a Comment

Related Posts Plugin for WordPress, Blogger...