There is a saying: “If you’re £1m in debt, you’re in trouble. If you’re £100m in debt, your bank is in trouble.” In which case, both Arsenal and their Bond Holders, to whom Arsenal owe a total of £266m*, are in double trouble.
But can debt in a football club ever be a good thing? What about all these high profile fan revolts, Premier League clubs going into administration and UEFA deeming it necessary to introduce Financial Fair Play regulations to safeguard the future of the game?
Well, in Arsenal’s case, the answer is “Yes”. Of course, having ‘good debt’ hasn’t brought them a trophy in the last five years – and it didn’t help in the game at home to West Brom, but it is worth contrasting Arsenal’s situation with the other high-profile debt stories in football.
Firstly, debt is not a bad thing, per se. In fact, it is a very good thing. How many people could own a house if they had to pay for it all in cash? Similarly, very few businesses have the cash they need to build a new factory, buy equipment, finance international expansion or conduct vital R&D. They rely on debt to finance these activities – debt is the engine of growth. In Arsenal’s case, they needed the debt to finance the new stadium. No debt, no new stadium.
Of course, there are two very important conditions that need to be met. Firstly, the debt must be used to finance an activity which generates returns over and above the total cost of that debt. Secondly, the cash flow from the new activity needs to be secure, predictable and able to service the interest payments.
Arsenal. In Arsenal’s case both conditions are met. They have used the debt to build a new stadium which has significantly increased their revenues and profits. To put it into context, the 9,000 premium seats at the Emirates generate more revenue per match than all 38,000 seats at Highbury did. The remaining 51,000 seats at the Emirates are all upside.
Matchday revenue (the gate receipts taken by the stadium) was £93m and the operating costs of the stadium were £55m – meaning that the stadium generated a profit of £38m. Total interest payments were £20.2m, providing interest coverage of nearly two times.
These ‘Stadium Profits’ are secure and predictable. As long as Arsenal play roughly the same number of games per year and have roughly the same attendance, then there will never be a problem paying the interest. The Stadium pays for itself and doesn’t rely on subsidies from broadcast revenue, commercial revenue or player trading surpluses. It is the very definition of a good investment.
Good debt: Arsenal borrowed money to build a stadium which has increased the clubs value. The increased cash flow generated by the asset can comfortably finance the debt
Manchester United. The debt was not taken out in order to finance an activity that would increase the club’s value – it was taken out to buy the club itself. So there is no reason to think that United’s financial performance is any better as a result of taking out the debt (in other words, the debt and the interest payments are pointless). Secondly, the level of their debt (over £700m) is such that it cannot be financed by matchday profits alone – they have to tap into broadcast revenues, commercial income and player trading surpluses. Last year, without the profits from the sale of Cristiano Ronaldo for £80m, they would have made a loss. And that is a problem.
Pointless Debt: Debt was not used to build or acquire an asset that increases Manchester United’s value. Debt re-payments cannot be met by a sustainable and predictable source of cash flow
Liverpool: This is a very similar situation to Manchester United. Again, the £350m of debt wasn’t used to finance growth but simply to buy the club (another case of pointless debt and interest payments). Last year they didn’t generate enough profit from all their activities to cover their interest payments and recorded losses of £55m. Big problem.
Leeds United and Portsmouth: Both of these clubs used debt to finance the purchase of players in the form of transfer fees and wages. It is pretty easy to see why this was a disastrous policy. Players don’t directly generate increased cash flow and their value is unpredictable and variable. If the new players had caused a significant improvement in the team’s performance which had led to increased revenue and the value of the players themselves had increased, then the gamble might have paid off. But it took very little for the house of cards to come tumbling down.
Chelsea and Manchester City: These two clubs also borrowed money to finance the purchase of players. Of course, this money was borrowed from a Sugar Daddy rather than a bank and it is unlikely that any interest will be paid, let alone the principal. Who knows what the long term consequences of this ‘Financial Doping’ model will be, but it is far from certain that it will end well.
In summary, Arsenal’s finances since they moved to the Emirates aren’t the problem. The problem is that they haven’t added to their trophy cabinet.
* Arsenal also have £127.6m in cash, making their Net Debt the widely reported £138.4m. Incidentally, a further benefit of debt is that interest payments are tax deductible – so 28% (the corporation tax rate) of any interest payment is re-captured in the form of tax savings. This is one of the reasons why Arsenal are in no hurry to use their surplus cash to pay down their debt.
By Carsten Thode on September 28th, 2010
Tags: Barclays Premier League, Default, Football, Football Sponsorship, Manchester United, Naming Rights
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