Going to attempt the impossible here. Make an article on the valuation methods of football clubs interesting. It’s good background before looking at the value of Moshiri’s partial acquisition of Everton.
I should say right at the beginning that in the real world the process and price of buying and selling a football club is no different from any other business transaction, it’s largely down to the respective skills of the seller to inflate the price, and the buyer to reduce it as much as possible. The ideal transaction is where the buyer feels he or she has paid a little less than expected, and the seller believes he or she has received a little more…
However, with football now being a huge multi-billion dollar (Pound Sterling) global sport attracting institutional investors, sovereign funds, oligarchs and other assorted billionaires there has to be some valuation model by which participants can at least on paper justify to themselves and their stakeholders the price paid for acquiring a football club.
There are of course, many methods of valuing businesses, including the traditional staples of the corporate finance world, discounted cash flow models, income multiples, market capitalisation (for quoted companies) and for failing businesses the administration/liquidation valuation.
There are also specific valuation methods developed over time for the football industry. Forbes for example have developed a model which has been tinkered with over time, but have a history and database going back to 2004.
However as covered in depth by the then, plain Tom Markham none of these methods are particularly accurate when direct comparisons are made between theoretical valuations and the actual value of the transactions themselves.
As a result, Tom Markham created a valuation method of his own, one that has become recognised as perhaps the most reliable method to date. It’s an elegant solution that looks at revenues, the state of the balance sheet, profitability, stadium utilisation and importantly the ratio of wages to revenues.
Prior to the introduction of Financial Fair Play in European competitions and Short Term Cost Controls in the Premier League, wage inflation and debt were the greatest concerns of the footballing authorities. Football clubs were spending unsustainable amounts of money, frequently borrowing as against using capital, in a rush to succeed as media rights revenues exploded upwards. As a result, one of the key measures of the sustainability of a club was how much of its income did it spend on wages.
Today, this is much less of an issue than perhaps even 7 or 8 years ago, partially through regulating (restraining) wage growth but also the underlying profitability of the largest clubs, particularly in the cash rich Premier League.
Effect of huge cash inflows into the modern game
However, the huge amounts of cash swirling around what is still an industry with very few participants, and effectively a closed shop, brings about other issues. It creates inflation. Just as quantitative easing (QE) created asset inflation after the 2008 global crash (by design, I should add), in football, not by design, the huge flows of money into the game have had the same effect. The increase in media rights payments has effectively become football’s own version of QE, benefiting largely the bigger clubs with an asset base, high revenues and the ability to bid up the value of players.
As a result, wage growth is not the issue any longer, but the growth in transfer values most certainly is, and needs to be taken into consideration when valuing a football club in my opinion.
So, the question is does Markham’s method take into account this change in dynamics?
For those not familiar, the Markham Multivariate Method is as follows:
Simply the bigger the revenues, the larger the asset value, profitability, and how close to stadium capacity the attendances are the higher the valuation. The higher the wage ratio (wages/revenue) the lower the valuation.
I’d like to dare to suggest a number of modifications. I like the structure and the principle of the method but I don’t believe it accurately considers the effect of large transfers.
A quick couple of lines about transfers. Incoming transfers are not accounted for in the year of the transfer. They are charged over the period of the outstanding player contract. Simply a player bought for £40 million on a 4 year contract ends up being a charge to the profit and loss account of £10m a year. This is known as amortisation.
Thus, the real cost of a player can be viewed as his wages plus the level of amortisation charged to the P&L.
The Markham method uses net profit to provide an uplift to the revenue plus asset value side of the equation. Net profit is an interesting accounting creation which does not reflect the amount of cash a company generates as it takes into account other additional costs including taxation, and most relevant, amortisation and depreciation.
Please stay with me this is not as complex as it may appear.
EBITDA is short for earnings before interest, tax, depreciation and amortisation. It gives those interested a view of the operating cash generation within a business before non-operating costs are deducted to give a net profit figure.
It’s my belief, and I’m happy to be challenged on it, that the use of EBITDA in the Markham model, plus the adding of amortisation to the wage ratio gives greater accountability to the issue of seemingly ever-increasing transfer values. Why? Because it balances the operating profitability with the true cost of a club’s playing squad.
As a result, a club that has invested heavily in its playing squad sees a reduction in its value because amortisation is used in the final ratio. (total amortisation increases as total player transfer value rise). To balance that it sees an increase in valuation through the use of the EBITDA figure in the first part of the equation.
Increasing the value of lower spending clubs
Putting it another way, this method rewards clubs who spend less on transfers. Why should this be so? If two clubs have identical financial performance yet one spends twice as much in the transfer market, shouldn’t the lower spending club be worth more on an efficiency of capital argument?
I believe this also reflects what happens in other industries, where large Capex requirements reduce the value of businesses when bought and sold. In football, (other than stadium and infra-structure spending) the signing of new players is the Capex equivalent.
Impact of successful academies on club valuations
There’s also another impact which club owners should consider. A highly successful academy that provides players for the first team, reduces the need to acquire players from elsewhere. This reduces the amortisation cost to the business, seeing a corresponding increase in the value of the club.
Thus, the revised version of the Markham model, might look like this (revisions in italics):
Club Valuation =
(Revenue + Net Assets) x ((EBITDA + Revenue)/Revenue) x (Stadium utilisation %) /((Amortisation cost + wages)/revenue)
Testing of this model produces results similar to Markham but rewards lower transfer expenditure on players. If two clubs had similar revenues, profits, assets and paid similar wages, the club spending less in the transfer market has a higher valuation – that to me makes a lot of sense.
The effect of owner debt
The other variable in football club valuations can often be the effect of debt provided by the owner. Mike Ashley at Newcastle United for example is owed £129m by the club and understandably would like that sum returned if and when he sells. The £380m figure used in the press reflects both the Markham valuation and the outstanding debt. Yet the debt is an asset to the club and that’s reflected in its valuation. Therefore would a buyer effectively pay for the debt twice? In all probability no, so perhaps there’s scope to remove what is effectively private debt from the Net Assets?
Farhad Moshiri will face a similar issue assuming one day he and the other shareholders decide to sell to a new owner. Will his £80m debt be reflected in the equity price (thereby enhancing the value to other shareholders) or removed from the equity value and paid separately?
Apologies for such a nerdy article. There’s quite a bit more to add to the above which demonstrates for example, with my Everton hat on, the extra-ordinary value of Moshiri’s acquisition to date.
That’s for next time though….