City's Finances (Part Three)
This is the next part in a series of articles written by Colin Savage first published in MCIVTA's newsletter with reference to City's Finances. With the permission of Colin and MCIVTA (thank you Heidi) it is re-published here. I think you'll find this to be another informative, interesting and factual article.
The Stadium & Those Debts
I was originally going to do this as the last article in my series but there are so many important issues surrounding these that affect the articles on the financial statements that I decided to move it up the list.
We've undoubtedly got a stadium that is the envy of many clubs around the world. I still get a thrill when I get anywhere near it. It's sad, I know, and the feeling has usually evaporated 90 minutes later. But how did we come by it, what happened to Maine Road, who actually owns CoMS and what does it cost us?
Our dear friends from Salford call it "the Council House" but that simply betrays their lack of sophistication in financial (and any other) matters. The truth is that the stadium is operated under something called a "finance lease". Accounting standards define this as a lease which, to all intents and purposes, confers the risks and benefits of ownership. So when they talk about "the Council House", refer them to SSAP 21, the accounting standard on the treatment of leases. (You could also tell them that it will be a useful exercise for when Glazer sells the Swamp and leases it back, as he undoubtedly will). We account for the income and are responsible for repairs and for the fittings, although there are restrictions in the lease over what we can and can't do. Hence we have seen all the fuss over signage and general customisation.
The lease can be looked at as Manchester City Council (the lessor) lending us (the lessee) the money to buy the stadium. They haven't actually given us the cash in hand and we haven't actually bought it but we pay it back with interest as though they had. Obviously this is a totally different situation to a council house, where you just pay rent. Maine Road was effectively a down-payment. We handed it over to the council in part exchange for CoMS and they "lent" us the difference. However, we still don't actually own the stadium and, as far as I am aware, never will. We have a 250 year lease on the stadium but its useful life is much shorter than this, maybe about 50 years.
After the Commonwealth Games in 2002 and once the remaining construction work had been done to put in the extra tier and build the North Stand (which was not our responsibility I believe) it needed fitting out with all the offices, bars, turnstiles and executive boxes that make a modern stadium and we had to pay for that. It has been reported that this cost around £20m.
So how do we pay for it? We have agreed a formula with the Council that allows us to keep all the gate receipts up to the capacity of Maine Road, that is, 34,000. After that, we pay them based on attendances over that amount. This includes non-football events as well. I don't know what that formula is so I can't tell you what the split is and whether it applies to the gross income or we are allowed to deduct expenses. But whatever it is the higher our crowds, we more we pay.
There are other financial implications. We have to set up an accounting entry that represents the total money we think we will be paying over the life of the lease and depends on a number of factors such as crowds, the rate of inflation and interest rates. On Page 28 of the 2005 Report is a table that illustrates this. You will see, if you read the notes above it, that we have assumed average attendance of 42,500 in making this calculation, as well as 2.5% inflation. The stadium was independently valued in May 2004 at just under £150m in that year's accounts.
I mentioned that lease is like a loan and includes interest. This is shown as an expense in the Profit & Loss Account whereas the non-interest element goes to reduce our total liability over the life of the lease. Just to illustrate this, suppose we have an outstanding lease at the start of the year of £30m. We pay 5% interest of £1.5m during the year, which will be shown as an expense in the Profit & Loss Account and will increase the total debt to £31.5m. We actually pay £2.5m in total in lease charges during the year, which reduces our total liability to £29m. Therefore we have reduced it by £1m, which is the total payment of £2.5m less the interest of £1.5m.
The interesting thing to come out of all this is the overall effect on our finances. We treat the stadium as though we own it (even though we don't) and show it at its full value in the balance sheet. This is the correct treatment according to the accepted accounting standard. Therefore we have gone from owning a stadium worth about £30m to "owning" a stadium worth £150m and this has improved our balance sheet enormously. However, even though our accounting treatment is strictly correct, the central question remains - what is it really worth to us if we ceased trading? If we owned the stadium then there would be an asset there to sell but we don't. Were we right to give up a £30m asset for one possibly worth nothing in practical terms in that way? I simply can't answer this question but it is, I believe, the key to really understanding our true financial situation.
