AST Analysis of Arsenal Holdings PLC

Full Year Accounts for the financial year 1 June 2016 to 31 May 2017

The following report is a short analysis produced by Simon Hill of the Arsenal Supporters’ Trust (AST) examining the financial performance of Arsenal Football Club for the financial year ending 31 May 2017.

As usual we start with a simplified version of the club’s accounts in table format. The figures are all drawn directly from the published accounts, which will be available on Arsenal.com.

Comparison with previous estimates

In our February review of the half-year figures, we gave an estimate that Arsenal would report a profit before tax of £41m for the full financial year. The actual profit was £44m. The principal reasons for this variance came from the fifth place finish saving on player Champions League qualification bonuses, offset by extra other football costs which the club attributed to a broad array of items.

Stadium revenues (matchday)

This year Arsenal again generated a record-equalling figure of close on £100m from match-going fans.

In 2016-17 Arsenal played 26 home games; the previous season Arsenal played 27 home games and hosted an Emirates Cup.

The club squeezed in an extra A game (Bayern at home) to substantially compensate for dropping a home cup game and curiously seemed to do almost as well from adding a Scandinavian tour to replace the Emirates Cup. Having fewer home FA cup games helped avoid revenue shares with away teams and mitigated the impact of £30 tickets for away fans at home league games.

The 11 per cent cut in season ticket pricing announced for the 2017-18 season will, we estimate, reduce income by around £9m. This cut was welcomed by us when it was announced; with record operating profits before player trading thanks to the new broadcasting deals it is clear the club has some room to breathe financially and recognises the benefit of a full vociferous stadium.

Broadcast revenues

Broadcast revenues increased by an eye-watering £59m thanks to the new TV deal (an extra £39m) and a bigger share of the Champions League pie converted at more favourable exchange rates (an extra £21m, making £58m total from this source).

Champions League income is significant (a minimum of approx £45m pa) and participation is important in achieving top level sponsorships. The club announced it expects a net drop in income of £20m from finishing outside the qualification places. We felt the impact would be somewhat larger, as the gate alone has seen a £9m cut and we would expect broadcast revenues to fall by at least £30m in 2017-18 but suspect that the club’s measure is comparing Europa League income against what a theoretical fourth placed finish would have yielded in Champions League income.

Commercial revenues

Commercial revenues increased by 11 per cent to £91m. The club explained in depth this was due to a 35 per cent growth in secondary sponsorships (up £6m to £23m pa) but it also includes their FA Cup winnings (£3m).

Whilst the two headline deals with Emirates and Puma are significant at £25m pa and £30m pa respectively, Arsenal’s commercial and retail income is only 50 per cent of the figures reported by Manchester United, whose kit deal with Adidas (£75m pa) together with other commercial revenues gives them a £100m pa spending advantage over Arsenal.

Arsenal also lag behind the commercial revenues reported by Bayern, Barcelona and Real Madrid and the state-sponsored PSG and Manchester City, who all receive close to £200m pa in commercial revenues.

Arsenal sit tenth in the European club table of commercial income, meaning they are in the second tier of commercial income earners behind the likes of Chelsea, Dortmund and Liverpool, who all receive over £100m pa, but well ahead of clubs like Spurs who are not historically Champions League regulars and receive around £60m pa.

Sadly the game at the top level in Europe is becoming increasingly polarised leading to a less competitive Champions League format. The super-rich clubs generate ever larger commercial revenues through sponsorships and merchandise sales linked to success in the Champions League with its large bonus and TV related payments.

Property and player loans

There was little property activity. The remaining property sites at Holloway Road and Hornsey Road are held in the balance sheet at £12m and are still to be sold. The Finance Director in his report confirmed Holloway Road will be sold this season (we would guess for somewhere around £6m). We estimate in excess of £75m to have been generated from the property assets, including from Highbury Square, since the stadium move commenced. We believe all this cash is available to the football side of the business although it is held within one of the club’s numerous property companies. We cannot identify if any of it has been spent as overall retained cash reserves are still over £100m.

Player loans delivered £8m in revenues in 2016-17, with Wilshere and Chambers notably out on loan. The club’s latest report and accounts confirm that loan deals do in fact always cover the player’s wages, with the fee being earned on top (no doubt to counter our assertion last year that they do not!).

