Southampton - The Saints Are Coming

As a rule football clubs that go through a lot of change do not perform very well, but in recent times Southampton have proved to be an exception with significant upheaval at all levels seemingly not impacting their progress. Not only have the Saints had three managers in the last two years, but they have also experienced significant player turnover.

Nigel Adkins, the manager who led them to two successive promotions, was unceremoniously sacked after a poor start in the Premier League, paving the way for Mauricio Pochettino’s arrival, before the Argentinian in turn departed for Tottenham last summer, leading to the appointment of the former Dutch international Ronald Koeman in June.

During the summer they made a number of big money sales, including Luke Shaw, Adam Lallana, Dejan Lovren, Calum Chambers and Rickie Lambert, but successfully replaced them through the purchases of Dusan Tadic, Graziano Pelle, Fraser Forster, Shane Long, Sadio Mane and Florin Gardos plus some astute use of the loan market to bring in Toby Alderweireld, Filip Duricic, Eljero Elia and Ryan Bertrand (subsequently acquired permanently).

Such a large number of ins and outs is normally a recipe for disaster, but Southampton have taken this in their stride. They have also survived the loss of their ambitious executive chairman Nicola Cortese, who left the club in January 2014 after a disagreement over strategic direction with owner Katharina Liebherr, who took control following the death of her father Markus. In fact, they have managed to outperform their resources, finishing 8th in the Premier League in 2013/14, despite only having the 15th highest wage bill.

In the process they recorded their first annual profit since 2005 with a £28.7 million profit before tax representing a £35.8 million improvement on the previous season’s £7.1 million loss. Profit after tax was even better at £33.4 million thanks to a £4.8 million tax credit.

There were two main reasons for the better figures: (a) profit from player sales shot up £31 million from just £1 million the previous season to £32 million; (b) revenue grew £34 million (48%) from £72 million to a record £106 million, very largely due to the first year of the new Premier League television deal three-year cycle. There was also a £2 million compensation payment for Pochettino’s move to Tottenham included in Other Operating Income.

This was partly offset by the wage bill rising £16 million (34%) from £47 million to £63 million, while player trading costs also increased by £12 million (player amortisation £8 million, impairment of player values £4 million). Net interest payable was also up £2 million following a rise in external debt.

This sizeable profit represents a major turnaround for Southampton after eight consecutive years of losses, especially given the club’s severe financial difficulties following relegation first to the Championship in 2005, then to League One in 2009. Chief executive Gareth Rogers explained the approach: “We very much want to run this as a sustainable football club. It was a key aim when Markus Liebherr bought the company out of administration in 2009. The word sustainability pervades this place.”

The impact of exceptional payments on the 2012 figures should be noted with £9.5 million being paid following promotion back to the Premier League, mainly £5.3 million in bonuses and £4 million to a former loan creditor.

That was then, this is now, and Southampton were actually the second most profitable club in the Premier League in 2013/14, only beaten by Tottenham’s £65 million, which was largely due to the mega sale of former Saints’ academy star Gareth Bale to Real Madrid. The combination of the new TV deal and the Premier League’s salary restrictions have resulted in a major leap in profitability with 15 of the 20 clubs reporting profits, but Southampton have done better than most with £33 million, ahead of the likes of Everton £28 million, Manchester United £23 million, Newcastle United £19 million and Chelsea £18 million.

The importance of player sales can be seen by the five clubs who made most money from this activity also filling five of the top six places in the profit league: Tottenham £104 million, Chelsea £65 million, Southampton £32 million, Everton £28 million and Newcastle United £14 million.

Southampton’s figures for 2014/15 will be similarly boosted by player sales, as Lovren, Chambers and Lallana were all sold after the 30 June 2014 accounting close (though the net receipts for Lovren and Lallana will be reduced by sell-on fees to Lyon and Bournemouth respectively).

