Will Real Madrid Be Able To Fund Mourinho's Plans?

There are many questions regarding Jose Mourinho’s arrival at Real Madrid, but one thing that is certain is that the “special one” will be demanding funds to fashion the team into his desired formation. According to the Italian press, Mourinho’s acquisition plans will cost around €100 million, as he looks for players with more defensive characteristics. Many names have been bandied about, but the usual suspects are Inter Milan’s Brazilian right-back Maicon, Lazio’s Serbian left-back Aleksandar Kolarov and either Roma’s Daniele De Rossi or Liverpool’s Steven Gerrard to add drive and energy to the midfield.

This expensive shopping list is on top of the money that Real have already shelled out to secure Mourinho’s services. Most of the media suggested that the nerazzurri allowed him to go for €8 million compensation, while Inter’s management has privately briefed that the true cost is €10 million in cash plus a further €6 million to be off-set against future transfers between the clubs. This is in addition to the €5 million pay-off that Real had to give to Mourinho’s predecessor, Manuel Pellegrini.

That’s a lot of money, but it’s still small change compared to last summer’s outlandish spending spree following Florentino Perez’s spectacular return to the President’s seat at Real Madrid. He wasted no time in making his mark, breaking the world transfer record twice in just a few amazing days. First, he bought Kaka from AC Milan for £56 million, only to surpass that sum almost immediately by paying £80 million to Manchester United for Cristiano Ronaldo. In total, Real invested a staggering €250 million in new talent, which also included Xabi Alonso, Karim Benzema and Raul Albiol.

"What does £80m get you these days?"

UEFA’s President, Michel Platini, was quick to condemn “these excessive transfers as representing a serious challenge to the idea of fair play and the concept of financial balance”, though the FIFA president Sepp Blatter insisted that the record deals merely emphasised the healthy state of football (under his presidency), bizarrely likening Ronaldo to a Picasso. Maybe these comments are best ignored, as we know that Blatter is a gigantic hypocrite, who a few years ago vowed to stop “greed ruling the world of football”. As Professor Simon Chadwick from Coventry University said, “Real Madrid are effectively injecting inflation into the transfer market. That’s a serious issue, because it’s something that football cannot afford when many clubs have major financial concerns.”

Perez acknowledged this in an oblique way, “We’re going through a delicate moment with the world financial crisis, but we had to make a big effort for the arrival of new players – which explains the debt.” Ah, yes – the debt. It’s certainly true that the debt “ballooned” (to use Real’s own word) last year to finance the player acquisitions, but it’s by no means the only element of Real’s strategy, which Perez explained thus, “We believe we can improve our accounts by aiming for three goals – increasing ticket sales, increasing bank loans and increasing the club’s economic value.”

"Getting shirty"

Nevertheless, Real were forced to take out €151.5 million of additional bank loans, split evenly between Caja Madrid and Banco Santander, to finance last summer’s signings. Eyebrows were raised at Real’s ability to secure this credit at a time when Spain is in deep recession with unemployment running at around 20%, but the prevailing economic conditions do not appear to apply within the Santiago Bernabeu. Furthermore, the interest rate is relatively low (tied to Euribor) and the collateral used to secure these loans is not specified, though most believe that they are backed by future money from the lucrative television deal. On the other hand, these are short-term loans that have to be repaid in six years, though even here Real have been given some leeway with lower payments in the first three years (€25 million in 2010, €16.665 million in 2011 and 2012), followed by a large payment of €42.170 million in 2013, before settling down to €25 million in the last two years. Given the tightness of available credit, this does seem like a remarkably generous deal.

Hang on a minute, aren’t Real Madrid’s debts the stuff of nightmares? After all, there have been accusations that their debts are around €700 million. Unfortunately for those seeking a conspiracy theory, the truth is much more mundane: it’s simply our old friends in the media playing fast and loose with the definition of debt once again in order to beef up their story. As I have written before, there are many definitions of debt, but the one used by most finance experts has actually been adopted by UEFA in their Financial Fair Play proposal, “Net debt is defined as the borrowings of the club less any cash and cash equivalents. A club’s borrowings will include balances such as bank overdrafts and loans, owner and/or related party loans and finance leases. For the avoidance of doubt, net debt does not include accounts payable relating to player transfers, nor trade and other payables.”

As you will see in the table above, that would mean that Real’s net debt per UEFA is just €38 million, having deducted €112 million of cash from the €150 million bank loans. Interestingly, Real’s own accounts show the progression of net debt and give a figure of €327 million, as they include €219 million owed to other clubs for transfers and €81 million still owed on the investment in the stadium and La Cuidada, the new training complex. In the context of Real’s business, this is probably the fairest figure. Helpfully, Real include a phasing of the outstanding transfer payments, so we can see that they have to find €113 million in 2010 and €63 million in 2011, which will apply a lot of pressure to their cash flow in the next two years. Note that this does not include the fee for Ronaldo, as this was paid in full last summer.

