Is Stan The Man For Arsenal?

After a few months of inactivity, Stan Kroenke yesterday increased his stake in Arsenal and is now within just ten shares of the threshold that forces him to make a full takeover bid. Kroenke’s latest purchase of seven shares at £8,500 each, his first since December, takes his total to 18,656 shares, which means he owns 29.9% of the club. If the Denver-based businessman reaches 30%, he has to make an offer for the remaining shares in Arsenal Holdings plc.

That much is clear, but would the American make a good owner for The Arsenal? Despite first becoming involved with the North London club back in April 2007, when he bought ITV’s 9.9% stake, there are still many questions unanswered, so here’s everything you always wanted to know about Stan Kroenke, but were afraid to ask:

1. What are his intentions?

Even at this stage of the game, it’s difficult to say for sure. Kroenke is a wily, experienced businessman who keeps his cards very close to his chest. He is not known as Silent Stan for nothing. Unlike many owners of sports clubs, he would prefer to stay out of the limelight. He was first exposed to the harsh words of the media in 1993, when he was the public face of St. Louis’ failed bid to win an NFL franchise, “I was somewhat naïve – not in a business sense, but as far as the whole public side of it.” Since then, he has chosen to conduct his business affairs in private and who can blame him. This is a lesson that Messrs. Gold and Sullivan (among others) would do well to learn.

At Arsenal’s Annual General Meeting (AGM) in October, Kroenke was invited to clarify his intentions, but opted not to speak to the assembled shareholders. This could mean something or nothing. Chairman Peter Hill-Wood pointed out that under Takeover Panel rules any public statements regarding future bid intentions must be ambiguous, otherwise the individual would be prevented from making a formal takeover move for the next six months. Even though the belief around the club is that Kroenke is happy with his position as Arsenal’s largest shareholder, there is a nagging feeling that Kroenke did not want to be constrained by those terms, hence his reluctance to speak.

"The future's so bright, I gotta wear shades"

2. Why is his approach so cautious?

Of course, he might genuinely not want to buy the team. Although an extremely wealthy man by anyone’s standards, it is not a given that he would want to commit so much of his capital to one venture, especially as he may feel that he already effectively controls the club. The board is so scared of Alisher Usmanov, the next largest shareholder (in every sense of the word) with 26.2%, that they will probably do whatever Kroenke thinks best (within reason).

His long game has also helped considerably in winning the hearts and minds of the fans, which would help prevent a hostile takeover, something a man like Kroenke would be keen to avoid. In any case, his influence is already clearly being felt at the club with the key appointments of Ivan Gazidis as chief executive and Tom Fox as chief commercial officer. They were recruited from Major League Soccer (MLS) and the National Basketball Association (NBA) respectively, which is a clear sign of Arsenal’s strategic direction.

3. Would he be happy with a minority stake?

The Arsenal Supporters' Trust (AST) have had the opportunity to meet with Kroenke on a number of occasions and their assessment is that “a takeover is not imminent” and that the recent purchases are just “the consolidation of an existing position”. That may well be the case, though Don Ellison, a former president at Kroenke Sports Enterprises (KSE) was quoted in the New York Times as saying, “There’s nothing so limited as being a limited partner. A lot of people get into sports and wake up later and realise, ‘I’m along for the ride. I’m beholden to the other guy’. That’s not Stan’s nature.”

Of course, it is possible that Kroenke is merely buying the shares as a good investment. Harry Philp, managing director Hermes Sports Partners said, “There is a precedent for this approach: JP McManus and John Magnier built up stock in Manchester United close to the 30% mark and everyone thought they were going to take over, but they didn’t, and made a good return on their investment when the Glazers took over.” However, most would see that as unlikely, especially given that, “in the sports arena he has never sold a share in any team he has had an interest in”, according to Arsenal director Danny Fiszman.

"When Stan met Danny"

4. Is there any chance of a takeover soon?

There are sound economic reasons for launching a takeover bid now. Interest rates are at a historical low, which would reduce the cost of any debt, while Sterling’s weakness makes the purchase price to any American buyer hundreds of millions cheaper in Dollar terms than two years ago.