Player trading is clearly integral to Southampton’s achievements, but that is by no means the whole story, as it is really more about player development. As chairman Ralph Krueger explained, “We are Southampton, we don’t just buy success, we breed it.” Much of the club’s progress is down to Les Reed, the former FA technical director, who is responsible for all football operations, including the youth academy, scouting, recruitment, sports medicine and science, who echoed the chairman’s views: “Instead of buying one player, we produce five players.”

Although this approach could originally have been considered a financial necessity after the club went into administration, it has now become a deliberate strategy, supported by significant investment into a state-of-the-art training ground and cutting edge technology, including the famous “black box” where the club can use software it developed itself to assess players’ performances.

"All the Young Punks"

As at the date of the most recent accounts Southampton had spent £25 million on the Staplewood training ground with the total expenditure expected to be around £38 million. The chief executive emphasised the importance of this significant investment: “This demonstrates the club’s commitment to continue to develop the site into one of the leading training facilities in the Premier League in order to encourage the sustainable success of our academy.”

This will both enable the club to replace any sold first-team players from within, but also to sell its graduates for a healthy profit. A recent study by the CIES Football Observatory showed that Southampton had the most profitable academy in Europe, based on the sale of academy graduates like Lallana and Shaw since 2012.

Incredibly, this put the Saints above the likes of Real Madrid, Barcelona, Bayern Munich and Manchester United. As CIESC noted, “Southampton is an outstanding example of how youth training can constitute a key competitive advantage both sportingly and economically even in the richest league of the world.”

In this way Southampton have made around £45 million from player sales in the last three years. Indeed, without the £32 million profit from player sales in 2013/14, Southampton would have reported a loss of £3 million.

Given Southampton’s focus on player trading, it is worth exploring how clubs account for transfers, as it has a major impact on reported profits. When a club buys a player, it does not show the full transfer fee in the accounts in that year, but writes-down the cost (evenly) over the length of the player’s contract. So, if Southampton spent £16 million on a new player with a 4-year contract, the annual expense is only £4 million (£16 million divided by 4 years) in player amortisation (on top of wages).

However, when that player is sold, the club reports the profit on player sales, which is essentially sales proceeds less any remaining value in the accounts. In our example, if the player were to be sold 3 years later for £19 million, the cash profit would be £3 million (£19 million less £16 million), but the accounting profit would be £15 million, as the club would have already booked £12 million of amortisation (3 years at £4 million).

Up to now, this has surely only interested accountants, but it’s become very relevant for Financial Fair Play (FFP). Furthermore, any players developed through a club’s academy have zero value in the accounts, so in these cases any sales proceeds represent pure profit. Like other clubs, Southampton are clearly keenly aware of this accounting treatment – though they also fully appreciate the impact on genuine cash flow.

Even though the annual cost of purchasing players is somewhat reduced in the profit and loss account, it is worth noting the impact of Southampton’s increasing gross spend in the transfer market via the increasing player amortisation, which has gone up from £3 million in 2012 to £27 million in 2014 (including £6 million of player impairment).

Obviously this is nowhere near as much as big spenders like Chelsea (£91 million) and Manchester City (£76 million), but it is still the 9th highest in the Premier League and will need to be kept under observation in future years.

Even though player trading (and particularly profits from player sales) have such an important impact on Southampton’s bottom line, we should acknowledge that the club has become profitable from its core business. This can be seen by looking at the EBITDA (Earnings Before Interest, Taxation, Depreciation and Amortisation), which can be considered a proxy for the club’s profits excluding player trading. After many years of negative EBITDA, this has turned positive in the last two years, rising from £9 million to £28 million in 2013/14.

That is not bad at all, but it does show that Southampton are “only” the 10th most profitable club in the Premier League if player trading is excluded. To place this into context, Southampton’s EBITDA of £28 million is still a fair way behind the top five clubs: Manchester United £130 million, Manchester City £75 million, Arsenal £62 million, Liverpool £53 million and Chelsea £51 million. This is despite the far higher wage bills at those clubs, so it does go a long way to explain Southampton’s greater reliance on a player sales business model.

