AST Analysis of Arsenal Holdings PLC Half Year Accounts

For the period 1 June 2014 to 30 November 2014

This analysis has been produced by AST Board member Simon Hill.

Firstly, we set out a simplified overview of the Arsenal’s accounts in a table format. The figures are drawn directly from the club’s accounts, with the full year to 31 May 2015 figures (and the split of football costs between wages and other football costs at the half year) being AST estimates.

Matchday revenues (gate receipts)

In the first six months of the financial year there were again 11 home games plus an Emirates Cup competition. Compared to last year, there was one more A-rated fixture and one fewer C-rated game plus the benefit of the 3% price increase. On the minus side there were no concerts held in the summer and only one tour game was played, compared to five last season, due to the 2014 World Cup.

The net effect of these changes was to decrease match day revenues by £2m. With Arsenal not progressing beyond the round of 16 of the Champions League and playing fewer FA Cup games at home than last season, there will be 27 home games in total for this season and this means that it is likely match day revenues will be approximately £3m lower at the financial year end.

Broadcast revenues

This is the second year of three of the latest domestic Premier League TV deal (Sky and BT) and the last year of the existing Champions League broadcasting deal (Sky/ITV). Arsenal again had seven televised Premier League fixtures in the first half of the financial year and seven Champions League games (including qualifiers), securing flat broadcast revenues.

We expect Arsenal’s full year broadcast income to experience a slight fall due toa weaker Euro exchange rate. Next season sees a new Champions League three-year prize money cycle with revenues for English participants underpinned by a new broadcast contract with BT, which is widely expected to increase Champions League prize payments by 30% and TV pool payments by up to 100%. This is likely to translate to an extra £10m pa based on Arsenal’s tendency to go out at the first knockout stage and the usual fourth placed finish. Improving on this scenario would see significant increases in CL broadcast revenues.

Commercial revenues

The new shirt sponsorship arrangement with Puma commenced on 1 June 2014 and helped boost commercial revenues to £38m (£28m last year) and retail revenues to £14m (from £10m) for the first six months of the financial year. For the full year, we expect commercial revenues to grow to £78m (£59m) and retail revenues to £22m (£18m) again largely due to the new deal with Puma.

Whilst the recent growth in commercial revenues is impressive and the two headline deals with Emirates and Puma are creditable by comparison to other top ten clubs in Europe, the fact remains that Arsenal are gradually being cut adrift in revenue terms as the top European clubs grow their commercial incomes by higher absolute amounts than Arsenal.

Even allowing for the benefit of the Puma deal Arsenal’s commercial income (£78m) is well below last year’s figures for Manchester United (£189m), Manchester City (£166m) and Chelsea (£109m) and this shortcoming manifests itself in a lower wage spend (United spent 30% (£49m) more on wages, City 25% (£39m) and Chelsea 20% (£27m) last season) and “on paper” a weaker squad. The shortfall is largely down to secondary sponsorships, merchandising and success on the pitch which fuels the virtuous circle Arsenal chose to highlight in their full year accounts. It only becomes harder to bridge the longer it persists. It should be noted that this “income gap” is partially mitigated by Arsenal’s higher match day revenues, but Arsenal also have debt repayments and interest that reduce the effect. Man Utd are the only British club with comparable match day revenues, but they also make debt repayments. The picture is complex, but one clear aspect is that commercial income is intrinsically linked to silverware.

The game at the top level in Europe is becoming increasingly polarised by this effect, as success on the pitch breeds commercial success off it through sponsorships and merchandise sales linked to TV appearances, success in the Champions League, star names in the team and ensuing global popularity. Arsenal’s position in this elite group is the most tenuous by virtue of its reliance on a fourth place finish and the usual closeness of its points position relative to its main rivals for that spot, Tottenham and Liverpool. With Tottenham’s commercial income somewhere approaching half Arsenal’s and Liverpool’s a gravity defying £100m due largely to past success, it feels like a situation that is not sustainable in the long term. However, both competitor clubs are committed to stadium development projects, and all three have been in this fourth place fight for somewhere approaching five years, so perhaps this will remain the new near-term norm for Arsenal. It might only be broken by a few years of sustained success and the retention of star names. You could argue that Arsenal should not struggle so hard to shake off these clubs given the huge wage spending advantage (well over £50m more pa is spent on wages by Arsenal).

Property and player loans

The club is still working on the sales of the Holloway Road and Hornsey Road sites which should realise in excess of £10m net once planning consents are obtained.

Wages

Another year of marked increases in wages has been driven by an upgrading of the squad, with Sanchez and Welbeck added and Park and Bendtner released. New contracts were awarded to Koscielny, Mertesacker, Szczesny, Ramsey and Cazorla during last season. The full impact of those new deals is reflected in the wage bill, which we believe is heading towards £180m for the full year and estimate at somewhere in the region of £90m for the first half of the financial year.

Although there will be some big earning players let go this summer (possibly Diaby and/or Podolski, as a start) and probably some sales of fringe players, further annual increases in wages of the magnitude seen in the last two seasons are, in our opinion, unlikely given the muted prospects for substantial revenue growth other than from continued Champions League group stage qualification. Under Premier League current wage cap restrictions, the club can only increase its wage bill for 2015-16 by more than £4m if it has cumulative non-Premier League broadcast revenue increases from 2012-13 to cover the actual wage increases over that period, less the £12m allowed and/or player trading profits to match in that year. That is quite complex maths, but basically qualification for the Champions League in 2015-16 would do the trick, as would selling a couple of players.