Other commentators have opted to use total liabilities of €683 million for the “debt”, but that includes trade creditors, deferred tax, provisions and accruals. Some of the journalism on this subject has been shockingly ignorant or lazy, such as a BBC report in March, “Sources in Spain disagree on how much Real actually owe. Perez stated at the start of the season that Real were 'only' €327 million in the red, a figure he admitted to when he presented his budget for this season. However, other analysts, who have done a bit of digging through the accounts and talked to banking figures, think the figure may be almost as much as 80 per cent higher. Whatever view you take, these are big, big numbers.” Thanks very much for that incisive “analysis” – worth the licence fee on its own.

Perez told the club’s general assembly that not only would the club be able to “comfortably” confront its obligations in the 2009/10 season, but the net debt would actually be cut by over €100 million to reduce the balance to €210 million (£180 million), mainly thanks to a projected increase in revenue. Anything’s possible, but I’m not sure how likely that is, especially when you consider that the club promised a similar reduction the previous year, only for the net debt to increase by nearly €200 million.

So Real Madrid are well within UEFA’s debt guidelines (net debt should be less than the club’s annual revenue), but how about the break-even rules? In fact, they’re also comfortably in line with those, as the club is actually profitable, reporting €24.9 million (£21.2 million) profit before tax in 2008/09 and making even more money the year before, €51.4 million. Of course, this may change as wages and amortisation increase to reflect the enormous spend on acquiring new players, but, as it stands, Real produce profits.

This is due to their astonishing ability to generate revenue. Real Madrid have topped the Deloittes Money League for five years in a row and this season became the first club to earn revenue of more than €400 million. Over the last ten years, revenue has increased from €118 million to €401 million, representing an average growth rate of 26 per cent. Much of that growth came in the early years, but Real still managed to increase revenues by an impressive 11 per cent last season.

All this despite being relatively unsuccessful on the pitch (by their own exalted standards). Real last won the Champions League in 2002 and have failed to reach the quarter-finals in the last six seasons. They have won La Liga twice in the last four years, but it was their deadly rivals Barcelona that finished victorious in the last two seasons.

"Meet El Presidente"

The other notable aspect to Real’s revenue is how balanced it is between the three revenue streams with about a third being sourced from match day, television and commercial. This diversified structure provides some protection against future fluctuations in income.

Match day revenue is over €100 million, which is pretty good, considering that this came from only 25 competitive home matches (top teams in England often get to 30 matches). To be fair, you would expect healthy revenue when your average attendance is 71,800, one of the highest in Europe. However, worryingly for Real, this represented a 6 per cent decline in the previous season’s attendance of 76,200 and is only 90% of the stadium’s 80,000 capacity. This revenue was also flat compared to the previous season, though it should be recognised that last year’s match day revenue had increased by €19 million, helped by the reconfiguration of some areas of the Bernabeu to increase corporate hospitality areas.

Real Madrid’s broadcasting revenue benefits hugely from the ability of Spanish clubs to sell their TV rights on an individual basis with their Mediapro contract guaranteeing €1.1 billion over the seven seasons up to 2013/14. In fact, Real earn more TV revenue (£137 million) than any other football club. To put that into context, it’s 80 per cent more than Arsenal’s £76 million. This provides both Real Madrid and Barcelona with a significant competitive advantage over clubs from other leagues, but there is obviously pressure from the other Spanish clubs to move towards collective bargaining, as their financial woes gather pace. In fact, Esteve Calzada, CEO of marketing agency Prime Time Sport said, “Real Madrid and Barcelona will try to make sure it doesn’t happen, but it’s inevitable.”

"How much?"

The broadcasting revenue would have been even higher if it wasn’t for a disappointing return from the Champions League, where Real only received €20 million, about half of the €38 million allocated to Manchester United. This is partly due to poor performance, but is also because the TV pool allocation is lower for Spain than England. Interestingly, Real were eliminated by Lyon, despite spending more on transfers last season than all of the teams in the French top division combined. On the other hand, Real earned good broadcasting revenue from friendly matches and the club-owned channel, Real Madrid TV.

However, the engine driving Real’s remarkable revenue growth has been the club’s ability to increase commercial revenue. This now stands at £118.6 million, which is second only to Bayern Munich’s Vorsprung durch Technik. That’s certainly the view of the President, who told the annual general meeting, “We’ll carry on being the leader in sales, because of the value of our brand.” That should not be under-valued with a Harvard University study estimating that 287 million people worldwide follow Real Madrid (even though they can’t fill their stadium every week).