Wages

The wage bill increased by £5m to £200m. The underlying increase was much larger as there was no Champions League qualification bonus included this season which we estimate saved over £10m in wages.

The club invested heavily in three players in summer 2016 and you will recall made a great deal of noise about it in last year’s report and accounts. There is no comment on the fact that one of the three “transformational” signings has left on loan or on the disputed rumour that a second also wanted a late move out of the club this summer.

There has been a deafening silence on the issue of contract renewals or the lack thereof since summer 2016. At the Fans’ Forum there was mention of the fact the club have a lot of sensitive data to hand that is not in the public domain that drives their thinking on wages offered but it is seemingly a trend now that players and clubs do not rush to sign new deals. With Ӧzil, Sanchez and Wilshere out of contract next summer and Ramsey down to one year come June 2018, Arsenal’s core is seemingly unsecured and it is hard to see like-for-like replacements coming in on lower wages than those currently being paid to these particular players.

This brings us nicely to the potentially troublesome Premier League wage cap: a maximum of £7m extra in wages per annum for the new TV deal plus any increases in non-Premier League income and average transfer profits referenced back to season 2012/13. Clearly a piece of complex maths even for club insiders let alone external analysts, but our best estimate as of season 2017-18 is that Arsenal’s current cap is around £220m with this summer’s super profits from player trading likely to add £12m to that figure for the averaged 5-year period. That is a lot of slack, but if Champions league bonuses are reinstated, it would soon go on any world-class signings or mega-renewal deals.

We believe Arsenal’s wages are double those of Spurs and increasingly observers of the game are questioning whether wages alone guarantee success. In last season’s report we noted that “the manager has hinted that the risk of being stuck with high earners who do not perform and cannot be moved on is a driver to his cautiousness in the transfer market.  Certainly the loan market is littered with unwanted, over-paid, expensively signed talents and it is also noticeable contract renewals are being run more tightly than before across the game as a whole.” Well that was prophetic. Are other clubs as exposed as Arsenal to contract run downs we wonder?

One last comment on wages is to draw attention to Ivan Gazidis’s pay (£2.65m last year including his performance bonus of £1.1m and £2.62m this year including £0.92m in performance bonus). When we asked at the recent Fans’ Forum whether he would be taking a bonus this year due to our disappointing performance we were frostily told that was a matter for the club’s independent directors to consider and we could not expect him to comment on the matter at the forum. Last year it went without justification in the accounts and this year was no different. However, it seems dropping from second to fifth in the league was only worth a 20 per cent reduction in Ivan’s bonus.

Non-wage football costs (“other costs”)

These costs cover running the team (travel, medical costs, etc) stadium running costs, insurances and retail costs of sale (stock and running costs of the Armoury, etc). For many years they had been remarkably constant (£57-62m pa), changing only marginally to reflect the number of games and events staged at the stadium.

In the financial year to May 2014 they suddenly jumped unexpectedly to £70m and despite the explanation in the accounts about staging more games and the costs of looking after sponsors, the biggest single factor was a payment of £3m to a Stan Kroenke-controlled company for “strategic and advisory services”.

The year to May 2015 saw non-wage football costs grow another £2m to £72m. There were savings from not touring and hosting fewer games, but some cost increase from the growth in shirt sales (ie the need to buy the stock before selling it to fans).

In 2016 the KSE fee was waived and other costs fell back to £70m but this year they have leapt alarmingly to £79m. In the accounts the club talked about US tour costs, sponsorship partner costs, the legends match proceeds and a £1m provision against empty property which all seemed a slightly lame way to get to a £9m increase, especially in a season with so few home games. There is no KSE fee again this year so that is not a contributing factor, and we remain slightly perplexed about this dramatic increase.

Amortisation

Amortisation is the accounting cost of buying the team spread over the length of the relevant players’ contracts and includes items like agents’ fees, Premier League levies and contract extension fees as well as the actual transfer fee paid for a player.