However, we think it is unlikely Arsenal will push the wage bill substantially higher unless they finish third, especially as a fourth place finish would only confirm Champions League qualification in late August, just before the end of the transfer window, assuming success in the qualification round. Failure to qualify could see the spending gap with the top three widen markedly as Arsenal might choose to belt-tighten rather than be pushed into a big loss, even though they could arguably afford it. A new set of wage controls is likely to be agreed for the new TV deal from 2016-17 to protect wage spending capacity of all Premier League clubs.

Non-wage Football costs and Amortisation

Non-wage football costs cover team support, travel, medical costs, stadium running costs, insurances and retail costs of sale (running costs of The Armoury, cost of shirts etc). They are remarkably constant other than being slightly impacted by the number of home games held (approx £200k cost per home match day), retail costs of sales and Emirates Cup appearance fees. Last year, there was the shock inclusion of a £3m fee paid to KSE for advisory services and it is unclear from these interim figures if a fee has been levied in the first half of the financial year or will be levied by the financial year end. We would be very disappointed to see a recurrence of the KSE fee and expect little change in other costs bar for extra retail sales and lower touring cost.

Amortisationis the cost of buying the team spread over the length of the relevant players’ contracts and includes costs like agent fees, Premier League levies and contract extension fees as well as the actual transfer fee paid for a player. The charge for the half year to November was markedly higher at £26m due to the substantial investment of £93m gross in players over the summer. In the full year we expect an amortisation charge nearer to £56m.

Profit on player sales

Arsenal booked a substantial profit from player sales (£27m) following the sale of Vermaelen and fringe players like Miguel and Djourou, plus profit from selling the option to buy back Vela from Real Sociedad. Most of the clubs competing at the top of the game have traditionally not relied on player sales for income, although some have begun to resort to generating profits in this way to balance the books for either FFP reasons (Chelsea) or because of failure to qualify for the Champions League. Arsenal are now a buyer of mature talent as well as a buyer of developing talent, as one would expect from a top club, and we expect profits from player sales to remain less significant than in the past when dissatisfied star players forced exits.

‘Spare Cash’ / Resources available to strengthen the team

Arsenal reported a free-cash balance at 30 November 2014 of £139m (up from £120m at the same time in 2013) – with further cash of £23m held back to guarantee debt service requirements. This was a significant decrease on cash reserves held in May (£208m total) and reflects the substantial investment in the squad during summer 2014 (net £64m).

In the January window the club made further investments in new players and signed new contracts with younger players breaking into the first team squad, which will probably total around £15m. With £63m net still to pay on player purchases and some allowance needed for paying the bills in the traditionally low cash receipt months of December to March, we believe that close to £40m of this amount can at present be judged as ‘available cash’.

The club would no doubt argue a further £18m should be reserved for transfer fee provisions payable in the future, but with £35m of the £63m referred to above not due for at least one year, we would argue enough caution is being taken in striking the free cash estimate given the impending new TV deal and current rate of annual cash surplus being generated before player trading (some £30m pa).

We estimate the cash available will grow in the second half of the financial year, which contains the bulk of TV and matchday revenues together with Platinum and Gold Season Ticket renewals, due in April and May, to somewhere in the region of £70m come 31 May 2015.

Spending all of that on transfers next summer is unlikely, though, as the club is no doubt holding some reserve for rainy days (the possibility of finishing fifth or lower) and needs to be able to accommodate a net increase in wages if it does invest further. Funding such an increase in wages can come from corresponding contract releases or player sales and of course from qualifying again for the Champions League group stages, which promises increased revenues in 2015-16. However, as explained above, it is hard to see substantial net revenue growth enabling another big upgrade in the squad in the short term unless the team secures a certain Champions League spot (ie it finishes third or better).

In summary

Arsenal are now in a situation where they need to focus on winning trophies and being more successful from the resources on hand as this is the key driver to any future substantial growth in revenues outside of the Premier League TV deal. The pressure should very much be on the players to perform (as they’re what ties up cash for four or more years at a time) or to be moved on to generate revenues to be reinvested, much as Chelsea have begun to do. That said, the new Premier League TV deal raises considerable uncertainty as it is unclear if any restrictions on spending that bonanza on wages and transfers will be introduced. It could be we are entering an era of renewed close competition between teams outside of the top commercial income earners, due to the ability of all clubs to create very competitive teams with the extra TV money.

The deal agreed for domestic TV rights is estimated to increase revenues by on average £35m pa and £46m pa in Arsenal’s case, based on last season’s fourth placed finish plus a potential £10m extra from the Champions League. Further off there is very likely to be a large percentage increase in overseas TV rights (currently £26m pa). The total effect could increase overall revenues for the club to £400m in two-three years’ time.

Whilst some of the Premier League’s owners would no doubt like an agreed wage cap so a large proportion of the extra TV cash can be kept for profit (and potentially dividends or even management fees) it needs 14 clubs to agree and that is by no means certain as aspirational clubs will want the ability to spend the cash on their teams. That said, we suspect political and social pressure as well as owner self-interest will see another set of wage restrictions introduced (they voted for it before), leaving some of the extra cash either for owners, or preferably for measures that will bring greater relief to fans through fairer ticket prices.