Jack Welch, the former CEO and Chairman of General Electric (GE), had a favourite saying. “If I had to run a company on three measures, they would be customer satisfaction, employee satisfaction and cash flow. Cash flow is the pulse, the vital sign of the company.”
If cash flow is so important, then what is it?
Cash flow is the net amount of cash being transferred into and out of a business. At the most fundamental level, the value of a company to shareholders is based on its ability to generate positive cash flows. For football fans it is important as it signifies the club’s ability to buy and sell players, build a squad and pay competitive wages over the long term. The list of football clubs (and fans) that suffered due to failing cash flow is long and extensive – it is what destroys clubs – Leeds, Portsmouth, Wigan, Bolton, Bury, Newport County to name but a few.
Cash flow is calculated by looking at 3 principal areas, operating cash flow, from investing activities and finally from financing activities.
The most successful clubs (in normal times) generate cash from their normal operations, i.e. they generate more cash from income (matchday, broadcasting, commercial and sponsorship) than they spend on expenses (player wages and operating costs).
Clubs also generate cash from investing activities. For football clubs this means the purchase and disposal of player registrations. For many clubs, player trading is a fundamental part of their business and can (especially in inflationary times) generate significant cash flows for further investment in talent. The reverse is also true, in deflationary times or perhaps through poor player acquisitions, player trading can reduce cash flow. For example, a raft of poor purchases that become difficult to sell plus the need to replace those purchases to be competitive on the field has a massive impact on cash flow. Everton, in particular, are a case in point with a series of poor player acquisitions either sold at a cash loss or in the case of not being able to sell having considerable wage costs to incur on non productive assets. As Evertonians are well aware, this is compounded by the need to acquire replacements.
If operations or investing activities do not generate positive cash flow what can clubs do? In the first instance if they have built up cash reserves in the past (Arsenal are the prime example of a club with significant cash reserves) those reserves can be used as a buffer between costs and income. Most clubs are not in that position and have to look to alternatives.
In the first instance debt is used. Even in pre-Covid times many clubs used future income as a means of generating cash through borrowing from banks (in the case of the largest clubs) and other specialist lenders (in the case of smaller clubs or those with poor credit profiles). Even in the income rich Premier League, many clubs have used future season ticket revenues and/or future broadcasting awards as security against short term debt usually repayable at the end of each season/financial year, only to be re-instated immediately after. This is both expensive in terms of interest payments and can also be inefficient in terms of the fees paid to arrange and administer these arrangements.
Finally there is shareholder funding. This is where the owner or owners provide funding for the club either through interest bearing debt with a defined term, non interest bearing and non term defined debt and finally through the issue of more shares to some shareholders (a placement) or all shareholders or indeed new shareholders (an issue).
Whilst debt and shareholding funding is very normal business practice, in football if the club is not profitable or is losing money outside of fairly strict limits, then both UEFA and the Premier League, then this form of funding is not sufficient alone to pass the financial regulatory tests (in normal times).
Before looking specifically at Everton, it should be noted that Covid-19 above all else impacts cash flow with the almost complete absence of matchday income, the potential for a reduction in sponsorship and broadcasting revenues plus limited opportunities for player trading profits.
Now, looking at Everton and specifically the 4 complete financial years that Moshiri has been the major, then majority shareholder:
|Cash Flow Analysis – Moshiri 4 complete years £’000s||30-Jun-20||30-Jun-19||31-May-18||31-May-17||Total|
|Net cash flows from operating activities|
|Operating cash flows before movement in working capital||(42,781)||(23,211)||(8,633)||27,453||(47,172)|
|Net cash generated from/(used in) op’s||11,059||(9,825)||(6,821)||22,716||17,129|
|Cash flows from investing activities|
|Proceeds from disposal player registrations||85,751||67,098||52,756||30,823||236,248|
|Proceeds from sale of fixed assets||40||7||47|
|Purchase of player registrations||(128,395)||(134,796)||(155,828)||(70,554)||(489,573)|
|Purchase of fixed assets||(7,638)||(1,926)||(7,920)||(5,737)||(33,221)|
|Shareholder loans treated as equity||49,999||149,250||44,775||104,475||348,499|
|Net cash flows used in investing activities||(241)||69,666||(66,381)||59,018||62,062|
|Cash flows from financing activities|
|Repayment of borrowings||(18,750)||(75,500)||(57,520)||(151,770)|
|Repayments finance lease||(20)||(34)||(54)|
|Net cash flows from financing activities||18,157||(41,887)||73,041||(69,361)||(20,050)|
|Cash at bank at beginning of period||27,429||9,475||9,635||(2,737)|
|Cash at bank at end of period||56,404||27,429||9,475||9,635|
Let’s look at the 3 main contributors (or not) to cash flow.
Firstly, from normal operations over the 4 years ( June 2016 – end June 2020) normal operations say a negative cashflow of £47.172 million, much of which is incurred in 2019/20.
However, as companies try to do, by increasing creditors (a person or company owed money to) over and above any increase in debtors (a person or company that owes us money) it is possible to turn cash flow positive. So for example, in 2019/20 Everton generated net cash of £11 million by increasing creditors (in particular HMRC which increased from £16 million in 2018/19 to £41 million in 2019/20 – a payment which is due before 30June 2021)
As mentioned earlier the buying and selling of players has a huge impact on cash flow. As is well documented, in the last four years (and in 2020/21) Everton have spent significant sums on players seeking a squad with sufficient playing quality to finish high in the Premier League and reap the financial rewards of European qualification. Sadly, we know this strategy hasn’t been successful to date. As a result in cash terms, player acquisitions to June 2020 have cost the club a staggering £489 million (plus another £70 plus million from last summer) whilst we have raised £236 million from player sales. Add in the purchase of fixed assets and over 4 years (before Moshiri’s loans) a negative cashflow of £286 million from investing opportunities. Now not all this has been wasted as clearly we have acquired a number of players worth more than we acquired them for, but this is an analysis of cash spent and received from investing activities.
