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AST Analysis of Arsenal Holdings PLC Accounts For Year Ending May 31, 2012

Posted Monday 8th October 2012

For seven years now the AST has been writing on Arsenal's finances and, along with some other excellent commentators, believes it has contributed to supporters having a far greater grasp of the financial position of the club, its financial strategy and the often crazy world of football finance in which it operates. Arsenal fans are the people who directly or indirectly contribute the vast majority of revenues the club receives, so increased accountability and transparency is a welcome development.

The new stadium project has been one long transformational journey for the club, and with the associated property development business now coming to an end the way forward is becoming clearer. The front loading of the two large commercial contracts (and catering) secured revenues used to fund the non-debt portion of the £440m stadium project instead of shareholder equity. The Nike and Emirates deals are close to renewal, which, together with the increased new mega TV deals, should take Arsenal to annual football revenues of over £300m from 2014-15 onwards - albeit still behind Barcelona, Real Madrid, Manchester United and Bayern Munich.

Arsène Wenger and Ivan Gazidis have recently given straight answers to some key questions on the business plan, how the wage bill is managed and the emphasis the club is placing on UEFA's Financial Fair Play (FFP) regulations, which are designed to minimise the financial investment taking place at clubs that cannot organically generate such football revenues.

Below the AST makes comment on the recently released figures for the 12 months ended May 31, 2012, and asks what the results mean for the future direction of Arsenal Football Club as well as answering some key questions our members have put to us.

The current business model - the reality is the 'day-to-day' football business makes a loss

Arsenal's football operation, not including player trading and the property, is loss-making and for the last year generated a pre-tax loss, before profits from player sales, of £31m. This is because the club's relatively flat revenues of £235m have not kept pace with the growth in wages. Payroll inflation is outstripping revenue growth. The £36.6m annual profit announced by the club arises as a result of player trading and to a lesser extent the property. In recent years, these two activities have basically kept the club from needing significant equity injections from shareholders, as debt capacity is capped due to the security structure around the long-term stadium debt.

Football Revenues for 2011-12 were £235m (£225m previous year). Ticket revenue from gate receipts rose by just £2m to £95m (from one extra home game) despite the 6.5% increase in prices (less VAT). This is slightly less than might have been expected and we believe some loss of revenue is due to weaker executive box sales. Broadcast revenues were flat at £84.7m (£85.2m) with a higher English Premier League (EPL) place and UEFA Champions League (UCL) pool share counterbalanced by a fall in the value of the Euro flattening UCL revenues in GBP terms. Commercial and retail revenues were up 13% or £6.2m to £52.5m (£46.3m) which is disappointing given it included the first tour to Asia (£4m gross?) and the much heralded raft of new secondary sponsorship deals. The lack of commercial income has been Arsenal's 'Diaby heel' for many seasons as the Emirates and Nike deals were long- term and locked in, whilst competitors have regularly renewed and powered away. Arsenal now rank eighth in EPL commercial income whilst being top three in both gate receipts and broadcast income. United's commercial income of over £120m pa is still the benchmark.

Arsenal's football costs of £200m are split between wages (£143.4m, up from £124.4m) and 'other costs' (£56.7m vs £54.5m) and were up by a considerable £23m from the same period last year. Other costs include those associated with revenue streams, eg stadium management, the non-wage costs of football operations (scouting, medical, hotels, legal, etc), retail costs and all the other kitchen sinks! Whilst wages have increased by over £40m during the last four seasons these 'other costs' have thankfully remained flat at around the £55m level. There was a marginal change to other costs this year as the one-off £3m charged to the club to cover Stan Kroenke's takeover (represented in last year's figures) was more than replaced by the summer tour costs and other medical and squad-related travel costs.

Wages rose by a staggering £19m (15%), after a £14m increase the season before. We know that in the last year some 'step-up' agreements and new deals were agreed with players including Wilshere, Djourou, Vermaelen and Ramsey. The wages of the departing players will have been more than matched by the new player additions and we can see over the full year that the £10m of revenue improvements were more than spoken for by the extra expenditure on player wages. 

