Newcastle: What’s The Colour of Money?

Newcastle: What’s the colour of money?

Newcastle United are officially up for sale.

http://www.espn.co.uk/football/english-premier-league/23/blog/post/3236029/mike-ashley-puts-newcastle-up-for-sale-but-can-club-be-great-again.

That’s not significantly different from the position over the last few months, where they were unofficially up for sale.

There are many interested parties, but the most important one is Mike Ashley, as the price that he’s prepared to accept that will determine whether recent noises from the club are to be taken seriously.

Stories abound of prices being asked of about £350-400 million. Which begs the question, how do you value a football club? We’ve looked at a variety of methods, to try to determine a range of prices that might be acceptable to both Ashley and a buyer.

We’re not Newcastle fans, (love the city, love Viz and a Saturday night out in the Bigg Market should be on everyone’s bucket list before they die, and indeed, could coincide with the night you die), so we are not going to praise Ashley, neither will we set out to bury him either.

Method 1: Balance sheet values

A balance sheet shows three things, assets (stuff owned by the club), liabilities (what is owes to third parties, such as suppliers, other clubs, tax, loans) and equity (the amount of invested capital from owners, plus reinvested profits).

The balance sheet is based on a simple equation

Assets minus liabilities = Equity

A look at the most recent Newcastle United Limited balance sheet shows the following:

It would therefore appear that Ashley’s equity investment in NUFC is just under £31m at 30 June 2016. With football clubs, (and to be fair, many other businesses) these figures are to a large extent meaningless, and often blurred.

The sum that Newcastle received for the shares when they were issued is £75.599 mill (£6.655m share capital plus £68.944m share premium). This is not the amount that Ashley paid when he took over the club in 2007, the quoted figure being £134.4 million.

Assets are measured by accountants at cost, less depreciation (for wear and tear of tangible assets such as the stadium) or amortisation (which is deducted from player signings over the life of the contract he has signed).

Cost is, as any football fan knows, are not a barometer of value (Angel Di Maria cost Manchester United £60 million and stank out Old Trafford for a year, Scholes, Butt, Giggs, Beckham and the Chuckle Brothers cost nothing, only the former appeared in the balance sheet).

Furthermore, the balance sheet is based on past costs, so ignores the wealth likely to arrive in future years from enhanced broadcasting and commercial deals, and fan loyalty, which brings in money year in year out to the club.

A closer look at the balance sheet shows that as well as the face value of Ashley’s equity investment, he is also owed £129 million in loans at 30 June 2016.

Ashley lent the club a further £15 million in December 2016 via one of his many tentacles, taking the total sum lent to £144 million.

If Ashley is going to get his money back, then he would need £134 million for the shares, and his loan of £144 million repaid too, a total of £278 million.

But for the reasons listed above, this is a case of getting his money back rather than any meaningful value of the club.

Method 2: Comparable valuation methods

If you are buying a house, one way to work out how much to pay is to look at recent prices for other houses in the same street, and use that as a starting point.

If the houses are different sizes, then a metric such as cost per square foot of house space, and use that to produce an initial figure.

Football clubs are different in terms of fanbase, commercial partners and so on, but could be compared in terms of income, profitability and so on.

The most recent Premier League deals have been in respect of Southampton, where an 80% share was sold for £210 million in August 2017, valuing the whole club at £262 million. Everton were sold to Farhad Moshiri in 2016, and he paid £87.5 million for a 49.9% share, valuing the club at £175 million.

The premium in respect of Southampton may seem surprising, but the club has a relatively new stadium, compared to Everton’s charismatic Goodison Park, which is in need of replacement. Everton also owed lenders over £57 million, compared to the Saints debts of £31 million.

Income multiples

Comparing those teams to Newcastle shows that they had very similar income in 2016 of between £121-125 million. Newcastle had higher gate receipts and commercial income (which may surprise many of Ashley’s detractors), but its TV income was lower due to the club being relegated.

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We could therefore work out the price of Everton and Southampton as a multiple of total income.

This gives a revenue multiple of 2.11 for Southampton (£262m sale price divided by income of £124.3 million) and 1.44 for Everton (£175m/121.5m).

On this basis, Newcastle, with revenue of £125.6 million, are priced between £181-£265million. My gut reaction is to go at the top end of that range given that the Southampton deal is more recent.

With these calculations there is an elephant in the room, which is relegation. Newcastle have been relegated twice in the last ten years. Relegation brings an immediate loss of about £50 million in terms of TV income, and can make a nonsense of asking prices. Randy Lerner of Aston Villa was touting the club for sale in 2015 for £150-200million, but accepted £60 million when the club was relegated to the Championship a year later.

