It's a Dodgy Old Game: Debt versus Equity

I enjoyed the Sunday Times article yesterday on the parlous state of the finances of Premier League football clubs. While the Sunday Times business section can regularly veer into sensationalism, the Premier League continues to reflect a truth that is stranger than any fiction.

http://business.timesonline.co.uk/tol/business/industry_sectors/leisure/article6991053.ece

The article, subtitled ‘How Manchester United became a piggy bank for its American owners’, confronted head on United’s attempts to restructure its financing (total debt of £700m). United are not alone. Liverpool are in a similar boat (net debt of £300m), with Chelsea and Manchester City’s owners having recently swapped their loans for equity stakes to stay on the right side of football’s traditionally impotent rule makers.

There is a certain irony of course that the Sunday Times is a Murdoch business – the same parent company that has funded the Premier League gravy train via Sky and some core international TV rights deals. I recall leading part of a due diligence process for Newcastle United some 12 years ago now. Even then, player salary levels were a significant, limiting concern for future value of cash flows. Now this has become a concern for current profitability.

It is widely expected that one Premier League club will default on its financials obligations this season. Hot favourite is Portsmouth. It is extraordinary to think that the England goalkeeper cannot get any games for his club in a World Cup year because that club is scared of triggering a clause in his contract which will commit them to paying another year of his salary. In particular when you think they are bottom of the Premier League and leaking goals.

The hard reality is the business model for professional football – where salary levels are typically 65% plus of total revenue and net profitability is marginal or non existent – simply cannot sustain that level of debt. It might survive it in the short term, but it cannot sustain it or thrive on it.

This brings an interesting reflection for those of us who work in professional services businesses. There are not many businesses in our sector where costs of our ‘talent’ are less than 65% of our total revenues. It is impossible for the average professional services business to make a debt versus equity swap on a week’s notice should things get a bit sticky. I know many who would envy Chelsea’s agility!

Many in our market continue to struggle. This will continue to be the case as demand remains flat, in particular if interest rates rise. It has been interesting to see the increasing number of clients who request our full company accounts when we are pitching for work – and rightly so. Several suppliers in our market have run the debt gauntlet to capitalise on early to mid noughties growth – developing their own software, buying competitors and so on. Any client would want to be sure their 2010 suppliers can continue to fulfil their obligations without needing to do the equivalent of dropping their England regulars.