However, we also know that Arsenal avoid paying top level star wages and tend to reward squad players more highly than other clubs. We calculate Arsenal's recent "wage equality ratio" - WER - to be 5:1. We're defining WER as the multiple paid to the top earning player compared to the low-end squad members, with the WER at most top clubs being over 10. This is a policy the AST have questioned, especially when it seems to leave the club burdened with players they then struggle to move on. Interestingly Ivan Gazidis' view on changing this policy seems to be in flux too. In June at the AST Q&A he was quite clear we'd move gradually towards paying a higher WER (top wages to top players) but then reiterated the previous position in his media interviews in mid-September that this was not Arsène's way.

Arsenal are now comfortably the fourth largest wage spenders in English football behind Manchesters City and United and Chelsea. United have just published their wage spend for last year as being around £160m, which reflects willingness to pay star wages (RvP!), but compared to Spurs (£100m) and Newcastle (£60m), Arsenal have a massive advantage. It is the wage spend vs season end position correlation that indicates those clubs under- or over-performing wage spend expectations. Arsenal are bang on track despite our reservations about significant wage spend on players with little value to the first team squad.

Player sales once again is a big impact in the accounts and during 2011-12 the club sold Fabregas, Nasri, Clichy, Eboue and Traore. These transactions generated substantial profits as the book value of these players was limited due to their contract status (contracts almost expired) and therefore the profit on player trading was £66m.

Player additions to the squad during 2011-12 came in two waves, early close season and last day of window, and were Gervinho, Oxlade-Chamberlain, Jenkinson, Campbell and Miyachi (first wave), then Mertesacker, Arteta, Santos and Park (last day of window). Vermaelen also signed a new long-term deal that we believe will have involved some upfront payment. All-in new player investment totalled about £78m including agents' fees (£4.6m) and EPL levies. This cost will be written down over the contract durations and will add approximately an annualised £18m to the amortisation charges. These went up £15m in 2011-12 to £37m, so another £3m or so is to follow in 2012-13. 

However, one surprise was that Arsenal also booked a £5.5m impairment charge toward writing off a player's value in the books. This can only relate to players not in the squad and with a book value the club can't hope to recover on any future sale. Logically this must relate to Park, as the likes of Denilson and Bendtner will have little carrying value as their contracts are almost at an end.

Property was a relatively minor element of the results for the first time in many years. There is still cash to be received as the remaining property deals close (c£50m for the infill properties at Highbury, the Queensland Road development and remaining sites on Holloway and Hornsey Road) and we believe that £20m of this will be banked in the financial year 2012-13.

This property cash flow would have comfortably allowed the club to keep running its present football operating loss in 2012-13, but will now be added to by the surpluses created by the sales of Robin van Persie and Alex Song.
Cash Arsenal's headline cash balance fell £7m to £153m. We believe the available free cash after deducting season ticket advance money and VAT (£70m), net money still owed on player transactions (£7m) and debt service reserve balances (£33.5m - almost two years' worth of debt service) was still circa £42.5m as at May 31, 2012.

Debt Total gross debt reduced in line with expectations and stands at £254.6m (£260.5m). Interest rates are broadly fixed and with scheduled repayments known until maturity the stadium debt will be zero come September 2031. The cost of servicing the debt was £13.5m (£14.2m) in addition to a principal repayment of £6.2m (£5.9m). Debt service remains very manageable given the football revenues, and as far as any debt can be "good" this was incurred to purchase income-generating fixed assets and not to sustain a loss-making business. Property and player sales are used for that!

Bearing in mind the club made a disclosed surplus on player trading (a post-balance sheet event) this summer of £11m and that there's at least £20m of property money coming this year we think it is fair to say there's plenty to spend (£70m to £80m) or hold for a rainy day (UCL was worth a hard £23m of TV revenue), even allowing for the headline football club loss that will need funding in 2012-13 (an expected £25m if 2011-12 is anything to go by).

What do we expect in 2012-13?

There is unlikely to be much change in ticket revenues this season (only Club Level prices increased (2%), with no increase for general admission following the disquiet of the previous year) and any growth in broadcast revenues will be largely linked to on-pitch performance in the EPL and UCL. Chelsea's win in the UCL will have an impact as Arsenal will only receive reduced merit payments (15%) instead of the 20% that would normally be paid for finishing third. That said there is an estimated 20% growth in UCL pool revenues (potentially £5m) and once again we would hope for commercial revenue growth of 10-15% (£5m). Wages will show less dramatic growth following the summer changes and general lack of renegotiations and some one-off costs will be saved (impairment provision £5m, pension fund top up £2m), so we would expect before player trading a loss around the £25m mark. Of course the summer generated yet more substantial player trading gains and we'd expect another £40m to be recorded pushing the club once again into profit.