As a minimum, we would expect the club to spend the amount of the annual amortisation charge (£77m) on new players every season with extra sums spent to replace players who leave at significant gain over their ‘book’ value in the accounts. Arsenal’s spending slowed down in 2015 as the manager chose to stick with the squad rather than sell on, let go or pay off older players and invest his spare cash. Sadly, this approach did not pay off and to fill the gaps in his squad over £100m was invested in three players at much increased prices in summer 2016. This summer, close to £50m was invested in one top signing but £70m was raised from selling other squad members. That is a substantial run down in the squad. At the recent Fans’ Forum, Ivan spoke of there being a pre- and post-Neymar market, and the concern must be that despite raising £70m in sales over the summer and having around £20m of slack in wages, Arsenal will not have enough for like-for-like replacements for Sanchez and Ӧzil if they run down their contracts or leave for reduced fees.

We may be seeing a breaking of the game financially where the very top earners like United, City, PSG, Barcelona and Real Madrid alone compete for top mature talents at all levels in their squads whilst others must do it a different way. In effect, this feels like a return for Arsenal to pre-2013 levels of financial competitiveness.

Profit on player sales

In summer 2015 and 2016 there were few sales, just retirements and lots of loans. We noted that the top clubs found it hard to move on unwanted players and we speculated as to whether Arsenal were similarly frustrated. We found it ironic that when it suited them to explain the club’s inactivity in 2015, the Chief Executive cited the retention of players bought over the past three seasons as a virtue, and then heralded their bold spending in 2016 as a sign of their commitment to winning.

How then to comment on summer 2017? Arsenal’s sale of one contract rebel who wanted to be more actively coached, of two players the manager believes he has upgraded and of one player who had seemed to be core was largely understandable given the squad’s size, which is what the club have emphasised. However, there seemed elements of extreme flexibility such as Giroud, Elneny and Chambers all being at one time leavers then stayers, while Perez (one of last summer’s core signings) went as did Gabriel and (if the BBC and other sources are to be believed) Mustafi nearly went too. The unkind would say the approach seems chaotic but the board maintain that the squad is, in their opinion, stronger than it was (arguably true), though surely its foundations do not seem that solid with so many seemingly not on the managers’ core keep list, nearly out of contract or heading for retirement? Perhaps extreme flexibility in managing the squad is the way to go when confronted with surging prices and wages, a finite pot of resources and only two years on the manager’s contract.

What the summer definitely did herald was a return to transfer profits being earned (£60m we estimate, net of the remaining book value of the players sold). Profits should not really be earned regularly unless you are operating in a rising market (which we are) where replacements cost more than the original player you are upgrading or you are farming young talent for sale (Spurs or Southampton) or unable to keep your rising stars (Arsenal of old).

Cash

Arsenal’s end of financial year (May 31) headline cash figure (£180m) is always bloated by up-front season ticket payments that are needed to pay some of the wages and bills for the rest of the summer (“working capital”). With falls in both season ticket prices and in the amount of renewals that had completed by the end of May and the impact of Thursday night football on TV revenues to quantify, this amount is harder than ever to assess this season.   UEFA cash tends to be back-end loaded, but excluding player sales it is likely the club will trade at a small loss next season. However, there are also a number of other items that will use up the cash held at year end. These include:

·         An allocation of cash on the balance sheet (£36m) that the club can’t spend because it’s held to the order of its stadium bond holders (“debt reserve protections”).

·         A net amount left in the balance sheet reflecting money to be spent and received on players spread between debtors, creditors and provisions. A big chunk of this is on a long-term basis as it relates to the agents cut on player transfers and wages and renegotiated contracts, and to deferred instalments on players and performance-related fees the club thinks will become payable in the future (in all approx £43m). In the next year we estimate that some £20m net is due to go out.

·         Money due to be paid out for corporation tax and the annual debt repayments (we estimate £21m).

·         One off factors: favourable movements in working capital that added to cash balances at the end of both 2015 and 2016 reversed in part in 2017, reducing available cash. Deferred income and accruals went up from £121m in 2013 and £145m in 2014 to £175m in 2015 and stayed at £174m in 2016. Much of this increase was due to Puma and Emirates payments under the new deals and to higher season ticket revenues from higher pricing and a strict cut off on renewals.  Indeed, last season the club took the unusual step of disclosing that advanced season ticket and sponsorship money was £101m (little changed on 2015) but noted this year it had fallen to £85m. We believe this £16m fall is largely driven by the cut in season ticket prices and in a delayed renewal window, but we do not know whether all the cash that flowed in over the three years to May 2016 (£54m) will stay permanently. We have to assume it will in the absence of explanations to the contrary, as the club have gone out of their way to highlight reasons why the headline cash figure should not be taken as free and are therefore considered unlikely to have overlooked good reasons to talk it down further.

