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Arsenal Executive Summary

Arsenal Executive Summary; 5th May 2016

Arsenal Report

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The Executive Summary

 A) Arsenal’s cash for Players? Does it have £200m?

”Spend more on players” is an often heard criticism of Arsene Wenger and of the Arsenal board of directors who include Sir Chips Keswick and majority owner Stan Kroenke.

The empty seats at Arsenal’s 2-0 victory over West Bromwich at the Emirates suggest its fans are angry with the current management. For the fans, it boils down to personalities.

Ever since Highbury was sold, Arsenal has held significant cash balances. Sometimes fans have wondered if / when that would be spent. So far the board have kept fans guessing on the timing and size of player investments. Partly this helps team morale. It also signals to the transfer market that Arsenal is no soft touch, it can and will walk away if it does not get attractive terms.

Then there is Arsenal’s culture of raising players internally as a reliable and less costly approach than the transfer market.

More sinister motives have been attributed to Arsenal retaining a high cash balance, such as a shareholder raid? This has not taken place. More plausible commentary has said that the board is holding cash as it expects player prices will fall.

But does Arsenal really have £200m odd for player spending? No. This is because once deductions are made for bills, there is not that much net cash.

In its interims (6 months to end November 2015) Arsenal had short term expenses of £206m (including £45m for player transfer instalments) against gross cash of around £212m. The board cautioned about higher player expenses.

We need to be careful with the first half as Arsenal generates most of its cash in the second half of its financial year to end May 2016 due to season ticket renewals in April/ May and more match days.

If we review our forecasts for Arsenals cash-flows to end May 2016 we expect the following during 2016:-

Cash flow from operations: £85.1m (the business operations)
Cash flow from investing activities: -£73.4m (player/ property spending)
Cash flow from financing: -£11.8m (mortgage/ bond repayments)
Net change in cash: -£0.1m

 

Opening cash: (31 May 2015) £228.1m
+/- Net change in cash -£0.1m
Total cash y/e (31 May 2016) £228m

 

Now for the constraints on the cash:-

– Mortgage/ Bond collateral requirement £32m
– Short term payables (net of receivables) £191.9m
+ Overdraft facility £50m
= Cash availability for players £54.1m

About £32m of cash cannot be used as it is held as cash collateral against Arsenal’s bonds. This reduces the funds available for corporate activities.

We are not assuming any windfall profits from player trading in the 2016 financial year. We have left the first half profit of £300k as the full year result. We have estimated net cash spent on players at £44.4m reflecting the Elneny purchase (c £5m) and the first half spend (£38.4m).

All things considered, we estimate that Arsenal has approximately £54m for player spending. This should be viewed as the amount that can “comfortably” be spent.

Arsenal has some flexibility, a £50m bank lending/ overdraft facility. The board have not drawn on this yet. They could do so in the future though the cost of the overdraft funds is more than the interest received on its cash deposits. So the overdraft will not be the first port of call. We assume Arsenal will draw on the overdraft facility if it embarks on heavy player spending.

Arsenal Chief Executive Ivan Gazidis recently made the same point that Arsenal is not sitting on large amounts of cash; “the vast majority of the cash is accounted for in various ways”.

Private references to a £70m odd “player budget” are a good pointer to Arsenal’s thinking. This is possible over 2016 and 2017.

B) Arsenal’s cash “from Players.”

Arsenal received £7.8m from player sales in the first half of 2016 – this is not much for a large club.

But Arsenal spent significant amounts on “player trading” – around £39.4m so far this year (this is net expense after taking into account player sales proceeds).

In the first half player trading profits were negligible (£0.3m) and we expect no profit in the second half due to a lack of player trading activity (we have identified only one transaction).

It is worth noting that player profits are a major contributor to Arsenal profits, in 2015 for example Arsenal reported a higher profit from players (£28.9m) than the club pre-tax profit. If profits from players are not there, the club makes very little profit.

A key decision awaits Arsene Wenger, what to do with maturing player contracts, three of which roll off by the end of June. This could free up some funds for new acquisitions, possibly around £12.5m regarding lower expenses in 2016/ 2017.

Are there further sales from the existing squad? Possibly, but we are not assuming this in the short-term.

Mr Wenger has further explained that there is a shortage of quality players, presumably at the right price. Careful evaluation is done on the merits of the player expense relative to the transferability of the player asset in future.

C) Arsenal’s “structural issues.”

By “structural issues” we mean that Arsenal is a subsidiary of Stan Kroenke’s KSE UK Limited. KSE owns 66.8% of Arsenal while Alisher Usmanov holds 30.05%. Relations between shareholders are reportedly limited.

All subsidiary companies are controlled to a greater or lesser extent by their parent company. In a traditional multi-national company, the parent company receives dividend payments from its subsidiary companies that are often determined by the parent company.

Arsenal does pay a “dividend” of sorts, a £3m annual payment to KSE in return for “consultancy services”.

Player spending budgets are in the hands of the Arsenal board which include KSE representatives. It may well be that these guys exercise significant influence on decision making generally and financial decisions specifically. The existence of a parent co tends to increase the number of decision makers.

It is unfair to blame Mr Wenger for not constantly changing the team, as he would be operating under internal constraints. Player decisions are made in the context of an overall budget.

There are other considerations that would impact Arsenal as a subsidiary of a parent that is possibly reluctant to inject new cash into a subsidiary.

i) Weak first half results. Arsenal lost £3.4m after receiving a tax credit of £3m. Profits from player sales were just £300k against £26.7m previously. In recent years, Arsenal player trading profits have been important to the overall result. The board mentioned higher costs in the form of inflationary wage pressures and transfer prices.

ii) *Arsenal has relatively low cash once you deduct the amounts it needs to hold against its borrowings and short-term liabilities. It has significant expenses over 2016. If one adds in the total debt, Arsenal actually has net debt (gross cash – total debt).

 

D) “Let’s give Arsenal some credit.”

*The weak environment will impact football clubs. There will be purchase opportunities if football club gets into trouble and need to sell. This may explain boardroom reticence, in that they expect sales by clubs in financial difficulty.

*Should Liverpool win the Europa League, it will be guaranteed a place in the Champions League. With Leicester and Tottenham virtually guaranteed a place this leaves Arsenal, Manchester United and Manchester City in a battle for the final place. At stake is £20m from a Champions position. At the moment it is too early to take this for granted – it is hanging by a thread. So the board are likely to hold off until this is in the bag.

*One has to step back from the short-term and look at what has happened in the last 20 years in totality. Arsenal’s income streams have been diversified; it has moved from cramped Highbury to the Emirates, a fantastic property deal. The business has been considerably strengthened. The Arsenal share price has risen 40 fold (from £400 per share to £16k per share) since Mr Wenger’s appointment in 1996. This is an outstanding track record of investor returns, and it has taken place in a football sector renown for business failure and last minute bailouts.

*The Arsenal approach is by nature cautious, partly reflecting the nature of asset pricing in the football sector and the difficulty realising cash from asset sales.

*Why on earth would shareholders want to lose someone with that track record? Mr Wenger’s departure will be a decision for him alone in our view.

*We are not recommending Arsenal as a share investment because of low marketability and valuation issues.

I would like to add, I am not a football fan myself, and have not looked at the football sector in depth before. This article is not written with any ill feeling towards Arsenal shareholders or supporters. From a football perspective, I wish them the best and may the best team win.

 

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