Financial outlook - can we afford that top, top player?

In the spring the AST was concerned that failure to secure another year tucking into the Champions League trough could damage the club's short-term potential. Its bargaining position would be weakened at the crucial time when the headline sponsorship deals are being renegotiated if a competitor replaced Arsenal in the top four. Clearly a lot changed! West Brom's keeper and Chelsea's lucky rabbit's foot gave us third spot and cost Spurs a UCL place. Queensland Road was sold for £26m, the new EPL deal due to increase revenues by 70% (potentially an extra £35m pa from 2013-14) was announced and the club moved into the playing year in which it will renegotiate its main sponsorships in better shape on the pitch. Luck, a calculated gamble, or sheer genius?

This all creates a shift in Arsenal's position relative to those beneath it financially. When you consider that in 2013-14 TV revenues will rise by at least £35m pa and that in 2014 the main sponsorship agreements will be reset, an increase likened by the club to the £50m impact of moving to the new stadium, it's clear cash is not a constraining factor at Arsenal in the near term. Revenues will breach £300m in 2014-15 assuming the club can hold its top four ranking. This would allow Arsenal to comfortably run a wage bill of close to £180m (60% wages/turnover payout compared to the present £143m (61%)) demonstrating that Arsenal have significant scope to further invest in their wage bill (close your eyes Theo).

This current outlook and future income potential demonstrate that Arsenal could, if they wished, certainly afford to invest in the next transfer windows in two players who would cost £25m and secure six figure weekly wages.

Beyond 2014 - The Financial Fair Play (FFP) promised land?

Ivan Gazidis recently spoke passionately about leading Arsenal into the promised land of Europe's top five financial elite off the back of the new commercial deals in 2014 and the new EPL TV deals (domestic and international), coupled with the impact of FFP (which will force huge cuts in spending at City, assuming the regulation has teeth).

The emphasis the club is placing on FFP is evident in that they chose to announce the annual report with a headline relating not to the club's football performances but its readiness for FFP. Ivan Gazidis' opening remarks were also about FFP.

We would not dispute that after nine long years it seems almost certain Arsenal will join Real, United, Barca and Munich at that top table of clubs earning £300m a year or more (although note Arsenal would be fifth by some distance and that FFP can lock these clubs into permanent financial dominance over Arsenal). This was the vision behind the stadium move. That period has been a rollercoaster: the alchemy of Arsène in selling £150m of top talent in the last four seasons alone while maintaining the 15-year unbroken UCL appearance record, including scraping over the line last time, and having at least a promising team in 2013 ready for the new deals being negotiated.

When we look back on the debate between ambition and conservatism during the recent wilderness seasons, no one will ever know if a cash injection (rights issue) to bolster those weak commercial revenues would have turned a team hovering round the podium to one standing where trophies are handed out.

We also wonder how a manager who for at least two seasons has not used all of his budget, and who now has £50m unspent and half a dozen unwanted players stuck on his books on multi-million pound salaries, will fare in 2014, when he has at least a further £50m a year to spend on his team.  

So what about the fans?

Arsène has often said we are his judges (come May) and the last AST survey showed overwhelming support for him despite his foibles and stubbornness over spending only what he considers good value. But as the surpluses get bigger and bigger surely the question must be asked about whether that bit more should be spent to secure trophies. If not what else happens to the Arsenal cash pile?

There are several options open to the club in the coming years:

  • Repay debt - costly and not a game changer to the club's financial position
  • Further investment in fixed assets - at 10% pa this would be £40m but there is probably little to spend on. £7m spent last season
  • Start paying dividends - basically a cash sweep from fans into the pockets of the owners. An alternative is management fees to the majority owner; the AST strongly opposes both
  • Invest more in player wages and signings
  • Have a three season break from the Champions League - urghh!
  • Reduce the ticket prices (for example more League Cup pricing, £10 Junior Gunner games to rebuild the younger fanbase and no more Cat A games)
  • Pay more tax - inevitable unless income is spent!

The AST will watch this space with interest while we keep paying the most expensive ticket prices in world football.