A Type of Business I'm Not Interested In
This is the second part of my “Interesting Financial Topic” writeup that I posted two weeks ago that dealt with my thoughts and takeaways from the MicroCapClub Leadership Summit. It is entirely unrelated to the first part, but possibly more intriguing.
I have previously focused on businesses that have high returns on capital or at least have a path to high returns on capital if they were to cut their debt load or stock-based compensation. This writeup will focus on businesses that don’t have those characteristics and whose valuation relies on the greater fool theory.
You may be wondering why I’m writing about bad businesses. Part of the answer has to do with Charlie Munger’s inversion principle. He’s famous for saying, “Tell me where I’m going to die, so I’ll never go there.” The same line of thinking applies to this writeup. I’m going to show you bad businesses, so you (hopefully) don’t invest in them. At minimum, if you do ever invest in a business like the ones detailed in this writeup, I want you to realize that they will most likely be very capital intensive and a slog to achieve any kind of sustained profitability. That’s not to say that the economics of each one can’t change in the future, but I’m not counting on it. There are other reasons why I’m writing about these businesses, but I’ll state those later in the writeup.
Please refer to the screencaps below of the six businesses that will be highlighted in this writeup. For now, I’ve labeled each one Business A, B, C, D, E, and F.
Business A
Business B
Business C
Business D
Business E
Business F
STOP READING FOR A MOMENT AND PONDER THE QUESTIONS BELOW.
What do you think of these businesses based on the financial data in the screencaps above?
Are any of them investable ideas in your opinion?
Would you consider learning more about them after looking at the financial data in the screencaps above?
What if I told you each business is valued at least five times more in 2022 than 2007? Would you believe that?
I intentionally left ten lines of space between this sentence and the rest of the writeup so that the businesses wouldn’t be revealed in case you scrolled through them quickly.
THE WRITEUP PICKS BACK UP HERE.
The screencaps below are the same tables posted above, but the name of each business has been revealed.
Business A
Business B
Business C
Business D
Business E
Business F
Yes, these are the “Big Six” clubs from the Premier League. Have you reframed the questions that I asked you previously? Does being a football (soccer) club make something more or less valuable to you as an investor? Does being a fan of any of the clubs change your mind regarding valuation? I can tell you that my answer is an emphatic “No”. A bad business is a bad business any way you slice it.
In the proceeding sections of the writeup, I’ll go into more depth on why I wrote about this topic and where I got my information from. I’ll also provide some notes about my financial analysis, show each club’s general performance between 2007 – 2021 and explain two big issues regarding football club profitability. Finally, I’ll list each club’s respective valuation per Forbes as it seems to be the most referenced valuation source.
Why I Wrote About This Topic
I will now list the other reasons why I wanted to do this writeup in addition to Charlie Munger’s inversion principle.
The sports industry has grown considerably during my lifetime and is now what I would consider a huge business. I am a big sports fan and root for several teams although none of the Big Six clubs specifically.
I’ve always wanted to analyze a sports team, but almost none of the teams here in the U.S. provide annual reports. The only team that does, that I’m aware of, is the Green Bay Packers. Instead, I casually look at a few European football clubs’ financial statements from time to time. When I do, none of the clubs report consistent profits or free cash flow. As English is the only language that I am fluent in, I had to read the annual reports from countries in the United Kingdom.
I figured the Big Six stood the best chance of being profitable as they generate the most revenue in the most popular football league on the planet.
Each Big Six club is ranked in the top 15 of most valuable clubs in the world by Forbes.
I wanted to show the disconnect between the reported valuations by Forbes and what I saw in the data that I looked at.
I wanted to switch things up for a change and write about something different.
Information Sources
Most of the information came from the UK Companies House website. I also obtained information on Manchester City and Manchester United from their annual reports. I tried my best to get purely club level data, but I wasn’t successful as they include associated activities like stadium operation fees or food and beverage fees.
I was able to get individual, club specific data on Manchester City up until 2018. After that year I had go to the Company House reports and get data for the entire City Football Group which includes results from the other clubs it owns, but they’re all consolidated and Manchester City’s results were not broken out individually :/.