There are also reasons specific to Kroenke that make a takeover more attractive from May onwards. Stock market rules oblige any prospective purchaser to make a bid at the highest price he himself has paid for shares during the last twelve months, which in Kroenke’s case is currently the £10,500 he paid to the Carr family for 4,839 shares (7.7% of the club) in May last year. Since then, the highest price Kroenke has paid is £8,500, so waiting until May for a full takeover could save him over £87m.

Reports in the United States also suggest that Kroenke is on the verge of selling his 40% stake in the St. Louis Rams. NFL cross-ownership regulations prevent him from making a full bid and he is unwilling to give up his NBA team, the Denver Nuggets, because basketball remains his first sporting love. There have been bids of $750m, but the owners believe the franchise is worth up to $900m, so a sale would free up $300-360m of capital for Kroenke to invest in the Gunners. Apart from anything else, as a sports fan, Kroenke would not want to distract the team during a thrilling end to the season, so would probably wait until the summer.

5. How much would it cost?

The American business magazine Forbes gave Arsenal a valuation of $1,200m (£800m at current rates) in their list of most valuable soccer teams, which is the third highest globally behind Manchester United and Real Madrid, but this is “based on past transactions and current stadium deals without deduction for debt”.

Arsenal Holdings has issued 62,219 shares, so if we take the price that Kroenke has paid for the majority of his shares of £8,500, that implies a valuation of £529m, but this is lower than the current market price (mid) of £9,250, which gives a market capitalisation of £575m. As Kroenke already has 29.9% of the company, he would have to pay £370m (at the lower price) or £403m (at yesterday’s price) plus another £30m or so on professional fees.

Of course, he might not want to buy the club outright, but be content with just over 50% of the shares to gain legal control, meaning he would “only” have to find between £106m and £115m.

"The winner takes it all"

6. Could he afford it?

You would certainly think so, given that he is listed in the Forbes 400 as one of the richest people in the world with an estimated worth of $2.7 bln. Not only that, but his wife, Ann Walton, has even more money at $2.9 bln, as she is a member of the family that owns the Wal-Mart shopping chain. He has made most of his money from real estate, not least because he has been uniquely placed to develop many of the plazas near Wal-Mart stores.

Nevertheless, last year it emerged that Kroenke still owed £50m on shares he had bought, largely from Danny Fiszman and Richard Carr. At the time a board room source said, “Unlike Usmanov, Kroenke doesn’t have £500m sitting in a bank doing nothing. It could be many months or years before he has paid off all the money.” In January, the club announced that the £23m owing to Carr had been paid, but Fiszman’s money is still outstanding. This could be for tax reasons more than Kroenke’s liquidity, but some have speculated that Fiszman is happy to wait for payment until Kroenke buys the whole club.

7. Would Arsenal welcome a takeover?

The board’s initial response to Kroenke was embodied by old Etonian Peter Hill-Wood, who sniffed, “Call me old-fashioned, but we don’t need his money and we don’t want his sort. Americans know absolutely sweet FA about our football”, but they gradually warmed to this American, not least as they considered him the lesser of two evils compared to Usmanov. So much so that in September 2008 they invited him to join the board of directors.

Having apologised for his previous remarks, Hill-Wood described Kroenke as “absolutely the right kind of shareholder” whose “experience in sports team commercial management, sports marketing, media and new media rights as well as real estate development will be of great value.” These were not just empty words, as Fiszman and Hill-Wood blessed the arrangement by selling Kroenke 5,000 and 100 shares respectively. The Arsenal Supporters Trust have given him guarded approval, “While the AST welcome Stan Kroenke's involvement, we agree with the sentiment of Peter Hill-Wood's statement at the most recent AGM that there is no need for any shareholder to launch a takeover of the club.” This is significant, as Kroenke is not a man to launch a hostile takeover, which he would consider too expensive and would also bring him adverse publicity.

"All the way from the MLS"

8. Is he like the Glazers?

Or Hicks and Gillett for that matter. As represented by the AST, Arsenal fans “would fight any plans that require the club to incur debt to pay for a takeover, as has happened at Manchester United and Liverpool”, but Kroenke has pointed out that none of his sporting ventures in the United States operate in this way and he has never done a leveraged buy-out. The New York Times said, “Though some Arsenal fans worry a new owner will saddle the club with debt and curb the signing of players, that has not been Mr. Kroenke’s style.” Whatever his method is, Kroenke is not a man whose name has been associated with greed.