In fairness, Southampton have managed to grow their revenue by over 600% in just four years from £15 million to £106 million in 2014. They have observed that this is “a result of strong management action to improve the revenue activities of the club across all areas”, but it is essentially the result of two promotions in that period. In particular, £79 million of the £91 million growth since 2010 is due to significantly better TV deals in the Premier League. That said, match day is up £7 million (70%), while commercial income has increased £6 million (143%), so the club does sort of have a point.

Southampton’s 2014 revenue of £106 million is the 11th highest in the Premier League, up three places from the previous season. They have overtaken Sunderland £104 million and are within striking distance of Everton £121 million, Aston Villa £117 million and West Ham £115 million. Although all clubs significantly increased their revenue in the 2013/14 season, it is worth noting that only Stoke City grew more in percentage terms than Southampton (48%).

Of course, it is still miles below the English elite, e.g. Manchester United’s £433 million is almost exactly four times as much as Southampton’s £106 million, while four other clubs earn more than £250 million: Manchester City £347 million, Chelsea £320 million, Arsenal £299 million and Liverpool £256 million.

Such an enormous revenue disparity underlines the magnitude of Southampton’s challenge in trying to reach the top table. As Koeman put it, “You never know, but it’s not realistic at the moment to finish in the top four. The Europa League for us is like the Champions League for Manchester United and Arsenal.”

However, Southampton’s revenue is now the 25th highest in the world according to the Deloitte Money League, around the same level as famous old clubs such as AS Roma £107 million and Benfica £105 million.

This is on the back of broadcasting revenue of £79 million, which now accounts for 75% of Southampton’s total revenue (up from 66% the previous season). Match day revenue contributes 16% with commercial income only 9%, so only a quarter of their revenue comes from sources outside television (excluding player sales).

As you might imagine, Southampton’s reliance on TV money is one of the highest in the Premier League, but six clubs do have a greater dependency with Crystal Palace the “leader” at 82%.

Southampton’s share of the Premier League TV money increased by 76% (£33 million) from £44 million to £77 million in 2013/14 thanks to the new deal. Given the importance of this money to the Saints, it is worth analysing how this is distributed.

The money is split into three elements: the UK TV deal, overseas TV deals and central commercial income. Much of this is split evenly between the 20 Premier League clubs, namely 50% of the UK deal and 100% of both the overseas deals and the central commercial income. The remaining 50% of the UK deals is divided into merit payments (25%), which is distributed depending one where you finish in the league, and facility fees (25%), which depend on how many times a club is broadcast live.

In this way, Southampton were helped by leaping six places in the league table from 14th to 8th. Each place in the league table is worth around £1.2 million, so it is still worth battling for position as the season draws to a close. However, they were held back a little by only being broadcast live 10 times, which is the contractual minimum, so they should receive more this season for this element.

Of course, there will be even more money available when the next three-year cycle starts in 2016/17 with the recently signed extraordinary UK deals with Sky and BT producing a further 70% uplift. My estimate is that a club that finishes 9th in the distribution table (as Southampton did in 2013/14) would receive around £117 million a season, which would represent an additional £40 million.

Southampton could also earn more TV money if they qualify for the Europa League, though this is small beer compared to the Champions League, with England’s representatives earning between €3.8 and €5.9 million from Europe’s secondary competition in 2013/14. Following the new 2015/16 deal, the money will be higher, but qualification would still be somewhat of a double-edged sword, given that it is a major test of a squad’s strength and can have an adverse effect on Premier League performances (as shown by Everton and Newcastle in recent seasons).

Match day revenue rose slightly by £0.3 million (2%) from £16.8 million to £17.1 million, as a 5% rise in ticket prices more than offset a reduction in the average league attendance from 30,807 to 30,212. Despite this increase, Southampton’s revenue is still miles below Manchester United and Arsenal, who both generate more than £100 million from this activity, though it is above Aston Villa £12.8 million and just below Everton £19.3 million and West Ham £19.5 million.