I'll deal with this is the next article on the Balance Sheet but be warned; the implications may shock you.
The one subject above all connected with the finances guaranteed to get us all into a heated debate. So what is the truth - are they as well-structured and manageable as Alistair Mackintosh would have us believe?
First of all, we talk about "our debt" but there are a few different types of debts we have. There are the people we owe money to in the normal course of business - our suppliers of goods and services. We receive an invoice from them and have a certain time to pay it. These are short term debts and as long as we have adequate income coming in then we should be able to pay these. We will also owe tax and national insurance, including VAT. Although these are debts, they are not part of what we refer to as "the debt"
Something else that falls into that category is the debt connected with the lease. As I said above we have to show an estimate of the total payments we would have to make over the life of the lease but this is an accounting entry as we only pay what we owe the council, according to the agreed formula, every three months. However, when you take these away, we have what most of us think of as the debt, which is the money we have borrowed. There are two main types of borrowings, secured and unsecured. The former means that, in return for the loan the lender has first call over an asset in case you cannot pay it back.
The best known form of secured debt is a mortgage, in which your house is security. Unsecured loans mean that the lender has no such security. We have both secured and unsecured borrowings. The secured loans totalled £43.3m in the 2005 accounts and consist of two separate loans. The first was for £30.3m and is repayable over 25 years at 7.27%. The second was originally for £13.7m as is repayable over 15 years at a rate of 7.57%. Of this latter loan, £700,000 was repaid during the year, leaving £13m. My best guess is that these will cost us somewhere around £5m a year to service until the fifteen year loan is repaid, then about £3m a year for the next ten years.
I said that these were secured loans and the next question should be - what are they secured on? Normally it would be our stadium but, as you now know, we don't own that. The answer is that they are secured on our future ticket income. This is an increasingly common financial instrument used by companies than lack the necessary assets for more conventional security. David Bowie did something similar, pledging his future royalties against a cash sum in advance.
Now, in order to agree to this, the financial institutions involved would have to have some confidence that these future income streams can be maintained at a respectable level. This is where the famously loyal City support comes in. Crowds of 28,000, even when we were in what is now League 1 convinced them that we could continue to pull in the cash whatever. Another element of this is that our payments are fixed over the life of the loan so all things being equal and assuming that inflation, ticket prices and TV income will rise over time means that paying £5m in ten years will not have the same impact as paying £5m this year. The down side of all this is that if our income were to fall significantly then we are still committed to paying, before we pay anything else. So if we continue in the Premiership and continue to pull in the crowds then there is no great problem paying out £5m from an income of over £60m. However, that's not to say that we couldn't find better things to spend £5m a year on (such as a striker who can actually score). But if things go disastrously wrong on the field and we lose a large chunk of our income from crowds and TV then spending £5m a year from a much lower income base gives us a potential problem.
So what were these loans spent on? The club is keen to stress that £20m went on the fixtures and fittings for CoMS but is less keen to publicise that the rest probably went on players. The basic rule of finance is borrow long term to buy long term but never borrow long term to buy short term assets. This means that it's OK to borrow money over the long term if you're spending it on an asset that will provide a return over that term. However it's not OK to borrow money long term to buy an asset that only has a short life. So, you shouldn't get a 25 year mortgage just to pay for a holiday, for example. Yet we took a long-term loan to finance player purchases, so we will be paying for these players for 15 or 25 years yet most have them have already gone. So that's not such good business but what's done is done.
The final debt is the one that we really need to look at and these are the unsecured loans from Messrs Wardle and Makin. The club calls these "soft" loans (and that's not a comment on Wardle and Makin for making them). It refers to the fact that, unlike the secured loans that we pay instalments on annually, there is no repayment plan in place for these to be repaid.