9. Why would he want to buy Arsenal?

First of all, football is a sport that crosses all national boundaries with huge global appeal. Larry DeGaris, professor of sports marketing at the University of Indianapolis agreed, “Where are the growth opportunities? In the world’s biggest game”, complaining that “American sports have a very poor track record of being exportable.”

The Premier League in particular is an attractive economic proposition with its lucrative TV rights (domestic and overseas). Although Arsenal would not be cheap, costing about the same as an NFL franchise and twice as much as Liverpool, Kroenke’s right-hand man, Paul Andrews, has described Arsenal as “one of the greatest brands of any sport – and I’m not just talking about soccer.” It’s the biggest football club in London with a brand-new world-class stadium that generates over £3m revenue a game. While other clubs struggle financially, Arsenal are making good profits and paying down their debt.

"If you build it, they will come"

10. What is his modus operandi?

When Kroenke buys a team, he likes to buy everything that surrounds it as well. According to one business associate, he is not just a man with an eye for an opportunity, but “the opportunities stemming from that opportunity.” Speaking to the Leaders in Football conference, Ivan Gazidis described his business model as diversified sports entertainment ownership, “Look at Stan Kroenke in the Denver market. He not only owns sports teams, he owns stadiums and the TV station that distributes the sport on local TV. He aggregates content and he distributes it.” He even owns the in-house ticketing system (TicketHorse).

As well as allowing him to leverage the shared infrastructure, this approach also allows Kroenke to better withstand any downturns. What he does do is maximize the potential of his sporting venues: the Pepsi Center in Denver hosts 270 events last year ranging from the Democratic Convention to Celine Dion concerts. Would he put a roof on the Emirates like the Millennium Stadium in Cardiff?

11. What would the impact be on Arsenal?

After buying approximately a third of Fiszman’s shares, Kroenke himself stated, “I will continue to work closely with my board colleagues to maintain the stable environment in which the club operates and to preserve the self-sustaining business model enjoyed by the club.” Gazidis echoed this view, “I have spoken to Stan and he believes in the philosophy of the club. He is going to ensure we have continuity in the traditions of the club.” In other words, if it ain’t broke, don’t fix it.

All well and good, but it’s hard to disagree with former Arsenal managing director Keith Edelman, who said, “Anybody who invests in a club, particularly from overseas, will want financial returns.” There is no doubt that Arsenal has been run relatively conservatively and I would expect the club to become more aggressive under Kroenke’s stewardship. He would look to raise the profile of the club overseas, reaching out to the American and Asian markets in the same way as Manchester United have done. So, we could expect pressure to take the team on pre-season tours a bit farther afield than Austria; significant improvements in commercial revenue once the Emirates deals expire; and some interesting discussions on televising Arsenal games – either via broadband or potentially even individual deals with TV companies (like Real Madrid and Barcelona).

"A corner of a foreign field that is forever Arsenal"

12. Does he understand sport?

He should do, considering he also owns the Colorado Rapids of the MSL, the NBA’s Denver Nuggets, the NHL’s Colorado Avalanche and 40% of the NFL’s St. Louis Rams. Kroenke has explained his desire to own sports teams, “I always thought I’d enjoy it, because the professional sports business is part business and part sports, and I love both of them.”

Sports industry expert Dean Bonham agreed with this blend, “He’ll enjoy those sports, but at the same time he’s sophisticated enough to know you can make a lot more money than you could twenty years ago.” Danny Fiszman emphasised “Stan’s long term commitment to sport”, while his local paper, The Denver Post, described him as “a genuine sports fan who also happens to be a billionaire.”

13. What about football (soccer)?

Although it is likely that Kroenke’s interest in soccer is as much for its investment potential as its inherent sporting characteristics, it is true that he would be the only overseas investor in English football who has also invested in football in his home market. He invested $70m in a new 18,000 stadium for the Colorado Rapids and surrounded it with 24 youth soccer pitches – the largest complex of its kind in America.