"Hair today, gone tomorrow"

Real benefit from long-term sponsorship agreements with key partners. Their partnership with Adidas commenced in 1998, but that did not stop Perez from negotiating a substantial increase on the existing contract after signing Ronaldo and Kaka, and it is now believed that Adidas pay €40 million a year for the privilege of being associated with the galacticos. Similarly, the club’s shirt sponsor, online betting company Bwin, extended its agreement by three years until 2013 for €20 million a season (a 40 per cent increase). Other high profile partners include Coca Cola, Audi and Spanish beer company Mahou (producers of San Miguel). Given that almost all sponsorship deals include performance-related clauses, the commercial revenue would presumably be even higher if Real were to win the Champions League again.

But does Real’s business model make sense? On the face of it, spending on such a massive scale appears to be financial suicide, but it is actually part of a carefully considered commercial strategy, based on the belief that marketable talent pays for itself in the long run. A club insider explained that “It is better to buy Ronaldo for €92 million than pay €20 million for a player of slightly less calibre and profile.” Perez confirmed this, “What I am sure of is that which seems expensive is the cheapest.”

"I have a cunning plan"

Real firmly believe that they are in the entertainment business, so act like a content provider, similar to a Hollywood movie studio. For Brad Pitt, read Cristiano Ronaldo (albeit with a considerably larger Adam’s Apple). For this strategy to work commercially, it follows that they need the best content, thus they consider the likes of Ronaldo and Kaka to be solid gold investments, which improve their brand identity and can be leveraged into higher sales. Unlike English clubs, Real insist on taking half of a player’s image rights, which can generate considerable money for the club.

This star quality can also help in other areas. As Nigel Currie of Brand Rapport explained, “They are looking to make money from these signings by maximising their future overseas TV rights. The team that has the most marketable players will get the best TV deals.” The presence of star players can also earn a club big money on the pitch, e.g. Real received €15 million for playing two meaningless friendlies in Japan during the David Beckham era, when Real cleverly projected their brand into Asia.

This punt on increasing commercial revenue may sound very optimistic, but Perez would argue that it has worked in the past for Real, pointing to the tripling of revenue during his first presidency between 2000 and 2006. Looked at another way, the University of Catalonia claimed that Real lost €45 million in annual revenue when “golden balls” moved to the US, but it remains to be seen whether Ronaldo can earn it like Beckham.

"Galacticos 1.0"

Or, for that matter, like Zinedine Zidane. Real maintained that they paid for all of the French maestro’s £46 million transfer fee through shirt sales. That claim may be open to question, but it is indubitable that annual merchandising and sponsorship revenues increased by €85 million during the first galacticos period (Figo, Zidane, Brazilian Ronaldo and Beckham). Even in these tough times, the club has sold 1.2 million shirts emblazoned with Ronaldo’s name in Madrid alone, according to the Portuguese sports paper A Bola.

However, many simply do not believe that the numbers add up. Barcelona’s economic director, Xavier Sala i Martin, scoffed, “He says he will recoup (the transfer spend) by selling replica shirts and so he will have to sell 30 million of them. That is impossible.” This may be attributed to envy from the club’s oldest rivals, but even the club’s supplier Adidas admitted that Real Madrid’s shirt sales lag behind Chelsea and Liverpool.

In any case, there is no doubt that Real Madrid has the highest revenue of a football club with £341.9 million, but they also have the highest cost base at £344.5 million, so they make a small loss at the operating level. Their wage bill of £159.4 million is even higher than Chelsea’s payroll, but the wages to turnover ratio is an excellent 46% (exactly the same as Arsenal) and has been on a downward trend for the last few years. Having said that, Real spend big when they feel they need to. They have six players in the list of top 50 footballers’ salaries and a survey by Sporting Intelligence said that Real Madrid is the sports club with the second highest average (first team) salary, only behind baseball’s New York Yankees.

Following last summer’s big money signings, not just in terms of transfer fees, but also salaries, you would expect the wage bill to have significantly increased this year, with Ronaldo on €13 million, Kaka €10 million and Benzema €8.5 million, but Real’s provisional budget hardly rises at all (from €187 million to €190 million), which looks completely unrealistic, even after offloading several players. We shall see.

In contrast, the 2009/10 budget highlights a massive increase in amortisation from €75.9 million to €101.7 million. Assuming that the depreciation on fixed assets is unchanged at €11.5 million, that implies a 40 per cent increase in player amortisation from €64.4 million to €90.2 million. Given the way that accountants write-off the purchase price of a player over the length of the contract, we know that the full cost of a transfer will not be reflected in the profit and loss account immediately, but it will catch up with you sooner or later – and that is what is happening here. Real’s player amortisation at £54.8 million was already higher than any other club, but next year it will be in a league of its own.

