Every two years, Forbes – the US business magazine, produces a list of the top 20 most valuable football clubs. Alongside the valuation there is a limited analysis of the overall trend and some specifics relating to notable movements among individual clubs.

The valuations, revenues and operating income are thus:

What is interesting is Forbes’ conclusions. Something which I will challenge further into the article.

The headline conclusion is that valuations are up 30% over the last two years. Why on the back of a pandemic is this possible? Why, when revenues have fallen and the prospects for future income growth in a post pandemic world have reduced significantly? Forbes believe this is a reflection of greater investor interest due to the “untapped potential in the sports’ global appeal”.

Most clubs are currently insulated against market conditions with regards to their commercial and broadcasting incomes, tied into multi-year deals, many of which were signed in the boom period prior to the arrival of the pandemic. As those deals mature and need replacing, it will be interesting to see (i) which partners wish to continue with sports (particularly football) marketing/sponsorship and (ii) how they value future relationships financially.

In terms of broadcasting revenues there is clear evidence that the market for broadcasting rights has peaked in the Premier League and the European Leagues. The Premier League has postponed its rights’ auction for the 2022-25 cycle from January of this year to an, as yet, undetermined date later this year. Domestic rights which peaked in the 2015-18 cycle fell by £500 million and are expected to fall further. International rights were expected to make good the shortfall once more, but as has been witnessed across Europe has significant challenges. The political disruption to the Chinese rights’ market in particular, is concerning.

Earlier in the year Deloitte published their “Football Money League”, an annual report into the finances of European football clubs. Interestingly, they publish the number of social media followers for each club. Thus it is possible to plot that figure against commercial revenues. It is certainly the case that most clubs are yet to crack the monetarisation of their international fan bases and social media followers. (x axis number of followers, y axis commercial revenue in € millions)

Whilst it is clear that the largest clubs have the greatest number of followers and have the highest commercial revenues, I must challenge the view that football club valuations have risen on the back of the potential for future revenue increases arising from football’s growth in popularity. Some clubs will see increases in revenue, but not equally for reasons I will explain.

Notwithstanding some clubs are better run, better capitalised, recruit well, achieve success on the pitch, are members of successful leagues etc, if the principal factor was growth in global popularity, then why the disparity between say PSG (an increase in value of 129%), Borussia Dortmund (112%) Liverpool (88%) and West Ham United (reduction of 18%), AS Roma (-12%) and AC Milan (-4%)?

Individual factors influence club valuations. Take Everton for example. In the two years between the reports and prior to planning permission re Bramley-Moore, Everton’s value according to Forbes has increased 38% to US$ 658 million. Yet in those two years, Everton suffered record losses, something that will continue for some time. The rise in Everton’s valuation according to the Forbes methodology is due to two factors – the capital injections (debt and equity) provided by Farhad Moshiri and the inclusion of the one off £30 million naming rights option payment by USM in respect of the proposed Bramley-Moore stadium, booked as income.

Yet, if one uses the Markham methodology of valuing clubs – a well established albeit basic formula created by Tom Markham, Everton’s value falls from £330 million in 2018 to £70.9 million as of June 2020 (US$ 455 million to US$ 98 million) . My own variant of the Markham methodology sees the fall in value from £254 million to £169.2 million (US$350 million to US$234 million).

The preferred and promoted methodology of valuing a football club, indeed any business, depends whether or not you a seller of equity (i.e. selling equity to external investors to raise capital) or a buyer of equity (issuing more equity purchased by oneself)

The money men of this world will therefore have numerous models to use in valuing clubs. It is thought that the Liverpool FC element of FSG’s part sale of equity to Redbird capital was calculated (among other factors) on the basis of an income multiple. Redbird paid 6.4 times FSG’s income for their stake. That’s roughly in line with multiples of other US sporting franchises – how much of perceived prospects of future income growth is factored in is difficult to say

Growth in valuation strategy

So, cutting to the quick, how are stretched valuations (based on the prospects of future income growth) squared against current fundamentals and a post pandemic global economy? A critical strategy if you are a seller of equity – looking to attract other investors’ capital.

There are two principal factors in projecting growth in your business in revenue terms. One is that the industry is growing, more customers (fans), more sponsorship income and greater broadcasting revenues – the equivalent of price increases, and/or (ii) as a business you increase your market share, i.e. whatever the size of the pie is, you receive a bigger piece usually at the expense of all those wishing to eat the same pie too.

As I have described above and elsewhere, I do not see a significant increase in the size of the pie in the near to mid-term (ignoring any structural changes to the footballing industry)

The second element – increasing your share of the pie, is, in my opinion, the factor that is most driving the increase in valuations (and something that can’t be reflected upon with models that use historic data for valuation purposes).

Investors are betting that the major participants will receive a greater slice of the pie in coming years. If the pie happens to grow then even better, but for a small select few, the prospect of a bigger slice drives forward their valuations.

Fenway Sports Group, alongside the Glazers at Manchester United were high profile advocates of “Project Big Picture” an outrageous attempt at a power and revenue grab across the Premier League. Simultaneously, alongside other large clubs, the second element of their income streams, the Champions League is similarly poised for significant reform (the Swiss model for example) or indeed replacement with the European Super league.

It is no coincidence that those clubs that require external capital to fund current losses or future investment are those most vocal in calling for a larger slice of the existing pie or indeed a totally new one. It is the classic behaviour before issuing and selling equity, to sell the idea of a bigger market (in total) or at least a bigger market share of the existing market in the future. The higher the valuation of the club or business, the less expensive it is for existing owners to bring in new investors.

The reverse is also true. To fund a business owned or controlled by one or a single group of investors, fund initial working capital requirements with debt, then convert that debt to equity at a convenient time, usually at a significant discount to earlier (perhaps initial) equity purchases. Then you participate on the upside as your business develops, or in the case of football you increase income through success on the pitch, European qualification etc. Clearly a business following such a strategy has to have a shareholder prepared to carry the cost without external assistance.

Investor confidence

The Forbes data demonstrates that investor confidence backs the idea of the bigger clubs increasing revenues in future years. As I suggest, due to the macro-economic picture, that’s unlikely to be achieved by just maintaining the status quo. It can only arise from (i) significant improved performance – difficult for those already at the top of the game) (ii) guarantees that their dominant position provides them with a great slice of the pie in the future or (iii) baking a brand new pie with limited participants sharing higher revenues amongst fewer operators.

The last two options, in my opinion, is what is driving investor interest particularly from the US private equity investors, and thus valuations – the prospects of a few clubs becoming significantly higher revenue generators. That’s good for a small number of existing shareholders but not good for the game as a whole.

The challenge for the likes of Everton is either how to stop those above from achieving even greater domination (as described) or how to join them. Investors (based on valuations) believe the chances of either appear slim.