The club’s managing director Jeff Plush declared, “What we’ve built here is a focal point for the game in this community, an inspiring and clearly identifiable home for the sport. There is no question about our commitment or the direction in which we believe we can go.” Advisors to Kroenke say that his interest in football was inspired by his travel in Europe, where he witnessed the fans’ fervour first hand.

"Under a blood red sky"

14. Are his teams successful?

Kroenke has transformed the team closest to his heart, the Denver Nuggets, from a bunch of no-hopers to title challengers, losing the 2009 NBA Conference final to the LA Lakers, though they have not yet won the championship he craves. In ice hockey, the Colorado Avalanche won the Stanley cup back in 2001, but the St. Louis Rams have been embarrassingly bad after winning the Super Bowl in 1999 and losing in the final in 2001. Last year, they finished rock bottom of the NFC West with a record of one win and 15 losses. His soccer team, the Colorado Rapids, have not qualified for the MLS play-offs for the last three years. As Paul Andrews so appropriately put it, “We want to win the championship every year, but nobody can tell you that they are going to do that.”

15. What sort of manager is he?

It’s hard to find anyone with a bad word to say about him. Ivan Gazidis has described Kroenke as a “model owner”, while MLS commissioner Don Garber is of the same mind, “Stan Kroenke is very, very bright and a capable sports man and I think he will be a good owner of Arsenal. He’s a strong silent type, and I think that’s not necessarily the worst thing when it comes to sports team owners.”

Former Kroenke lieutenant Don Elliman stressed his long-term commitment, “Stan is a buyer and holder, not a trader. He expects to be the owner of these franchises for many years to come”, while David Stern, the NBA commissioner, said Kroenke was “as knowledgeable a person as there is.” He delivers on his promises, as evidenced by building an excellent stadium for the Rapids, while the Pepsi Center has been named the most “fan friendly” sports arena in the country several times.

"Ground rules"

16. Would he provide money for transfers?

He is regarded as an owner who wants to win, who will spend money in order to do so, bring in star player like Carmelo Anthony, Allen Iverson and Chauncey Billups to the Denver Nuggets. When Iverson came up as a possible trade, Kroenke’s response was simple: “Go get him.” Billups even said, “For us, it’s simple. Mr. Kroenke is the MVP (Most Valuable Player).”

However, his teams do not buy for the sake of it, as Paul Andrews explained, “There is never a quick fix in sports. You might see that one player, who looks like a great player, who might come at a very high price, so do we bring that player into our basketball team? The answer to that, however tempting, is that maybe, when you bring that person in, it upsets the chemistry of that team. Typically, history would tell us that doesn’t work to build long-term success.”

17. Does he interfere in team affairs?

Although he keeps close tabs on his investments, he does not have a reputation for interference. Ivan Gazidis reassured Arsenal fans, “He believes that the manager should be in charge of what happens on the pitch and his role is to support the manager – not to make a big fuss about his involvement.”

Paul Andrews endorsed this approach, “The experts in soccer are in the UK and Arsenal, in our opinion, is the foremost expert. You hire people you have confidence in and you let them go out and prove they can do the job.” This was confirmed by former Colorado Avalanche manager, Pierre Lacroix, “We could have had all kinds of problems. Instead, this cool guy walked in and said, 'OK, what’s the plan? Fine, do it’.” In any case, given all his other sporting responsibilities, how much time could he realistically devote to Arsenal?

"Usmanov considers his options"

18. What is Arsene Wenger’s view?

While it is rumoured that Wenger has made it plain to the Arsenal board that he would not work under Usmanov, he has been far more balanced in his reaction to a possible Kroenke takeover, “The only important thing is that the club is run properly in every department. And the most important department in any football club is what happens on the pitch. As long as who owns the club doesn’t interfere with what we do on the pitch, for me it's OK.” A veiled warning not to meddle in football matters, but hardly unexpected.

19. Would he want to retain Wenger?

Kroenke’s executive managers have stressed their appreciation for Wenger’s brand (sic) of football, but there are clear similarities between the two men. They both focus on youth development and involve themselves in every aspect of their business. One of Kroenke’s partners, Charles Banks, said, “He throws himself into it and he fully understands every aspect of it. It’s not micro-managing, it’s micro-comprehension.”