Manchester United is publicly traded so I was able to easily find information on the club after it IPO’d in 2012. Before that I used Companies House reports.
Here are my data sources for each club:
Please remember what I stated above. I was not able to find standalone data for the clubs for the entire 2007 – 2021 timeframe. They all had some sort of affiliated business in addition to the club’s operation during some or all of the period between 2007 – 2021. However, the overwhelming driver of each club’s operating group was their respective football team. I knew this wasn’t going to be a perfect comparison, but it was the best that I could do and I wanted to make sure that you were aware of this.
Arsenal - https://find-and-update.company-information.service.gov.uk/company/00109244/filing-history
Chelsea - https://find-and-update.company-information.service.gov.uk/company/02536231/filing-history
Liverpool - https://find-and-update.company-information.service.gov.uk/company/00035668/filing-history
Manchester City - https://find-and-update.company-information.service.gov.uk/company/08355862/filing-history and https://www.cityfootballgroup.com/information-resource/reports/
Manchester United - https://find-and-update.company-information.service.gov.uk/company/05321162/filing-history and https://ir.manutd.com/financial-information/annual-reports/2021.aspx
Tottenham - https://find-and-update.company-information.service.gov.uk/company/01706358/filing-history
Financial Analysis Notes
I had to enter all the revenue, operating profit, profit on ordinary activities, income taxes paid, short-term debt, long-term debt, capital lease, total equity and goodwill data in manually so there is a chance I typed in a wrong number here or there.
I wanted the analysis to be at a high level and not super in depth. In depth reporting would’ve required that I investigate the parent companies of each respective club which I can tell you is beyond complicated. Plus, it should be obvious that a business is good when you look at it from a high level.
Pro tip: If you encounter a business that is controlled by a parent company and it’s hard to find information on it or locate its financial statements then you should avoid it. That is a huge red flag 🚩.
Given that I didn’t investigate the parent companies, I took all the data that I found in the financial documents “as is”. The only club that didn’t have a traditional parent company was Manchester United. However, it is controlled by the Glazer family through their shareholdings.
In the screencaps above you will see a metric called “profit on ordinary” which is short for “profit on ordinary activities before interest and taxation”. The “ordinary activities” are the profits or losses made on the disposal of player registrations. Per Football Benchmark, the profit or loss on the disposal of player registrations is defined as “… the difference (+/-) between the income associated to the sale of players’ registrations, and the net book value of the player registration recorded as an intangible asset.” So, if the “profit on ordinary” figure is higher or less negative than the “operating profit” figure above it then that means the club made money on player disposals. You’ll also notice a metric called “NOrPAT”. This is the same calculation as NOPAT except using “profit on ordinary activities before interest and taxation” instead of “operating profit”.
Per my other writings, the formula for invested capital is:
Invested Capital = Total Debt + Total Lease Obligations + Total Equity – Goodwill
I didn’t include capital leases for most of the clubs because most of them were under <£1 million a year. I did start including capital leases when I felt they were a material amount like in Tottenham’s and Manchester City’s case.
The last piece of business I’d like to mention is the time frame. I used 2007 as the base because that was the first year Forbes started valuing football clubs. I ended the measuring period in 2021 because not all the clubs have reported their Fiscal Year 2022 results as of the publishing date of this writeup. Also, the ending dates for the valuations fluctuated between May and June of each year. I have no idea why this was the case.
Club Performance Since 2007
Anything that’s written below besides each club’s performance since 2007 are general takeaways that I noticed after reading through their financial documents. I may have missed an important blurb here or there, but I tried doing the best that I could.
The club performance data was taken from each club’s Wikipedia page.
Arsenal
The Gunners have done a pretty good job of being profitable over the last 15 years in relation to the other clubs. They were unprofitable in only four of the years measured with the last three years being particularly hard on the club.
Arsenal’s short-term debt vanished after 2019. Per my note in the cell, “Arsenal's short-term debt is magically no more. There is a line item for "other creditors", which was grouped with "loans" in previous years, but that is no longer the case so I'm going to be generous again and assume that Arsenal has no short-term debt.”
