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.
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
I recently heard the thing about the board foregoing their dividends and I thought it must be a joke. But after reading it here, I’m starting to wonder if it’s actually true……
Phil,
I hope Arsenal never falls into the LBO trap or that the ownership model doesnt change in the near future. LBOs drain a club of its resources.
Siddhant, Its actually true. The shareholders in Arsenal donot get dividends for their stake. All the profits generated are reinvested into the club. That is one of the main reason why Arsenal’s financial health is so good.
also a nice site on football finance http://swissramble.blogspot.com/
Phil,
Good blog put nicely in layman terms. Thanks.
I was reminded somewhat of Elton John and Watford, if I remember the club correctly. What exactly was his position with regard to the money he put into them? It certainly seemed to work before he decided on no more, but was he repaid? Or was he just a big fan with full pockets?
I do assume that the “no dividends” set up is only temporary. At a time when we were paying out high interest on the property development side, the board didn’t want to take money out of the club, instead the money was put towards paying down the debt to reduce the total interest bill.
For the polar opposite of this idea, take a look at what I wrote about Newcastle http://blog.emiratesstadium.info/archives/6016 . Basically, they were paying a huge mortgage on their stadium, and could’ve paid it off had they not taken vast dividends out.
Such an example just goes to show how we are fortune not have such a decent board.
This is undoubtedly the best blog in the Arsenal Blogshere, and while there may be more knowledgeable persons out there on some aspects, be it finance etc. , I always leave here with some more knowledge and a feel good feeling that reaffirms why I love this club… I love this club, whether they win trophies every year or not, because they face tremendous media bias, referee bias, all the while running with a 30000 seater stadium. They have upgraded, borne the financial meltdown without a sugar daddy, all the while playing the type of football that I admire, and I am sure ( even though they wont admit it) , makes then the envy of many a club worldwide…It has been a partnership I have thoroughly enjoyed, the good times, the bad times. I believe in the philosophy, the style and the method,and I am sure the results will come..
Vive La Arsenal…Joga Bonita
Hi Tony, Phil, Walter and the rest of the Untold Team … thanks again for your great blog.
I apologize for not commenting on this particular story, but I saw something today that really pissed me off.
Front page of the Times – a story on Liverpool’s impending buyout by the Chinese government. And a few paragraphs in – a statement that Arsenal are foreign-owned.
Later in the sports section there was a graphic showing us as majority owned by the US, with Kroenke as the owner.
I don’t know about the rest of you guys, but this really pisses me off – Kroenke is only one of the shareholders, he does not own us outright – and Arsenal is one of the few English-owned clubs (albeit with two majority foreign share-holders). Some might say these are technicalities, but surely we cannot be called a foreign-owned club ?
I’m not even English, but I am proud that the Arsenal is still an English-owned club – so to see an ill-researched article like this on the front page of a major newspaper has really made my blood boil.
Phil
“Usmanov isn’t trying to take over to burden the club with debt, he wants to hand over money to win trophies like Abramovich.”
Where did you hear this? Usmanov, out of all the major shareholders, is the one who has complained about not getting a dividend payment, so given that he wants to make money out of the club, I think it’s quite likely that he WOULD try a leveraged buyout.
He has never said he wants to “hand over” money, either. He was careful to talk (through his intermediaries) about money being “made available” which I think we know means “borrowed”.
In the US and in the 70/80s, LBOs became notorious thanks to the activities of some business men that came to be known as “corporate raiders”. T. Boone Pickens comes to mind.
The sole objective of corporate raiders was to do an LBO, break the company into pieces and sell the pieces off. Most often, the pieces were worth more than the whole. Workers who had invested years of their lives, their pension reserves and the traditions /employment of the usually small communities that the companies were located suffered terribly…but the corporate raider smiled happily to the bank.
In some cases, some unintended good came out of the fire sales, some of the parts prospered in the hands of their new owners and, guess what, the corporate raiders pointed to this unintended good – wrenched out of the pain and suffering they visited on the corporate entities as justification for their bare-faced, money grabbing activities.
