I have two passions in life and they are wildly different. I love analyzing and valuing businesses, which is why I started my blog. I also love sports and by sports I mean football. It’s the perfect balance because my love of financial valuations takes my mind off football and vice-versa. But as a combination, I would argue that they are oil and water. As an investor, I believe one should never invest in a football club to make money. And yet, most football fans would have you believe that their owners don’t care about the club or sporting success. They are just in it for the money. While owners can make money in football, the chances are slim at least as far business valuations are concerned. So, let’s focus on the business of football and let’s focus our study on the top tier of the domestic leagues in Europe.
This is perhaps the strongest argument of investing in football. The revenue growth in the last ten years has been a big factor in the perception that football is a great business. I looked at the top clubs in Germany, Spain, England and Italy and they have all managed to sustain a compounded annual growth rate (CAGR) of over 8% in the last ten years. The story is the same for mid-sized clubs as well. This is big when the GDP growth has been very low in this period. Momentum/growth investors will always be enamoured by this and to that extent, there is an opportunity to make capital gains in the short to medium term. The growth is likely to continue with several OTT platforms taking an interest in football and the TV deals likely to get bigger as European football becomes a truly global phenomenon. However, revenue growth alone can’t be a good argument to invest in a business.
Football is plagued by extremely low margins. The reason being that its an extremely competitive industry and wages make up more than 50% of the annual turnover for almost every club which wants to compete. Simply put, if there is to money to be made in football, players and agents seem to make most of it. The last ten years may have seen tremendous revenue growth but the median net profit margin hasn’t become better. I looked at the top 20 richest clubs in football right now and the median net profit margin was less than 5% with several clubs making losses.
Note, Tottenham Hotspur football club just moved to a new stadium leading to a disproportional increase in revenues with respect to expenses for the time being but that gap is likely to close down in the future.
Equity investors earn the cash flows after reinvesting into the business. In football, reinvestment is a huge part of the business. Fans demand huge transfer spending every transfer window. Hence in football, not only are the margins low but you need to reinvest a huge amount just to sustain it. This results in a considerably low return on capital as well. Most of the times, the fan pressure is so much that it leads clubs to make irrational decisions which damage the long term prospects of the club.
As mentioned earlier, revenues in football have grown at a phenomenal rate. But this isn’t true for every club and it isn’t true every time. What I mean is revenues are extremely dependent on performance. If you finish in the top 4 (champions league places), you earn disproportionally more than if you finish out of it. Same goes for Europa League places. If you get relegated, then that’s a catastrophe because your revenues can take a hit of more than 50% with very little chance of coming back.
I have covered this earlier but competition in football is different from other industries. In other industries, if margins and returns become unsustainable most of your competition drops out until they become sustainable again. This isn’t the case with football with clubs often being in business for over 100 years. There is an emotional connect with the fans which means someone always swoops in at the end to save the club.
Valuation: Manchester United Football Club
To illustrate my point let me take the example of one of the biggest football clubs in the world. Manchester United football club is a truly global club with fans all over the world. Sporting success has been hard to come by recently but they have been riding on the wave of tremendous commercial success. Their current market cap is over 2.5 billion pounds. To value Manchester United, I need to estimate the future free cash flows to equity and discount it back to its present value at the cost of equity. To do this, I need to estimate the following inputs:
- Net Profit Margin: Currently at 3%, I expect the net profit margin to rise to 5% which is about the 80th percentile of the richest football clubs
- Sales to Equity Capital Ratio & Return on Equity: Sales to equity capital is a measure of how fast or slow the company’s investments in projects generate revenue. Manchester United’s current sales to capital ratio is pretty good at 1.5 which indicates a strong brand presence. I expect it to sustain this. The return on equity is given by the following formula:
Return on Equity=Net Profit/Sales*Sales/Equity Capital
- Reinvestment: The reinvestment rate is a critical piece of valuation. Football clubs need to buy and sell players in order to sustain. It is important to note that here that by reinvestment I mean net reinvestment i.e. net spend. Growth comes from the choices a company makes. Here, I introduce you to a formula that value investors are very proud of:
Growth Rate=Equity Reinvestment Rate*Non-Cash Return on Equity + Efficiency Growth
How to think about this is that growth in profits will need to come from whatever is reinvested into the company multiplied by the return on that investment added to the increase in efficiency from existing assets. Hence my equity reinvestment rate for a particular year will be the growth rate that year after subtracting the growth rate due to efficiency divided by the return on equity that year.
- Rate of growth and Period of Growth: I expect the strong growth in revenue to continue for the next 15 years at 10% compounded annual growth rate. This gives me a revenue at the end of the 15th years of more than 2.5 billion pounds. Post this, I expect the football club to mature and grow eternally for 2%.
- Cost of Equity: The cost of equity is my measure of risk. It is the discount rate I use to discount my future cash flows. I use the CAPM i.e. Capital Asset Pricing Model to estimate my cost of equity. It is given by:
Cost of Equity=Risk Free Rate + β*(Equity Risk Premium)
Given the high amount of financial leverage, I compute the cost of equity at 7%.
I now have all my inputs to value the football club. They are summarized below:
The valuation sheet is given below:
In my valuation, I portrayed an optimistic picture about Manchester United. I forecasted that they would be able to marry commercial success with sporting success in addition to doing it more efficiently. Yet, I computed the market value of equity at just under a billion pounds as opposed to the current market cap of over 2.5 billion pounds. This brings me back to my original point. There are far easier ways to make money than through football. Most long term owners in football must know this and yet invest for different reasons. It’s hard to speculate what they are and they may range from one-upsmanship to better PR or just the love of the game. But it’s very hard to argue that anyone would invest in football right now to make money.