Southampton’s match day revenue is outperforming their attendance, which is only 12th highest in the Premier League, because their ticket prices are on the high side (and were increased by a further 4% in the 2014/15 season).

However, Southampton’s renaissance can be seen through their improving attendances over the last few years with their 30,500 average since their return to the Premier League being 70% higher than the 17,800 low point in 2008/09.

Commercial income grew £1.5 million (18%) from £8.0 million to £9.5 million, due to “incremental increases on pre-existing sponsorship deals”, but this is still one of the lowest in the Premier League. Clearly, clubs like Manchester United £189 million and Manchester City £166 million are out of sight, but it is a little surprising that Southampton are below Stoke City, Fulham and WBA.

Chief executive Rogers has acknowledged the need to significantly improve the club’s commercial operations: “You look at what you can achieve and you look at our peers both in the Championship and in the Premier League, they are significantly ahead of us. Some of those clubs I believe that we should at least be on a par with, and, therefore, we need to work hard to match and to come up with those deals. Whilst commercially we absolutely want to grow, it’s not something that happens overnight. If you’re trying to sign long-term, significant contracts, they take a long time.”

That’s certainly evident when you look at Southampton’s main commercial deals, e.g. the shirt sponsorship with consumer electronics firm Veho is one of the lowest in the Premier League at £1 million a season (with only Crystal Palace having a smaller contract). Given the club’s booming brand, they should certainly aspire to securing a £3-5 million deal when the current agreement expires at the end of the 2015/16 season.

Southampton terminated its long-term kit contract with Adidas in December 2013 (after it released a controversial home shirt without the traditional stripes), but surprisingly there was no replacement in place, which meant that the 2014/15 kits were made in-house. Adidas will return as kit supplier for the 2015/16 campaign, but this will have an impact on this season’s financials.

The wage bill rose 34% (£16 million) from £47 million to £63 million, mainly “due to the strengthening of the first team squad”, though the number of employees did increase from 230 to 282. Despite this growth, the substantial revenue increase reduced/improved the wages to turnover ratio from 66% to 59%. It had been as high as 125% in 2012, though this did include £5 million of bonus payments for promotion to the top flight.

This was still the 9th highest wages to turnover ratio in the Premier League, but a lot better than WBA’s 75%. In fairness, 13 of the 20 clubs are in a fairly narrow range of 56-64%.

It is also striking how much Southampton have over-performed relative to their wage bill, as this was only the 15th highest in the Premier League in 2013/14. Only five clubs were below them (Stoke City, Cardiff City, Norwich City, Crystal Palace and Hull City) and two of those were relegated.

Nevertheless there is a clear bunching of clubs in the £60-70 million range, as the traditional bigger spenders like West Ham and Aston Villa have only grown a little, while the nouveaux riches like WBA, Stoke City, Swansea City and indeed Southampton have all had to significantly increase their wage bill in order to compete. The Saints are likely to further increase their wages in 2014/15.

Southampton’s net debt increased £6 million from £19 million to £25 million, as the £18 million rise in gross debt from £33 million to £51 million was partially offset by the £12 million growth in cash balances from £14 million to £26 million. This is a fairly high debt level for a club of Southampton’s size, which was admitted by Rogers: “What we can’t do is shy away from the fact that there is a significant debt sitting on the club, because of what’s been built and the past decisions the club has made.”

That gross debt includes £14.7 million owed to Liebherr (including £0.8 million of accrued interest), a £14.5 million bank loan secured on the shareholder’s personal estate plus £21 million of other loans. Some £19 million of this was owed to the Vibrac Corporation, a company based in the British Virgin Isles that has provided finance to several Premier League clubs, though this debt has since been repaid using an additional £20 million loan from Liebherr that was made since the end of the accounting period to June 2014. This means that all of the club’s financial debt is now effectively owed only to the owner.