A similar event happened with its long-term debt between 2015 and 2020. Per my note, “The only long-term debt listed are "debenture subscriptions". There are "other creditors" listed but I'm going to give Arsenal the benefit of the doubt here and assume that these "other creditors" aren't a form of debt.”
In 2021, long-term debt skyrocketed to £186.6 million. Per my note, “Per Note 14 of the 2021 Financial Statements - the balance is due to the parent company, KSE UK Inc., and related to the redemption of Arsenal Holdings Group's stadium finance bonds. Certain direct costs of the refinancing have been capitalized and will be amortised to the profit and loss account over the estimated term of the underlying loan…”
Club performance since 2007:
Premier League: Has not won the Premier League since the 2003 – 2004 season. Arsenal’s best result between 2007 – 2022 was 2nd in the 2015 – 2016 season.
FA Cup: Winners in 2013 – 2014, 2014 – 2015, 2016 – 2017 and 2019 – 2020
EFL Cup: Has not won.
FA Community Shield: Winners in 2014, 2015, 2017 and 2020
Champions League: Qualified every year between 2007 – 2017 with its best result being a semifinal appearance in the 2008 – 2009 season where it lost 4 – 1 to Manchester United on aggregate.
Europa League: Qualified every year between 2017 – 2020 with its best result being 2nd after it lost to Chelsea 4 – 1 in the 2019 Europa League Final.
UEFA Super Cup: Has not qualified.
Chelsea
Chelsea didn’t experience a lot of profitability between 2007 and 2021. That was by design though. Roman Abramovich, Chelsea’s owner from June of 2003 until earlier this year, was asked in an interview in 2003 if his purpose was to turn the club into a money maker. His response after laughing was, “No, it's not about making money. I have many much less risky ways of making money than this. I don't want to throw my money away, but it's really about having fun and that means success and trophies.” A link to the interview can be found here. Chelsea’s financial documents repeatedly mentioned that the club was reliant on its parent company, Fordstam Limited, and Mr. Abramovich for financial support which made sense given the lack of profitability.
Chelsea also claimed to be debt free which I found bizarre because Mr. Abramovich was owed ~£1.6 billion in loans when he sold the club. After learning more about them, the terms of the debt were interesting. They were interest free and issued by Fordstam Limited. Essentially, Mr. Abramovich lent money to himself as he was the owner of both companies. Luckily, he agreed to waive the debt and have any profits paid to charity as part of the deal when the club was sold. Technically, the club was right in this instance.
Club performance since 2007:
Premier League: Winners in 2009 – 2010, 2014 – 2015 and 2016 – 2017
FA Cup: Winners in 2008 – 2009, 2009 – 2010, 2011 – 2012 and 2017 – 2018
EFL Cup: Winners in 2014 – 2015
FA Community Shield: Winners in 2009
Champions League: Winners in 2011 – 2012 and 2020 – 2021
Europe League: Winners in 2012 – 2013 and 2018 – 2019
UEFA Super Cup: Winners in 2021
Bonus achievement: Signing Eden Hazard for £32 million in 2012 and selling him to Real Madrid in the summer of 2019 for a reported ~£85 million.
Liverpool
I didn’t find anything of note in Liverpool’s financial documents. I will say that it did a decent job of being profitable, for a football club, between 2014 – 2020. However, its profitability was never consistent or anything to write home about for more than a three-year period.
There was one interesting tidbit of information that deserved further mentioning. John Henry, the principal owner of Fenway Sports Group, flirted with the idea of taking the group public back in 2020. Fenway Sports Group is the parent company of Liverpool FC, the Boston Red Sox and the Pittsburgh Penguins. Click the link here to read more about it. He also managed to cause an uproar when the club joined the European Super League in 2021.
Club performance since 2007:
Premier League: Winners in 2019 – 2020
FA Cup: Winners in 2021 – 2022
EFL Cup: Winners in 2011 – 2012 and 2021 – 2022
FA Community Shield: Winners in 2022
Champions League: Winners in 2018 – 2019
Europa League: Best result in the competition was 2nd after The Reds lost 3 – 1 to Sevilla in the 2015 – 2016 Europa League Final.