The above figures are distorted to a degree by TV income, which can vary considerably from season to season, as each position in the league is worth an extra £1.9million. So finishing five places up the table from one season to the next is worth £9.5 million.

If we strip out TV income, then the income of the three clubs is

Newcastle £53.1 million
Southampton £33.9 million
Everton £39.0 million

Southampton were therefore sold for a non-TV multiple of 7.72 (262m/33.9) and Everton 4.49 (175m/39).

Applying these metrics to Newcastle gives a price range of £238-£410 million.

Profit multiples

Income multiples are flawed in many respects, especially as it ignores the ability of the business to control costs, which in the case of football clubs, is mainly wages and player transfer amortisation (transfer fees paid spread over the life of the player contract).

Profits are therefore seen as a better measure at valuing a club when using multiples.

Mike Ashley has proved to be very good at controlling wage costs for Newcastle. Wages only increased by 6.7% between 2008 and 2016, compared to a rise of 26% in income. That may be linked to the struggle the team has had to maintain competitiveness during that period, as Everton’s wages grew by 89%, Arsenal 93%, Manchester United 93%, Liverpool 132% and Manchester City 264%

This period has coincided with Ashley taking over a loss-making club (loss after tax £33 million in 2007) and converting it to a profitable one (profits after tax of £100 million since 2011).

There then comes a problem. Which profit should we use for a football club?

In theory we could use either:

Operating profit (profit before interest and tax)

EBIT (operating profit after stripping out non-recurring costs, such as sacking managers)

EBITA (EBIT adjusted for amortisation of player registration fees)

EBITDA (Same as above but also adjust for deprecation)

In practice negotiators look at all of the above when trying to determine a price range.

If we apply those relationships to the Southampton and Everton deals (if the profit figure is a negative them then ignore the figures) we end up with a value of somewhere between £126-968 million, which is of little help.

Sale price Op Profit EBIT EBITA EBITDA
Everton 175.0 (20.6) (9.3) 5.3 7.1
Multiple (8.5) (18.8) 33.1 24.6
Southampton 262.0 8.6 (16.4) 14.6 17.3
Multiple 30.6 (16.0) 17.9 15.1
Newcastle 4.1 0.9 29.2 32.0
£’m £’m £’m £’m
Using Everton multiples n/a n/a 967.4 784.7
Using Southampton multiples 126.0 n/a 523.9 483.4

Discounted cash flows

This method involves calculating the cash that Newcastle would generate in future years, and working out how much you would be prepared to pay now for that cash flow.

There are two big problems.

Cash flows for football clubs are very erratic, they are significantly influenced by relegation, position in the league, and sales of players.

Secondly, which interest figure should we use to work out today’s value of future cash flows? This is a similar procedure to determining a credit score when lending money, but is as much art as science. It is highly unlikely that the Manchester clubs, or the big London clubs would be relegated, so they would have a better credit score than the likes of Newcastle, who have been relegated twice in the last ten years. Working out a precise figure is very difficult though.

For many clubs future cash flows may be negative (almost certainly the case for those in the Championship, where wages have exceeded income for the last three seasons).

Therefore a discounted cash flow approach is unlikely to work for a club, unless there is greater predictability of income.

Markham Multivariate Method

Dr Tom Markham, in his PhD thesis, came up with the following formula for a club valuation.

If we plug the figures into Newcastle for 2016, it gives a valuation of £568.2 million. The method has a lot of merit, but assumes that the club continues to be a member of the Premier League. We have already seen that Ashley is good at wage control, and so the wage ratio % (wages as a proportion of income) for Newcastle is relatively low. This has a significant impact on the valuation, but also increases the likelihood of relegation.

If, for example, Newcastle’s wage control was 71% (the average of the non ‘Big 6’ clubs in the Premier League), and adjusting for Ashley’s loans to the club then the value would drop to £259 million.

This still looks an appropriate value for the club.  Any new owner wanting to make Newcastle competitive with the Big 6 and challenge for a place in Europe would have to increase the wage bill still further, and that would still give no guarantee of success on the pitch.

Summary

Trying to value a club is far more complex than for many other businesses, due to the volatility and unpredictability of the income and costs. What a club like Newcastle needs is not an investor who will use the above methods, but a sugar daddy who will transform the club in a similar way to Chelsea under Abramovic or Manchester City under Sheik Mansour. If anyone has the phone number of a bored billionaire, direct him to Sports Direct as quickly as possible.

However it is difficult to see anyone who will be willing to pay Ashley’s asking price. If he wants someone to fund player recruitment in January then the price needs to be right for any interested party to conduct due diligence. Recent HMRC raids and Ashley’s colourful public image won’t help him maximise the price, which is why a £260-280 million tag seems about right, based on the mid point of the above analysis. Add on a premium for the potential growth and you are looking at about £300 million at a push.

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