To fund such acquisitions, Moshiri to June 2020 has provided a total of £348.5 million in non interest bearing and non term specific loans. Because of the lack of repayment terms they are viewed as equity, but as things stand they remain as loans. Without these loans we could not have been so active in the transfer market (nor engaged in other investments Finch Farm, Goodison and the preparation for Bramley-Moore)
To assist cash flow over and beyond operating and investing activities, Everton have used short term debt. The net cash flow of loans from ICBC (now wholly repaid), Santander, Metro bank and Rights and Media Funding is negative over the period by an amount which is only slightly greater than the interest cost. Again though without continued and continuing use of such facilities, Everton could not operate without higher cash flow contributions from investor or operation contributions. They form a critical part of our day to day financing.
As a result, to a degree compounded by Covid-19, Everton could not have operated in the manner that they have without the financial commitment of the majority shareholder.
The bottom line of the above table shows cash in the bank increasing by some £46 million over the 4 year period but to a large extent that is an illusion – it’s funded by the shareholder loans of £348.5 million and an increase in the net creditor/debtor position of the company.
The question for Moshiri is (i) how long is he prepared to fund losses (ii) how long will the regulators allow such losses and (iii) how does he restructure the debt position of the club to provide reassurance to potential stadium lenders and also make his own position more secure with the club.
His commitment to the playing side and the acquisition of Ancelotti suggests he still sees the potential of European football to help re-balance the finances in the years to come (which will also give relief for point (ii) in the future).
The remaining question to be answered is point (iii).
Potential placement of new shares
As has been seen above, the club has survived by cash injections from player sales, increased debt, an increase in creditors and critically the continued financial support of Farhad Moshiri.
At the time of publication of the most recent accounts the club released information about a proposed placement of up to £250 million worth of new shares. The placement would be supported in its entirety by Farhad Moshiri through his company Blue Heaven Holdings. It is worth therefore looking at how exactly this is achieved and the impact it has on existing shareholders.
What a company can and cannot do and the protections afforded to shareholders are covered by statute and the provisions of a company’s articles of association. In the case of Everton both the Companies Act 1985 and the Companies Act 2006 apply, as do the most recent articles of association (amended in 2008).
Firstly, the right of the company (The Everton Football Club Company Limited) to issue more shares. (An issue of shares is when a company creates new shares which it sells to shareholders as a means of raising cash) The right to issue more shares in laid out in Section 8 of the articles.
Using the above, an ordinary resolution of a general meeting (requiring greater than 50% approval) is sufficient to increase the share capital. However, this would allow all shareholders to participate in the offer of new shares through existing pre-emption rights (the rights of shareholders to acquire new shares in line with their existing holding).
The plan though is to make a placement of shares to which only Moshiri will participate. How is that achieved? It can only be achieved through a special resolution (requiring greater than 75% approval) denying all other shareholders their pre-emption rights. At the time the general meeting is called, a written statement provided by the directors must be included with the resolution. The written statement supporting the special resolution must include the following:
- The reasons for making the recommendation
- The amount to be paid to the company in respect of the allotment
- The directors’ justification of that amount.
With Blue Heaven Holdings in possession of 77.23% of the clubs shares, Moshiri does not need to call upon additional shareholder support to pass the required special resolution. Thus he can (after following due process) with the support of his directors be the sole recipient of new shares.
From the briefings by the club the share placement would be up to £250 million. Of that £250 million, £100 million would be fresh investment – including the £50 million committed in November 2020, a further £50 million injection and a capitalisation of existing shareholder debt up to the value of £150 million.
The capitalisation of some of the existing shareholder loans strengthens the balance sheet (necessary for the external stadium financing) and strengthens Moshiri’s position with the club.
It is likely that the new shares be offered at £3,000 per share. If the proposed maximum of £250 million of shares were issued this would have the following affect:
|Existing shareholding||%||Shares issued at £3,000||New shareholding||%|
|Blue Heaven Holdings||27,031||77.23||83,333||110,364||93.27|
What would be the impact of Moshiri passing through the 90% shareholding threshold?
Firstly, minority shareholders lose the (possibly mute) authority to ensure a poll is undertaken to pass resolutions at general meetings. At above 90%, Moshiri can override that requirement. Secondly, and perhaps more importantly, if Moshiri was to make an offer for the whole company then the minority shareholders have no option but to sell their shares. It is important to stress two points:
- By virtue of the placement (as described above) he is under no obligation to acquire the minority shareholdings
- it should be said that Moshiri has always stated it was his intention to allow minority shareholders to retain their shareholding. Obviously if Moshiri was to sell the club at some point in the future, there is no guarantee that that undertaking would be honoured by a new owner.
Further information will be provided by the club in due course. What is clear from all the above is the extent to which Moshiri has committed himself to the club financially. What is not clear is whether the money has been spent wisely or whether the board and the executive have the necessary skills to turn around the operating and investing performance of the club.
In the meantime Moshiri confirms a commitment of £350 million already received, a further £50 million committed in November and an additional £50 million at a yet to be determined date.
All this and we haven’t even spoken about what he will have to commit to Bramley-Moore!