By Phil Gregory
Leveraged buy-outs (LBOs) are – thanks to the situations at Manchester United and Liverpool respectively – all over the papers. They are something most fans don’t really “get”, and pertinent questions such as “how could they buy our club if they didn’t actually have the money?” pop up quite often. I’m going to take a look at what an LBO is in the business world and how it transfers over to football.
On a basic level, LBOs are quite easy to understand: someone takes over a football club using borrowed money and then uses the club’s profits to pay the interest bill on that borrowed money.
If they’re lucky, they can also pay down the debt – but that requires the profits to be greater than the interest bill. More likely is the situation in which the new owners look to make a quick buck from selling the club a few years down the line for more than they borrowed to buy it themselves. They pay off the debt, and are left with a tidy profit.
Relying on the club to gain value is a bit like the “buy to let” housing marketing Britain: houses were bought with debt (mortgages) and profits (rent from a tenant) paid off the interest, while the houses were expected to go up in value over the period and could be sold off for more than the mortgage.
Leveraged buy-outs are fairly common in the business world, and the theory behind them stands up. The benefit that leveraged buy-outs bring is offering more alternatives to the current owners and management structure of a given company. That is undoubtedly a good thing, as it should act as an incentive for managers towards best practice, as well as meaning that if incompetents find themselves at the helm of a large firm, they can be moved on via heavy borrowing if need be.
If an LBO brings something positive to the business, it isn’t a bad thing. When West Ham were being run appallingly by their Icelandic owners, an LBO would probably have been welcomed: shrewd running of the club could quite easily have turned them into a profitable club with the debt paid down over time. But with the Glazers and Hicks & Gillett, are they really bringing something good to the table?
As I touched on earlier, the downside of LBOs is the high level of risk involved. As they’re funded through debt, the company taken over suddenly finds itself burdened with an extra substantial cost: the interest bill. By extension, the company is reliant on it’s continued profitability in order to service the interest. In business, planning with the assumption of continued profits carries inherent risks; the surprise nature of the recession should prove that to us all.
So can you rely on continued profits in football? Not really. Sure, a club could be turning good operating profits, but as Liverpool will testify, things can change quickly in football. You just can’t predict the need to suddenly splurge on transfers, so it is a dangerous game to have profits already earmarked for an interest bill. Football finances are incredibly volatile; think about the impact on the bottom line of promotion/relegation or Champions League qualification.
Now, for a normal business, I’d argue the risk involved in an LBO is more acceptable when you consider what the positives there are. Let’s imagine an LBO takes over a firm, but over time cannot manage the debt burden. That is the downside of the risk-reward situation that those behind the buyout put themselves into. They take the opportunity to purchase a business they couldn’t personally afford (with all the future benefits they would receive as a result of that) but also take the chance of potential bankruptcy.
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Fundamentally, they incur both the benefits of success or the costs of failure (though the cost to society of the unemployment is also important to consider).
With a football club however, the new owners almost solely benefit from the upsides of their risky ownership, but don’t incur all the potential costs of the downsides in the event of failure. Fans may not be financial stakeholders, but without a doubt they are emotional stakeholders in the club and share the burden in the event of failure. Indeed, you could argue that even before the LBO fails, the fans of a club such as Manchester United are suffering, if one considers the decline in their transfer spending since the Glazer takeover (if one adjusts for inflation in football) as well as the substantial increases in ticket prices over the same period.
This is the paradox we see all too often with football: the financial stakeholders in a club are considered, but the emotional stakeholders are often left unmentioned. Given the risk associated with a LBO, I don’t believe the benefits of such a takeover in its present form ever comes close to outweighing the potential downsides, and as such I don’t believe they have a place in football.
One person who I’m sure will agree with me on the last point was the blogger Andersred, who has been well involved in the efforts to raise awareness of the situation at Manchester United. He was kind enough to field some questions from me on this subject, and contributed significantly to the proposals I’m going to put forward in the next part of the article.
There are various ways to stop the prospect of future LBOs in our game. Remember that the key of an LBO being worthwhile is that the future profits are used to pay off the interest. This leaves us with a point of attack in regards to reforming LBOs out of the game.
Putting cash limits on debt itself would be an error in my opinion. It is clear that the size of the debt doesn’t matter, but the size of the debt relative to the club’s turnover does matter. A lower league side will struggle under a debt that only approaches a million pounds, whereas Arsenal took on the best part of £400million and have since halved it. Thus we can say, debt is not always bad, again see Arsenal. The risk is not the size of the debt, or even the size of the debt relative to turnover, it is the ability of the club to service the debt, the interest bill.
Formal limits could be implemented that restrict the amount of debt that can be used to take over a football club. A takeover solely funded by debt brings little good to a football club, but what if an incompetent owner was ejected, and the cost was a takeover funded by 50% of debt, or even 20%? Such limits could be decided and would introduce an element of flexibility into the issue: “good” LBOs would pass, while high-risk alternatives wouldn’t. Perhaps the limit could be incorporated in the Fit and Proper Persons Test, so debt would be allowed based on what the owner brings to the table. Naturally that has it’s own pitfalls, given the joke that Fit and Proper tests have been shown to be.
My personal favourite proposal however, and the route that UEFA seem to be taking in their Financial Fair Play (FFP) criteria, is formal limits on the removal of dividends from a club. In the FFP criteria, dividends are considered an expense and as such taking too many would mean the club failed to meet the break-even criteria of UEFA. Such a regulation would also stop the immoral awarding of dividends that was a hallmark of Newcastle pre-Ashley. In United’s case, the PIK debt isn’t secured on the club itself so dividends would be one method of using club money to pay off the debts, and this reform would shut that loophole.
Most likely, a limit on the amount of debt allowed in a takeover and a limit on the level of dividend payments in football clubs (tied to the level of a club’s profits) would do the trick and slam the door on LBOs in our game.
Are we likely to see LBOs in the future, and are Arsenal at risk? Well, with tighter lending criteria since the credit crunch, loans are just less available than they were, and with RBS’s experience with Liverpool not meeting repayment deadlines, lenders are even more wary of high-risk ventures such as LBOs. Then there’s the financial fair play rules, which made dividends an expense under the break-even criteria as I mentioned.
In regard to Arsenal, you have to look at the wider ownership situation. Looking at our two biggest shareholders…
- Usmanov isn’t trying to take over to burden the club with debt, he wants to hand over money to win trophies like Abramovich.
- I’ve only ever heard good things about Kroenke’s ownership of his American sports franchises (big contrast to the Glazers with the Buccaneers).
Moreover, even if either of those two do manage to hit the 30% threshold (and Lady Nina is not showing herself to be a willing seller at just any price, regardless of being booted from the board) there is no way our current board would sell out to someone who didn’t have Arsenal’s best interests at heart. Let us not forget, this is a board who have forgone their due dividend payments in favour of reinvesting the money in the club. None of the actions of any of the involved parties lead me to suspect they may be interested in stacking debt onto Arsenal, and the financial backdrop renders the opportunity to do that remote at best.
I’d like to thank Andersred for taking the time to answer a few questions that I had when researching this piece. Most people wouldn’t give their time so freely so it is the least I can do to advise readers with an interest in the finances of the game to take a look at his fantastic blog.
There’s more on football finance in The economics of football
There’s more on Arsenal at www.blog.emiratesstadium.info
Why are Tottenham fans so bitter? www.blog.woolwicharsenal.co.uk
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