·         Payments for players acquired in the summer. At a headline level these are believed to have cost around £46m plus agents’ fees due on the players contracts. Not all this amount will have been due straight away, and for the top signings we believe based on past experience it is fair to assume 50 per cent will not be due for at least another year. Accordingly, we have estimated £23m as being the maximum up-front outlay the club incurred.

·         Receipts for players sold in the summer (£70m). Some of this will also no doubt be on deferred terms, we estimate 50 per cent, to be consistent with purchases.

So to summarise, we set out below our view of Arsenal’s current cash position:

In past reports we have made an allowance of £25m as the amount the club could sensibly hold as a contingency to cover a rainy day, or more specifically a season of not qualifying for the Champions League. That rainy day has now arrived and the club can weather it thanks to the TV deal that has locked in surplus cash flow, so we do not think any contingencies are required for this season. Accordingly, we estimate around £95m remained spare at the end of this summer’s transfer window.

Of course, trading during the course of the current season will also generate cash at the end of the season when ticket renewals are received to go toward next summer’s spending (we estimate approximately £50m) and that would add to any unspent monies at the moment.

Our estimates of spare cash available for transfers have long been an irritation to the club, and of course they tell us they cannot explain exactly what is available without letting all shareholders and the world at large know – something they do not want to do.

Whilst we appreciate the commercial sensitivity surrounding spare cash for transfers, it’s inevitable fans want to understand what funds are available and we try and do this in as informed a way as possible, based on the official report and accounts.

Last year we encouraged Arsenal to help all fans and shareholders understand exactly why so much money needed to be held in reserve, by explaining more fully in the company’s annual report and accounts what working capital is required for the financial year. It is only right therefore, that we acknowledge the steps they have taken to more fully explain what cash is not free and to acknowledge that after this summer’s net sales they are in a “robust financial position” – accountant-speak for loaded.

We continue to believe our current and past analysis is correct and we note that another widely read and valued independent report on Arsenal’s finances by the blogger Swiss Ramble drew similar conclusions.

Overall financial performance: what does it mean for Arsenal?

In 2013 Ivan Gazidis spoke about becoming like Bayern Munich and in 2014 about matching Chelsea’s wage spend, but whilst the accounts demonstrated that Arsenal had ever-more resources available to compete – even if they weren’t all utilised – we kept noting in our reports they were miles behind the commercial earning power of Bayern Munich, Barcelona, Real Madrid and Manchester United.

For 2015-16, the Board’s emphasis in the accounts was resolutely defensive of their approach to cautious spending and running a mixed strategy of player development and acquisition. The high summer spending and acknowledgement in 2016 that there was more cash in reserve certainly helped make that a more palatable message than 2015’s blind insistence that they had a perfect squad and that it was a virtue that they did not need to spend.

However, in 2016 our concern remained that Arsenal’s position as a top 10 spending club critically relied on annual Champions League participation (£45m+ pa), and that participation extended to supporting match day incomes and higher-level sponsorship deals. As it happened, last season was the year our concerns became a reality and we now face an unprecedented drop in matchday and TV incomes of close to £40m, money that will flow instead to our rivals (Spurs and Liverpool). Arsenal spend close to all their income on the team so a long-term major loss of income implies belt-tightening at a time when prices are rising and contracts on star players are expiring.

Whilst United have been able to brush off missing out on Champions League qualification due to their logic-defying commercial revenue growth, other clubs, like Chelsea and Arsenal, are susceptible to losing that source of income. Clubs like Spurs, Liverpool and Dortmund show annual participation is not a pre-requisite to having a competitive team domestically, but it has certainly upped Arsenal’s risk profile and is probably going to result in top players leaving.

The one upside is, as we reported last year, that it seems top flight football in England is becoming slightly more of a meritocracy, with seven or more highly competitive participants, only one or two of whom seem to be on a different financial level to the others, suggesting money of itself does not guarantee success.

In large part, this is because the TV cash English clubs now receive gives them an income above all but the very top European teams, meaning they can all compete for most of the best players. So we can perhaps remain competitive and in with a shout at the Cup come May!