Other expenses (including leases, maintenance and professional services) are also very high at €141.5 million, though this was impacted by €45 million of once-off adjustments, including €20 million of asset write-downs and an €11 million reduction in player valuations. However, this was off-set by €37 million of non-recurrent revenue (television €19 million, marketing €18 million), so, everything else being equal, this would mean an €8 million improvement in profit this year. In terms of the UEFA fair play criteria, Real could also boost their profit by €23 million simply by excluding the loss made by their basketball division.

"One that got away"

The small operating loss was more than compensated by the €32m profit on player sales with the notes in the accounts revealing that a further €34 million was made after the books closed, presumably for the Dutch contingent sold in August 2009 (Arjen Robben, Wesley Sneijder and Klaas-Jan Huntelaar). This may seem low in relation to the transfer spend of €250 million, but it is obviously a buyer’s market with other clubs keenly aware that Real want to get off their books players who are no longer wanted. This could be important for Mourinho, as there have been rumours that the club will limit his transfer budget to “only” €50 million, unless he raises more funds by selling players like Rafael van der Vaart, Lassana Diarra and Fernando Gago.

Indeed, Real’s peers have expressed doubts over the Madrid club’s strategy. Barcelona’s economic director harrumphed, “I don’t know where the €300 million that Florentino Perez thinks he has for signings actually comes from”, while David Gill, Manchester United’s chief executive said, “I don’t understand the economics of what Real Madrid are doing. Their turnover is not materially different from ours, so I am not quite sure how they can make the profits to justify their salaries.” Here’s a clue, David: in fact, their turnover is £60 million more than yours – and they’re not paying the banks £70 million a year in interest.

"We'll meet again, don't know where, don't know when"

There’s also no shortage of academics queuing up to put the boot in. Barcelona University’s Jose Maria Gay said, “Real’s most important revenue streams won’t be enough to offset their spending. The costs have soared and they need to increase income by about 20 per cent to balance the accounts. It’s a very risky investment.” Michael Stirling, managing director of Global Sponsors Ltd agreed, “It’s a high-risk strategy. Revenues are not going to come through instantly.” Simon Chadwick was singing from the same song sheet, “Many people would have legitimate concerns that the club will be unable to generate an acceptable return on their player investment strategy. It would seriously undermine Real Madrid’s business model.”

Of course, when the club got into serious financial difficulties in the past, it cleared its €200 million debts by selling the family silver or more accurately the club’s training ground in 2001. Even this was mired in controversy, as the European Commission believed that the price had been inflated by the city authorities reclassifying the area as development land, thus significantly increasing its value before purchasing it – effectively a state subsidy. Jose Maria Gay said that “extraordinary gains are finite”, but in extremis Real could always repeat the trick and sell their mythical Santiago Bernabeu stadium and build a new ground out of town, though this would clearly not be popular with the fans.

"Royal Madrid"

And after all the club does belong to the fans or at least it’s owned by thousands of members who elect the president, so he should take their views into consideration. As a social trust, rather than a PLC, this is a club that does not have to worry about takeovers and does not face the same pressure from creditors. As Gabriele Marcotti put it, “They play by a different set of rules.”

Although the club’s constitution does not allow Florentino Perez to fund the club, his position as one of the wealthiest men in Europe with wide-ranging business interests clearly helps Real’s relationship with banks and sponsors, as he has a huge network of influential friends and contacts, maybe best demonstrated by the fact that a Catalan bank provided the €57 million guarantee that he needed to stand for the presidency.

In many ways, Real Madrid are viewed as the establishment club in Spain with immense cultural and political significance. In other words, they are almost certainly “too big to fail”. The accusation is that they can afford to live in a “Real” world, as opposed to the real world, and can keep on spending, because they know that no bank would ever dare to call in their debts. Stefan Szymanski, co-author of “Soccernomics”, agreed, “Real’s really too big to disappear, whatever debt they incur. No bank would ever be allowed to be the one that sank Real Madrid.”

"Say hello, wave goodbye"

So, the jury’s out on whether Real Madrid’s model works. Despite the huge money splashed out on buying players, the club is profitable, though whether this is simply due to the time lag before this expenditure is fully reflected in the accounts, we shall have to wait and see. When challenged on the financial implications of being knocked-out of the Champions League, Manuel Pellegrini responded, “There is a serious misconception. The project isn’t for a year, far from it.” Obviously for him, it was in fact only for a year, but I take his point: we may not understand whether the numbers add up for a couple of years yet.

All of this leaves us with some conflicting thoughts. While changing managers every season seems like a recipe for disaster, at least this time Real Madrid have gone for a proven winner in Jose Mourinho, which rather begs the question of how much Real would earn if they actually won something?