Wenger’s economics background has helped him look after the club’s financial affairs, while continuing to produce teams that challenge for honours. If Kroenke were tempted to go for an alternative like Hiddink or Capello (or, God forbid, Mourinho) in an attempt to win trophies immediately, he would surely appreciate that this would require another substantial investment to rebuild the squad along their lines.

"Passing the baton?"

20. Who are the other key players?

Through his investment vehicle Red and White Securities, Alisher Usmanov has the next largest holding with 26.2% and some believe that Kroenke would only proceed with a takeover bid if he was sure that the Uzbek was willing to sell his shares. The other major shareholders, who could well hold the balance of power, are Danny Fiszman with 16.1% and Lady Nina Bracewell-Smith with 15.9%.

We know that Fiszman looks favourably on Kroenke, having already sold him over 8% of the company, but Lady Nina has been considering her options after she was ousted from the board in what she called “a ruthless fashion”. Although Peter Hill-Wood only owns around 1% of the company, he is still highly influential from his position as chairman, though his incredibly relaxed manner at last October’s AGM might just indicate that he is on his way out. One advantage of a Kroenke takeover would be to remove this uncertainty and bring stability back to the board room.

So many questions, very few with a definitive answer. As is so often the case, the wisest comment on the situation came from Arsene Wenger (he knows), who said, “A takeover is not inevitable. It can have both a positive and a negative influence, that is the same with every owner.” Whatever happens next, let’s hope that Stan Kroenke is indeed a man with a plan, as he appears to hold the future of the club in his hands – at least from a financial perspective.

I Owe You Nothing

In a period when most English football clubs seem to be lurching from one financial crisis to another, culminating in Portsmouth going into administration last week, Arsenal’s recent half-year results shone like a diamond in a dustbin. While most have focused on fans protesting at the mountain of debt constructed at Manchester United, the Glazer family’s plaything is by no means the only team that is leveraged to the hilt, as evidenced by the recent UEFA report which stated that 56% of all the football debt in Europe was held by 18 clubs in the English Premier League. And this figure excluded basket cases Portsmouth and West Ham, who did not even qualify for a UEFA licence, so it’s fair to say that English football is grappling with a major debt problem.

Therefore it was hardly surprising that the media reacted so positively to Arsenal’s results for the six months ended 30 November 2009, which included a dramatic £129.2m reduction in net debt from £332.8m to £203.6m. Moreover, profit before tax of £35.2m rose an impressive 44% from £24.5m in 2008 on the back of turnover of £196.8m (up from £156.8m the previous year). This is an impressive performance by anybody’s standards and is fair reward for a club that has consciously tried to manage its business in the right way. However, contrary so-and-so that I am, whenever I see the media universally applaud anything, I am always a tad sceptical, so thought it worth digging a little to see if everything is indeed as wonderful as it appears on the surface.

"Peter Hill-Wood - Old Skool"

The first obvious point to note is the impact of property development, which was acknowledged by Chairman Peter Hill-Wood, the original Eton Rifle, who stated that, “This has been a particularly strong period for our property business with Highbury Square making a significant contribution to the results”. You can say that again. Property development accounts for almost half of the turnover with £96.6m, compared to football revenue of £100.2m. Even more striking is that just about all of the Group’s year-on year revenue growth of £40.0m comes from the property arm (£38.2m), while the football segment barely grew at all with a miniscule increase of £1.8m. The huge importance of property development is further emphasised when looking at operating profit (before player trading, depreciation and finance charges). At a Group level, this actually dropped £0.5m to £29.3m and this was again a “game of two halves” with property rising £5.0m to £11.3m, while football fell £5.5m to £18.0m – that’s nearly a 25% decrease.

The press release made great play of the fact that the pre-tax profit from the “core business of football” increased to £25.8m from £19.7m, but again this is a little misleading, as it includes £20.8m from player trading, primarily the sales of Adebayor and Toure to Manchester City, up from “only” £8.0m in 2008. Excluding this £12.8m increase, as you would not expect (or hope) for similar big money sales every season, the football operating profit was actually £6.7m lower than the prior year. Not only that, but the profit margin on the real core business, assuming that Arsenal are not a selling club, was slashed by almost 60% from 11.9% to 5.0%, which has to be a cause for concern. In fact, the reported increase of £10.7m in Group profit before tax to £35.2m would also have been more than wiped out if this factor were excluded.

