Making money out of football

The Financial Times had a very interesting article yesterday about the growing interest of American private equity investors in the English Premier League. Of course, American investors have been deeply involved in the biggest clubs for some time now – Manchester United, Arsenal and Liverpool are controlled by Americans, as well as Aston Villa and Sunderland (and some Championship clubs). The idea that a new wave of Americans (and possibly others) is coming, attracted by the growing profitability of the EPL, is worth considering, not least because such investors would not necessarily have a commitment to retaining traditional structures. I think this is especially true of promotion and relegation, which undermines the profitability of football clubs.

The renewed interest is almost entirely a function of the broadcast contracts. In the space of four years the EPL will have signed contracts which will have increased broadcast income about threefold. In 2012/13 the average club received about £50 million from broadcast rights, and by 2016/17 that will have risen to about £150 million. In the process broadcast income will have come to account for about 80% of revenue for the average club. Already this is showing through to the bottom line. Swiss Ramble’s latest blog on Everton is a good example of how the finances of middle-ranked clubs are being affected.

The most telling statistic is the following:

Deloitte’s Annual Review of Football Finance showed that EPL clubs reported a combined £614 million in operating profits in 2013/14, up from £82 million in 2012/13. UEFA recently published their Club Licensing Benchmarking Report for the financial year 2014, and reported that the 700 or so top division clubs in Europe generated total operating profits of €805 million, which at 2014 exchange rates is less than £614 million. That’s not quite the same as saying that all of the profits in European football come from the EPL, but it’s not far from the truth. According to Deloitte, the operating profits of the EPL in 2014 were three times larger than those of the Bundesliga, long held up as a shining example of profitability by critics of the EPL.

Private equity investors will typically be interested in buying assets cheap, cutting costs, boosting revenues and then selling at a profit. EPL clubs might look cheap right now. Forbes, which values both European football clubs and major league franchises in North America, typically values the latter at a multiple of 4 times annual revenue but the former at typically around only 2 times. This difference is that American franchises make profits (even if they are often well concealed) while European football clubs traditionally do not (with one or two exceptions).

If EPL clubs have become profitable but most investors have not yet understood that fact, then you could buy a club for twice its revenue today, and then resell it in 3 years for 4 times its (increased) revenues – without doing anything!

But before you get carried away and invest your life savings, it’s as well to remember that we have been here before. Between 1995 and 1997 sixteen English clubs raised capital on the London stock exchanges. Investors believed that the growth in broadcast rights values back then would lead to an era of sustained profitability – in 1993 the rights value rose seven-fold and in 1997 it doubled. Investors were encouraged by the the profitability and share appreciation of Manchester United which had floated in 1991.

These hopes never materialized. Within a decade all of the clubs had de-listed and the exit price entailed substantial losses for investors who bought at flotation. Together with Stephanie Leach I wrote a paper documenting this experience: making money out of football.

The problem was straightforward. Almost all of the clubs spent the money they raised, as well as the broadcast money, on buying players. They failed to generate profits. Hence (among other reasons) the Forbes multiple of only two. So why would it be different this time?

It’s not hard to tell a story. The scale of the revenue in the EPL is now such that any EPL club can outspend almost any club outside the EPL and still have money left over. For the first time, the EPL clubs are, economically speaking, in a league of their own. Moreover, competition within the EPL is now limited by Financial Fair Play (both the UEFA and the EPL versions). And this time the private equity owners will control the purse strings (the public equity investors didn’t).

Two problems remain. German conservatism (e.g. the 50+1 rule) has constrained the growth of the Bundesliga, but that may not last. Germany is, after all, Europe’s largest football nation, and the desire to compete with the EPL globally will, I think, be irresistible. Spain and Italy also have some big clubs that can compete with the EPL. Secondly, there is promotion and relegation. Exiting the EPL increasingly amounts to financial meltdown, and clubs will need to compete in the transfer market in the attempt to avoid this fate.  I still think the day will come when owners try to abolish promotion and relegation, and that will in the end be a political rather than an economic fight.

Since all this is speculative, and right now the EPL clubs look cheap, I think the private equity investors will come. A showdown over the soul of English football looms.