UEFA Super Cup: Winners in 2019
Manchester City
I couldn’t find financial data on Manchester City between 2007 – 2008. During that time the club was owned by Thaksin Shinawatra. He bought the club after having been the Prime Minister of Thailand until he was overthrown in 2006. Per Wikipedia, he bought the club for ~£82 million in the summer of 2007 and flipped it to the Abu Dhabi United Group a year later for a reported £200 million.
Tifo Football made a video about him and his brief ownership of the club several years back if you want to check it out. A link can be found here:
He also has an extensive Wikipedia page. What can I say? The guy has a one hell of a story in my opinion. His Wikipedia page can be found here: https://en.wikipedia.org/wiki/Thaksin_Shinawatra
I mentioned it earlier, but wanted to remind you about it again. The club stopped providing balance sheet and income statement data in its annual report after 2018, so I had to go to the Companies House website and get data for the entire City Football Group (Manchester City’s parent company) which includes results from the other clubs it owns, but they were all consolidated and Manchester City’s results were not broken out individually :/.
What stood out most in Manchester City’s financial statements was the explosion in shareholder equity. It increased from ~£30 million in 2007 to a little over £900 million in 2021. This was due almost entirely to massive increases in the “called up share capital” and “share premium account” line items on the balance sheet. It doesn’t link up perfectly, but the increases correlate well to Sheikh Mansour’s initial and continued investment in the club and other investments by China Media Capital and Silver Lake, a U.S. private equity firm, which now owns 14.5% of City Football Group.
Club performance since 2007:
Premier League: Winners in 2011 – 2012, 2013 – 2014, 2017 – 2018, 2018 – 2019, 2020 – 2021, and 2021 – 2022
FA Cup: Winners in 2010 – 2011 and 2018 – 2019
EFL Cup: Winners in 2013 – 2014, 2015 – 2016, 2017 – 2018, 2018 – 2019, 2019 – 2020 and 2020 – 2021
FA Community Shield: Winners in 2011, 2014, 2021 and 2022
Champions League: Qualified for the competition for the last 12 seasons in a row and made the knockout stages every year since 2012. The club’s best result in the competition was 2nd when it lost 1 – 0 to Chelsea in the 2021 Champions League Final.
Europa League: Best result was a quarterfinal appearance in 2008 – 2009 when it was still called the UEFA Cup. Manchester City lost 4 – 3 on aggregate to Hamburger SV.
UEFA Super Cup: Has not qualified.
Bonus achievements: Signing Sergio Agüero for ~£35 million in 2011. Signing Erling Haaland for a little over £51 million this summer which seemed like a relative bargain given the current transfer fee environment.
Manchester United
There were four line items, two of minor importance and two of major importance, that I noticed when reading about Manchester United’s finances. First minor line item, the club got rid of “profit on ordinary activities before interest and taxation” and consolidated it into its operating profit calculation after going public. Second minor line item, its Fiscal Year 2013 was wildly profitable, but this was due to a huge tax credit.
The first major line item that I noticed was the debt that hangs on the club to the tune of £530 million at the end of Fiscal Year 2022. I used Fiscal Year 2022 data because the club has posted its results already and I wanted to give you the most up to date information as possible. The club seems to be in a precarious financial position given its debt load, downturn in performance since Alex Ferguson retired and its inconsistent profitability over the years. Per its most recent (Fiscal Year 2022) Annual Report, the debt is made up of £347,173,000 of secured notes, a secured term loan facility in the amount of £183,192,000 and another £100,000,000 in outstanding loans.
Per p. 158 of the 2022 Annual Report, the secured notes have a fixed coupon rate of 3.79% and are due in June of 2027.
Per p. 158 of the 2022 Annual Report again, “The secured term loan facility attracts interest of US dollar LIBOR plus an applicable margin of between 1.25% and 1.75% per annum and interest is paid monthly. The remaining balance of the secured term loan facility is repayable on 26 August 2029, although the Group has the option to repay the secured term loan facility at any time before then.”
There was no additional information provided about the £100,000,000 loan other than it being scheduled to expire in June of 2027.