"Ivan Gazidis - facing the future"

Let’s be very clear about this: even if the once-off profits from property development of £9.4m and player trading of £20.8m were to be excluded, Arsenal would still have made a profit, but it would have been considerably lower at just £5.0m. This argument may remind some of the old saying, “if my aunt had balls, she would be my uncle”, but I do think that it’s worth exploring the underlying fundamentals, as Arsenal will exit the property business in the foreseeable future and no fan wants the club to sell their best players every summer.

So, why has the football business become less profitable? You don’t have to look too far for the main reason, which is a “significant increase” of £10.1m in operating costs to £101.4m, largely due to the £8.6m rise in player wages, despite the departure of Greedy-bayor and Toure, who were on pretty high wages. This reflects the re-signing of 17 first-team players on long-term contracts, which the Chairman described as an “investment in a very talented group” and as the “best means of protecting the value of one of our most important assets”. That may well be true, but it still goes against the grain to reward these players for: (a) not winning any trophies for five years; (b) spending lengthy periods in the treatment room with assorted injuries and ailments. This level of investment implies an annual growth of around £20m in player salaries, on the assumption that the increases were spread throughout the period, which is a lot of additional cost to carry, especially as Cesc Fabregas’ new contract will inevitably mean even higher costs.

"Businessman of the year"

Such an increase in the cost base is clearly worrying, but would not be that big an issue if the revenue were rising at the same rate, but the problem is that it only grew by an insignificant £1.8m (less than 2%). Gate and match day revenue is still the highest portion of football revenue at £41.4m, but this was £3.0m lower, though to be fair this is simply a reflection of one less home fixture against the comparative period last year. Commercial revenue also fell – by £0.9m to £23.4m, due to “recessionary factors”. On the other hand, broadcasting revenue grew by an impressive 23% to £35.4m, mainly due to the extended run in the Champions League.

The really good news in these accounts comes from the property side, where there has been considerable progress over the last few months. The last couple of reports have stressed the risks and uncertainty arising from the property downturn, but now “the position is completely different”. Indeed it is: sales of 261 apartments at Highbury Square increased turnover by 65% from £58.4m to £96.6m, while operating profit was up almost 80% at £11.3m. This means that 524 of the 655 private apartments have now been completed with cumulative revenue of £217m, leaving only 131 units still to sell. The proceeds have been used in repayment of the project’s bank debt, which was cut from £123.6m in May to £35.7m in November and has been further reduced to £12.9m since these accounts were published with Hill-Wood stating, “we can clearly now anticipate the point at which the (Highbury Square) project will become debt free”. Furthermore, the sale of the social housing element of the Queensland Road development site to Newlon Housing Trust means that the Group’s other property activities are now also free of debt.

"How much is my budget?"

The breakthrough in property sales has resulted in a staggering reduction of £129.2m in net debt from £332.6m to £203.6m, which is presumably now down to £180.8m, given the further reduction of £22.8m in the Highbury Square balance. This is a major achievement, which is worthy of the lavish praise from the media, especially when you consider the £716m (and rising) of debt that the Glazers have loaded onto Manchester United. However, I would point out that most journalists have been comparing apples with pears here, as the United figure is gross debt, i.e. ignoring £140m of cash, while Arsenal’s gross debt is actually £305m, before including £101m of cash to produce the net debt of £204m. Even so, it’s clear that Arsenal are prudently managing their balance sheet with new kid on the block, Chief Executive Ivan Gazidis stating, “I think it’s important that clubs act responsibly with respect to debt”. Having said that, it’s all relative. For example, Portsmouth went into administration with debts of around £75m, which is a lot less than Arsenal’s reduced balance, but the point is that Pompey cannot service their debt, as their earnings capacity is much lower and their cost base is too high compared to those earnings.