LBOs took a bad name in my mind from then on and, I’m sorry, going by the havoc it has done in ManU and Liverpool, your piece didn’t convince me that it bears more good than bad in its wake.
I learnt something though: I never knew that LBO is “buy-to-let” (which I understand and which makes good business sense) writ large. I never knew that the LBO proponents were supposed to pay for the interest on their loans from the only the corporate profits.
However, with this insight come a better understanding of why LBOs are easily abused. While the buy-to-let investor is hardly able to tamper with his house without permits etc or sell off parts of it or redefine the use of parts of it with permits etc. The fact of ownership of a company bestows a general right that enables the LBO owner to blur the lines so that he can earn personal profits whether or not the company is doing well in the market. This is probably why you can see things like the “management fee” and asset splitting (e.g. ManU’s Old Trafford no longer owned by MUFC or something like that).
Taking the buy-to-rent analogy to its logical conclusion, is it possible to debar the LBO owner from making any profit whatsoever from the company via accounting fiddles and asset re-arrangements/sales and only via validated higher profits arising from better management and prevailing healthier business environment or sales of the company’s shares at higher prices than it was acquired. More simply, is it possible to have a supervising authority that scrutinizes the activities of LBO owners strictly to ensure they are not engaging in corporate larceny?
Unless this is possible, I doubt I will ever see the greater good that LBOs are capable of delivering over the terrible pain and suffering they bring to those who love and have invested their lives, literally and figuratively on the good of the raided company.
Arsenal fc is the most attractive option for an LBO in football we are the only the premiership club turning a significent profit that is not dependent on player sales. Who would ever have thought UEFA would have a good idea that actually benefeits football. The model Arsenal have followed cant be replicated everywhere as we have beeen lucky to have a very understanding board/shareholders an economic and footballing genius for a manager and smart officials at the club which supported the vision
As far as I know the no dividend thing has been there for maybe five years.
I wouldn’t have such a naieve few of the shareholders though. They are obviously thinking only about their own profits, and that includes the legacy members. Danny Fiszman made millions in profit selling his shares, similalry Lady Nina shares have much more value than her husband ever expected them to. If these people really cared about the club they would donate the shares to the AST or something similar.
Fungunner: I’d not heard of him complaining about that, I’d be interested to read the story if you had a link? Most likely he’s complaining at the lack of a dividend payment when he wanted a share issue to raise funds if the debt was such a burden that the board weren’t taking dividends.
But my impression on the direction Usmanov wants to go stems from the quotes from David Dein on how we need to spend like Chelsea to compete. Remember Dein subsequently sold his shares to a Usmanov-backed holding company.
Femdee: I did argue at the end that they aren’t in any way appropriate for a football club. What I was trying to do in this article was to explain how they can work in the normal business world, but I do point out they are inherently risky. At no point do I back LBOs as a solid business model, I more point out that there are both positives and negatives.
As I mentioned in the article, the Uefa financial proposals make dividend payments a “relevant expense” so i you take too much money out, then your club won’t get into Europe. That’s not the whole story though, and I do go on to give a couple of other methods of dealing with this blight.
AndyE: Any profit made on shares is as a result of their value rising, and it is the board who contributes to that rise through running the club well. If they sell out, they deserve to be rewarded for the job they’re doing. The AST is a nice idea, but ultimately naive : we expect them to sacrifice their income for the good of the club, but do we pay some of our own money to AST to help them buy shares? It’s a big ask to expect someone to do something that we ourselves don’t do, and I strongly believe people should be remunerated for the job they have done.
LBOs work in a buy-to-let home because as a landlord you only really need to stick your hand in your pocket once in a while to replace some curtains or a washing machine and thus doesn’t really take anything out of the profit used to pay down the original payment+interest. LBOs don’t exactly work when you need to spend £100s of millions to keep the place you bought from falling into disripute.