You’d better hope that the club consistently makes the Champions League and competes for league titles going forward if you’re a fan of Manchester United because the financial outlook doesn’t look great from my perspective.
The second major line item you’ll notice is the sizable amount of goodwill on its balance sheet. This is due to the Glazer’s takeover of the club in 2005 and the price they paid being more than the fair value of the club at the time.
Club performance since 2007:
Premier League: Winners in 2007 – 2008, 2008 – 2009, 2010 – 2011, and 2012 – 2013
FA Cup: Winners in 2015 – 2016
EFL Cup: Winners in 2008 – 2009, 2009 – 2010 and 2016 – 2017
FA Community Shield: Winners in 2007, 2008, 2010, 2011, 2013 and 2016
Champions League: Winners in 2007 – 2008
Europa League: Winners in 2016 – 2017
UEFA Super Cup: Has not won.
Tottenham
Out of all the Big Six clubs, Tottenham, along with Arsenal, did the best on a profitability basis. Daniel Levy, the chairman and second largest individual shareholder of the club, is notoriously shrewd in player dealings and deserves some credit here.
An interesting fact about Tottenham is that it was the first sports club in the world to go public back in 1983. It is now owned by ENIC International Limited which, along with Mr. Levy, is owned by Joe Lewis.
The biggest concern with Tottenham’s finances was its debt load which was and still is mostly related to the financing of its new stadium. Luckily, the club was able to refinance its loans and has an average interest rate of 2.65% as of its most recent fiscal year. Even with the refinancing, interest payments alone amount to more than £22 million a year. Like what I said about Manchester United, fans of Tottenham better hope it consistently competes for league titles and qualifies for and makes deep runs in the Champions League. Mr. Levy needs to continue his shrewd transfer policy too.
Club performance since 2007:
Premier League: Has not won the Premier League. It did win the First Division twice back in 1950 – 1951 and 1960 – 1961. The club’s best finish since 2007 and in the entire Premier League era was 2nd in 2016 – 2017 season.
FA Cup: Has not won since 1991. Made the semifinals four times since 2007.
EFL Cup: Winners in 2007 – 2008
FA Community Shield: Has not won the competition since 2007 and I was unable to find the club’s best performance in the competition since.
Champions League: Best result was 2nd after making the 2018 – 2019 Champions League Final where it lost 2 – 0 to Liverpool.
Europa League: Best result was making the quarterfinals in 2012 – 2013 where it lost to FC Basel in a penalty shootout after being tied 4 – 4 on aggregate.
UEFA Super Cup: Has not qualified.
Bonus achievements: Singing Gareth Bale for <£10 million in the summer of 2007 and selling him to Real Madrid in September of 2013 for a then world record transfer fee of ~£85 million. Signing Son Heung-min in the summer of 2015 for £22 million. Scouting Harry Kane at 11 years old and signing him.
Profitability Issues
After looking at the data I posted above, it is obvious that the Big Six aren’t the most profitable businesses around. What’s causing this? Football clubs, as a business, don’t scale very well for two reasons and the first creates the second. The first reason why clubs don’t scale well is because they are primarily concerned with winning and not profitability. To win you must have the best players possible and that means you almost always have to go to the transfer market and pay increasingly large sums for new additions to the squad. The requirement for constant, increased spending to compete is an automatic red flag 🚩 as a potential investor. The second reason why they don’t scale well is because their expenses as a percentage of revenues don’t seem to be getting smaller as time goes on. This is another red flag 🚩. One only needs to look at the increases in revenue and compare them to the NOPAT, NOrPAT and net income figures in each screencap above to understand this. Then, if you’re like Tottenham and Manchester United, you must worry about large debt loads on top of your already large expense bill. The TL;DR is that each club is desperate to win and will spend as much as it possibly can to get the best players. As stated above, the fees paid for these players have increased substantially and it doesn’t look like that will be slowing down any time soon.
Let’s look at it from the perspective of not worrying about money. One club, Manchester City, has almost infinite resources so it can focus on having the best manager, coaching staff, facilities and signing the best players more than the other clubs. Unsurprisingly, it was the most successful club overall, by far, in terms of performance since 2007 out of all the ones profiled. Being bankrolled by a wealthy sovereign wealth fund has its advantages. It also tied Chelsea for having the most unprofitable years since 2007. That seems to be the general tradeoff; you can spend less, not win as much and have some profitable years or spend a ton, win some more and not be profitable. It’s very capital intensive either way.