This is a sign of Liebherr’s support, as Rogers confirmed: “There was an opportunity to clear the entire debt of the football club and take out money that had been put in, but Katharina didn’t do that. Instead she allowed us to re-invest all of the money, either in fees or contracts. And she also put another £20 million in.”

"Grazie, Graziano"

At some stage the owner will surely want some of this money repaid, but not at the expense of the club’s development, as the accounts explained: “Financial plans are in place, which target an improvement in this position over the medium to longer term in order to further support the ambitions of the club to achieve financial sustainability and be able to invest further in football activities both on and off the pitch.”

The club has also made use of transfer fee funding, i.e. stage payments, as can be seen by the increase in transfer fees payable to £26 million, though Southampton are in turn owed £35 million by other clubs. In addition, the accounts note that there is an additional net £12.6 million payable as a result of sales and purchases made since the accounting year-end.

Given Southampton’s improving profits, it may have come as a surprise to some supporters when director Hans Hofstetter said a year ago, “we have inherited a difficult situation financially”, but this is basically down to the difference between accounting profits and cash flow. This was explained by Rogers: “The club has risen quickly in a short period and committed itself to high levels of expenditure both on the development of Staplewood Training Ground… as well as significant future transfer fees.”

This can be seen by looking at the cash flow statement for the last two seasons where EBITDA of £37 million was boosted by £8 million of favourable working capital movements to give £45 million of cash flow from operating activities. That’s great, but  £40 million was then spent net on player purchases with a further £26 million invested in capital expenditure (such as the training ground) and £2 million on interest payments, leaving a deficit of £23 million before financing. This was funded by a combination of loans from the owners and Vibrac Corporation, producing a cash surplus of £24 million, which was required for the summer 2014 transfer expenditure.

Liebherr had put in £52.7 million of funding by the 2014 accounts, but a further £20 million was injected after that date, increasing her contribution to a cool £72.7 million. However, in 2013 she wrote-off the £38 million of loans made up to June 2012 by converting these into equity capital, leaving the amount owed to her at £34.7 million (£14.7 million in the 2014 accounts).

Interestingly Southampton’s cash balance of £26 million was only a little below Newcastle’s £34 million, but the two sets of supporters have greeted the news very differently, as there is an expectation from Saints fans that their board will invest the money (and invest it well), while Ashley is not trusted to do the same.

In this way, Southampton have spent a gross £138 million in the transfer market in the last three seasons with a net spend of £44 million, compared to net sales of £35 million in the previous nine seasons.

Despite this increase, Southampton are not exactly splashing the cash compared to other leading clubs. In the same period, the usual suspects all spent more than £100 million (Manchester United £222 million, Manchester City £164 million, Chelsea £132 million, Arsenal £107 million and Liverpool £100 million), while Southampton were also outspent by West Ham, Hull City, Aston Villa and QPR.

The difference with Southampton is that it feels like they have a long-term plan where any sales are made on their terms and at their price. Rogers confirmed this: “We make decisions based on what is the best thing for the club at the time. We don’t need transfer fees to fund the operating costs of the club. We don’t need to sell any players in the summer.”

That is certainly true, but the support of the owner will still be important for a while. There have been some reports that Liebherr would like to sell the club, but if she does it will be in a considerably better position than when her father rescued it from administration.

There are obviously no guarantees that the Southampton model will continue to work, as it is very difficult for clubs to continually change their key staff (whether that be executives, managers or players) and continue to flourish. However, their recovery since the dark days of administration has been truly impressive, being achieved through a combination of sound business practices and solid football knowledge.

The objective is to focus on what Southampton can influence, as Rogers explained: “What we can do is create a club that maximizes on-field performance through best business practice, innovation, sustainability and profitable commercial growth.” Importantly, the approach is still geared towards the playing side with the chief executive adding: “We believe it is possible to be a well-managed, well-structured football club that is successful both on and off the pitch.”

It’s still too early to say that they have definitively made it, but in their own under-stated way the Saints are indeed coming.