Enough already with the past, there are some key questions that need to be answered in the future:

1. Can revenue from the football business be increased?

(a) Commercial revenue – this is clearly an area of weakness with revenue lagging way behind the club’s English peers. According to the Deloitte's Football Money League 2010, Arsenal’s annual commercial revenue of £48m is much lower than the other teams in the so-called “Big Four” (Manchester United £70m, Liverpool £68m and Chelsea £53m). The comparisons are even worse against the continental European teams (Real Madrid £119m, Barcelona £96m and Bayern Munich £136m). Understandably, Arsenal tied themselves into long-term contracts with Emirates (stadium naming rights until 2021, shirt sponsorship until 2014) in order to provide security for the stadium financing, but recent deals by other clubs highlight the opportunity, which is probably worth another £20m a year. Gazidis is well aware of this and has recently restructured and strengthened his commercial team to explore new partners and overseas markets.

"That's what I call branding"

(b) Gate and Match Day revenue – partly depends on the number of home games that the club plays, which is in turn dependent on how far the club progresses in the various Cup competitions. Deloittes estimated that 20% of Arsenal’s total revenue came from participation in the Champions League in 2008/09, when they reached the semi-final. It is difficult to see how the club could greatly increase ticket prices, which are already among the highest in Europe. Indeed, demand at the higher end has not been so strong this season, which is important, as those 9,000 premium seats generate approximately 35% of match day revenue. Any continued lack of success in terms of winning trophies might also negatively affect demand.

(c) Broadcasting revenue – this is again partly linked to performance on the pitch, especially in the Champions League. Despite the recession, football continues to be vitally important to television companies. Whatever faults Premier League Chief Executive Richard Scudamore may have (and there are many), he has secured some impressive broadcasting deals, recently increasing the domestic rights contract by 4% to £1.8 bln for the three years from season 2010/11 and overseas rights by a rumoured 70% to £1.2 bln for the same period. However, the top English clubs suffer from the Premier League’s collective bargaining, compared to the Spanish giants, Real Madrid and Barcelona, who are allowed to negotiate individual deals with broadcasters, thus earning almost twice as much (£137m) as Arsenal (£76m).

"More Songs About Buildings And Food"

2. Can costs be controlled?

This is difficult to address, as the accounts do not provide much detail for operating costs, but we do know that players’ salaries have significantly increased as a direct result of the strategy to sign young players to long-term contracts. I can only see this trend increasing, especially if the market continues to be artificially inflated by the arrival of extremely wealthy benefactors. The weakness of Sterling and the harsh UK tax regime also makes countries like Spain more attractive for players, which can only be compensated by increasing gross salaries in England. I don’t think that it is in Arsenal’s DNA to demolish the wage structure, unless the Board suffers a communal fit of madness and appoints Harry Redknapp, but Arsenal’s wage/revenue ratio is currently among the lowest of top football teams, so costs are more likely to increase than fall here.

3. How much money could the club get from property development?

Peter Hill-Wood confidently stated, “It is clear that the next couple of years will see our property activities deliver excess cash”. Ivan Gazidis confirmed, “We will soon be delivering a profit back into the football side of the Group”. We can estimate the value of the 131 remaining apartments at Highbury Square as between a conservative £32.8m (assuming the quoted starting price of £250k) and £54.3m (based on average price for sales to date of £414k), which would produce net proceeds of £19.9m to £41.4m, say £30m, after clearing the outstanding debt of £12.9m. That would be an extraordinary achievement in the current economic climate. Furthermore, the club’s other three property assets (Queensland Road market housing, Hornsey Road and Holloway Road) are now free of debt following the sale of Queensland Road social housing, so any future sales here represent pure profit, generating cash that would be available to use elsewhere in the Group. I have no idea what that could be worth, but let’s say £10m.

"I'll tip my hat to the new constitution"

4. How much money could be available for transfers?

Arsene Wenger has always maintained that he has the funds to compete in transfer negotiations. This was confirmed by Ivan Gazidis when commenting on the results, “We have money available to invest in the transfer market, when we can identify the right players to add into the mix that add something to the squad”, but just how much money could be available? The starting point is £101m of cash, but £22m of that must be maintained on deposit as security against future interest payments, leaving £79m. To that, we could add £30m from the sale of the remaining Highbury Square apartments plus the £10m guesstimate from the other three property assets. The core football business should also contribute £10m, which is calculated based on annualising the £5m profit for the last six months, having stripped out the £20.8m earned from player trading. Against that, the accounts mention contingent liabilities of £11m, which represent further transfer fees payable to other clubs is players make a certain number of first team appearances, play for England, etc. All this gives you a very rough figure of £118m for the transfer pot. Wow. Of course, Arsenal still have to pay a hefty annual interest charge of around £20m (£5m repayment, £15m stadium financing) for many years, so they might want to reserve even more than the specified minimum, unless they can substantially increase commercial revenue. Either way, there will definitely be a lot of cash available.