These two issues are ultimately why I wouldn’t invest in any of these clubs. I haven’t seen proof that they can be consistently profitable, increase profits or achieve operating leverage. Let me be clear, they’re cool and unique assets, but that doesn’t make me think they’re worth billions of dollars. They only seem to be worth that much because that’s what the next rich guy, investment group or sovereign wealth fund will pay; this is the greater fool theory that I mentioned above. Their valuations don’t seem rational or sustainable to me.
Forbes Valuations
The data in the screencap below was taken from the “Forbes list of the most valuable football clubs” Wikipedia page which is linked here. If you look at each club, you will see that their valuations have increased significantly since 2007. For whatever reason, there was no data for 2020 – 2021 and my guess is that it was due to COVID.
I have no idea how Forbes is getting to these valuations based on the clubs’ financial performance. Yes, some of them have been profitable from time to time, but it’s been inconsistent at best. I tried finding what valuation metrics or multiples Forbes used, but I was unable to find anything concrete. I searched “how to value a football club” in Google and there were a ton of results. There wasn’t one method that stuck out versus the others. Ideally, I’d value the clubs based on their cash flows, but I was unable to get all their data because, in the U.K., a business doesn’t have to report cash flows in its Companies House report if it is owned/controlled by a parent company. This was the case for several of the clubs that were profiled in this writeup.
Although I didn’t calculate it, I came across an absorbing topic when thinking about the free cash flow that a club generates. The calculation for free cash flow is shown below.
Free Cash Flow = Operating Cash Flow – Capital Expenditure
To their credit, a club’s Operating Cash Flow (OCF) can be positive due the amortization of player contracts. This is usually what keeps their OCF in the black. The absorbing topic was Capital Expenditure (CapEx). The definition of CapEx per Wikipedia is “… the money an organization or corporate entity spends to buy, maintain, or improve its fixed assets, such as buildings, vehicles, equipment, or land.” It goes on to say that intangible assets can be considered CapEx, but only in some cases. Per the same Wikipedia page again, “… the expense is considered capex if the financial benefit of the expenditure extends beyond the current fiscal year.” I think that you can make a good case that this applies to the transfer fees paid for players as the expectation is to have them be at a club for years. I have a question for those of you who don’t think that transfer fees should be considered part of CapEx. If the intangible assets (read as “transfer fees”) that the clubs pay for aren’t CapEx, then what are they? I’m genuinely interested in your feedback.
If you were to include these figures net of the sales of players, then it wouldn’t be good for clubs’ cash flow on a year-to-year basis based on what I’ve seen from the Big Six and other European club’s financial statements. Even if you don’t include the net spend on transfer fees, my gut tells me most clubs aren’t generating a lot of free cash flow. This would go a long way in explaining the constant investment that is required for the Big Six clubs. I could’ve written an entire piece on this, but it was not the focus of this writeup. I urge you to look at a handful of football clubs if you don’t believe me and report back. If I’m wrong about this, with definitive proof, then I’ll change my tune.
Final Thoughts
That’s all I got for today. I wasn’t expecting the writeup to be this long, but here we are 😅. I thought the Big Six would have the best chance of being profitable businesses, but my analysis showed me that wasn’t true. If you ever find yourself thinking about investing in a football club just remember that it may not be the most profitable endeavor and will most likely be very capital intensive. You probably won’t get a lot of bang for your buck, but you may get the glory that comes along with a successful sports team. I can only hope the glory is worth more than the financial investment.
Thanks again as always for reading. If you liked this writeup then please feel free to share it and subscribe!
Please reach out to me at possiblevalueresearch@gmail.com, @PossibleValue on Twitter and @Heshy on MicroCapClub with any comments, concerns or questions. Lastly, don’t forget to tell someone that you love them.
*** Remember that this isn’t investing advice. Consult a trusted financial or investment advisor before making any kind of investment decision. ***