(However, I did discover, on examining the 2003 accounts, that we owed Wardle £5.7m at that time and supposedly had a plan in place to pay this back over 12 quarterly instalments. Yet in 2004 this had seemingly been ditched, suggesting we couldn't afford the £2m a year it would take). However the loans are not so soft that they don't attract interest. There's nothing wrong with this, by the way, as the lenders are entitled to some reward for their risk. Interest is at a very reasonable 5% and some or all of it is still owed to them. There are things I could criticise Wardle over but not his generosity. We have really relied on these loans to stay in business, as you will see when I talk about Cash Flow in a later article. Furthermore, if we were to cease trading they might not see some or all of that money again.
In the 2005 Accounts you will find the details of the loans on page 31 in note 17. The loans from Wardle total £14.7m with just under £4.5m from Makin. You will notice that Wardle's loan has increased from £7.7m the year before. Therefore he has pumped a further £7m in during the financial year. (Our bank balance is also just over £7m by the way so the obvious conclusion is that it is the additional £7m sitting in the bank and it went in close to the year end). So that's £19.2m we owe these two. So add the £43.3m to the £19.2m and we have total ongoing debt, excluding trade creditors and the lease, of £62.5m. We also had an outstanding amount of £2.2m, (which wasn't repaid until July 2005) and other loans totalling £1.25m. So, strictly speaking our unsecured lending was £22.65m as at May 2005 (although this would have been down to £20.4m in July, assuming no other debt had been taken on). So when I asked you what you thought our total borrowings were in the last article, you should have come up with a total of £65.95m, as against £62.2 the previous year. But the club did a very effective PR job in convincing people that debt had actually been reduced over the year. In fact, if you look at the Chairman's Report on Page 4 under Financial Performance, the last sentence of the third paragraph says "Total debt…has fallen to £57.7m". So is our chairman telling porkies? Well, not really, but he is being very selective. The £57.7m is "net of cash" which means that he has knocked off the near £7.5m we've got in the bank. At least we had it in the bank on 31 May 2005 - if we spent it the next day our net debt on 1 June could well have been back to nearly £66m. And you would have to be some accountant or PR person to prove that £62m had "fallen" to £66m.
So what was all that in the Chairman's report about net external debt falling from £50m to £38.5m? When Wardle talks about external debt he means that owed to third parties i.e. not to him or Makin as shareholders. Therefore the £50m in 2004 was made up of the £44m secured loans, another loan of £4.4m (which has since been repaid in two instalments) and £1.6m we owed the bank via our overdraft. On that basis the £38.5m is therefore the £43.3m of secured loans (we paid off £700,000), and the £2.2m still outstanding on the other unspecified loan at that time. But, I hear you cry, that's £45.5m and you are not wrong. However, once again he has knocked off the £7m plus in the bank on 31 May 2005. The same question applies; was it still in the bank on 1 June? We will find out shortly.
Now, what do you understand by the word "manageable"? I take it to mean that I can deal with something, it's within my control. Alistair Mackintosh constantly assures us that this unsecured debt in "manageable". So what does he mean by that? He means that it's within our control because Wardle and Makin aren't asking for it back, either all at once or in instalments. Which is just as well as we only had £7m in the bank at the end of May 2005 and this is somewhat less than £19.2m. It did occur to me that perhaps they don't want it back yet because they know we can't pay it. I will try that one with the mortgage company if ever I can't pay; "There's no problem - if you don't ask me for it back it's quite manageable". So if they did want it back all in one go then we would have to find the money from elsewhere. Like, by selling our most valuable player(s), for example. But I'm sure the board wouldn't do that. It will be interesting to see what our unsecured debt is in the forthcoming accounts. So if you are one of those calling for Wardle to resign, could you replace the £14.7m that he would take with him? Because if you couldn't we would probably be in a really serious mess.
So are our debts well structured and manageable - Yes Or No, I'll leave it to you to decide but hopefully you can't now say that you are a "Don't Know". In the next instalment I'll look at the first of the actual Financial Statements, the Profit & Loss Account. We're one of the top twenty European clubs by income but couldn't apparently afford a couple of million for Thomert. So what do we spend it all on?