5. How will the funds be invested?

Well, we already know that Arsene Wenger’s budget not only covers the purchase of new players, but also salaries, so it is likely that some cash will be allocated to improving the contracts of the existing squad, most notably Cesc Fabregas, but potentially also Andrei Arsahavin. Those fans that would prefer to see the club put money into the “Arsenalisation” of the team rather than the stadium, would be comforted by Ivan Gazidis’ comments after the results, “We have delivered a profit before tax of £35m for the first half of the year, but it’s important to note that this isn’t our primary objective. The reason we run a responsible, profitable and self-sustaining business is so that we can deliver success to the club and invest in the club and ultimately deliver success on the pitch”. However, Peter Hill-Wood said, “In addition to investing in the team, I think we will examine investment in club projects and infrastructure … into the next phase of growth”. Might that mean expanding the stadium to 80,000, as per the original design?

"Hands off, she's mine"

6. What will happen to the club’s debt?

The majority of Arsenal’s debt is long-term, a mixture of fixed rate bonds £178m, floating rate bonds £53m and debentures £26m, at an average interest rate of around 5.6%, which is much lower than the exorbitant rates required by Manchester United’s lenders (over 9% on the bonds and an eye-watering 16.25% of the PIK notes). Net finance charges for the last six months actually increased from £7.9m to £9.2m, but that is almost entirely due to lower interest receivable, as interest rates have declined. It’s not clear whether it would be possible for Arsenal to pay off this debt early in order to reduce the interest charges, but my guess is that they are in no hurry to do that, as Gazidis has argued that debt is sometimes justified, “The debt that we’re left with is what I would call ‘healthy debt’ – it’s long term, low rates, very affordable for the club, and it’s effectively a mortgage on our stadium, which generates revenue for the club. Not all debt is bad and I think Arsenal’s debt delivered an asset to the Club that will be an asset for generations to come in our stadium”.

7. Will the financial success have any impact on the club’s ownership?

Some people have claimed that the Board’s desire to reduce the debt is part of some sort of Machiavellian scheme to make the club more attractive to a prospective purchaser like “Silent Stan” Kroenke or Alisher “Fat Boy Fat” Usmanov. Granted, both Danny Fiszman and Peter Hill-Wood have sold shares to Kroenke, but this does feel like a conspiracy theory too far. For one thing, everything else being equal, increased profits should increase the share price, making any acquisition more expensive. On the other hand, you could argue that this would make selling shares more attractive for the current directors. The real concern is that any take-over would be in the form of a leveraged buy-out (like Manchester united), which would mean that the club would once again be saddled with large debts, but frankly this could happen at any time.

"Of course, we're going to buy"

The Board should be commended for how they have managed the club’s finances over this challenging period, especially as Arsene has kept the team competitive, albeit not actually winning anything. When it became palpably obvious that Highbury was simply too small to provide the revenue required for a major European club and could not be expanded, due to the proximity of local housing and two stands being listed, the club embarked on an ambitious five-pronged strategy: (a) develop and sell Highbury; (b) build a new stadium with a much larger capacity; (c) invest in the youth academy to develop talent; (d) improve and sell players to cover finance charges; (e) not waste money on big money transfers.

This could loosely be described as the Barcelona model, whereby you rely on bringing through young talent, coached to play in the club’s style, and supplement this with a couple of world class acquisitions every season. Arsenal are not quite there yet, and some may argue that they have erred too much on the side of frugality when it comes to the transfer market, but they will soon be able to exit the property business and fully concentrate on football. At that stage, we will see whether the strategy was successful – not just in property development, but also on the pitch.

Moneyball

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.