Friday, 9 November 2012

Why Arsenal’s version of the ‘self-financing model’ is not the way forward


Arsenal’s profitability over the last few years has been remarkable in an industry where financial prudence and sporting success are so often an impossible combination to achieve. The last time Arsenal reported a loss was 2002 making them one of the best financially operated football clubs in the world. However, over the last few seasons the realities of operating under such financial constraints has become apparent, not least to the Arsenal fans that are now questioning Wenger’s leadership despite his reputation as the most successful, longest serving manager in Arsenal history with the highest win ratio of any Arsenal manager ever (excluding caretaker managers). Arsenal have not won a trophy in seven years, quite a shocking fact for a club that had the 5th highest revenue in Europe in 2011 according to Deloitte. The club has vastly increase their revenue production since their move to The Emirates in 2006, and the subsequent sale of property at Highbury, yet this money does not appear to have been used to strengthen the team. This article explores the financial data to highlight exactly what is going on at Arsenal in comparison to their main Premier League rivals, and anticipates the likely impact of FFP on the future success of Arsenal.



Financial Success


Arsenal is a financially successful club. Over the last nine years since 2003/4 Arsenal have produced an average annual pre tax profit of £26.8 million. They are also becoming more profitable as the last three years (period 3) show an average of £35.8 million pre tax profit per season.

Pre tax profit (£’000)
2004
2005
2006
2007
2008
2009
2010
2011
2012
10,577
19,265
15,885
5,573
36,668
45,512
55,968
14,776
36,588
Average pre tax profit of 26,757
Period 1 average of 15,242
Period 2 average of 29,251
Period 3 average of 35,777

This increase in profitability is being driven by a number of different factors.

Total revenue breakdown (£’000)

Total revenue
Match day income
Media income
Commercial income
Player trading income
Other income
2004
159,169
33,765
59,780
21,017
2,282
42,325
100%
21.21%
37.56%
13.2%
1.44%
26.59%
2005
141,289
37,397
48,594
29,092
2,894
23,312
100%
26.47%
34.39%
20.59%
2.05%
16.5%
2006
156,562
44,099
54,870
33,014
19,150
5,429
100%
28.17%
35.05%
21.08%
12.23%
3.47%
2007
219,310
90,613
44,312
41,582
18,467
24,336
100%
41.32%
20.2%
18.96%
8.42%
11.1%
2008
249,428
94,580
68,360
44,311
26,458
15,719
100%
37.92%
27.41%
17.76%
10.61%
6.3%
2009
336,516
100,086
73,239
48,138
23,177
91,876
100%
29.74%
21.76%
14.31%
6.89%
27.3%
2010
417,993
93,929
84,584
43,973
38,137
157,370
100%
22.47%
20.24%
10.52%
9.12%
37.65%
2011
261,948
93,108
85,244
46,323
6,256
31,017
100%
35.54%
32.54%
17.69%
2.39%
11.84%
2012
308,469
95,212
84,701
52,515
65,456
10,585
100%
30.87%
27.46%
17.02%
21.22%
3.43%




The move to The Emirates in 2006 significantly elevated match day income for The Gunners, more than doubling annual income from matches. Match day income in 2012 was almost three times the amount received in 2004, and more than double the amount received in Arsenal’s final year at Highbury. Media income has also grown, however, this is not exceptional to Arsenal, as broadcasting deals have continuously increased income for the vast majority of clubs, and certainly for Premier League clubs. Arsenal has also grown commercially over the period, but again this does not appear to be anything extraordinary when compared to other Premier League clubs. Player trading income at Arsenal has been consistently significant over the last few years, and is one of the most contentious elements of Arsenal’s ‘self-financing model’. This will be explored later, but for now, it is clear that income from the sale of players has played a pivotal role in driving Arsenal’s revenue over the last few years. Other income fundamentally includes financial investments, and in Arsenal’s case property investment. The extraordinary revenue peak in 2010 can largely be attributed to the sale of property at Highbury and should not be considered as a long-term growth in revenue streams. Overall, Arsenal have almost doubled their revenue since 2004 (up 94%), and are in an extremely healthy position with the advent of Financial Fair Play.

Arsenal are also doing well in terms of their costs.

Total cost breakdown (£’000) (excluding exceptional costs)

Total costs
Costs of sales and other operating costs
Staff costs
Amortisation + player acquisition costs
Finance costs
2004
114,808
22,888
69,889
20,137
1,894
100%
19.94%
60.87%
17.54%
1.65%
2005
110,075
27,599
66,012
14,993
1,471
100%
25.07%
59.97%
13.62%
1.34%
2006
136,091
37,725
82,965
15,401
0
100%
27.72%
60.96%
11.32%
0%
2007
168,466
44,677
89,703
18,782
15,304
100%
26.52%
53.25%
11.15%
9.08%
2008
186,654
46,603
101,302
21,757
16,992
100%
24.97%
54.27%
11.66%
9.1%
2009
199,846
55,359
103,978
23,876
16,633
100%
27.7%
52.03%
11.95%
8.32%
2010
208,943
54,994
110,733
25,033
18,183
100%
26.32%
53%
11.98%
8.7%
2011
210,012
49,745
124,401
21,658
14,208
100%
23.69%
59.23%
10.31%
6.77%
2012
250,462
56,716
143,448
36,802
13,496
100%
22.65%
57.27%
14.69%
5.39%

Like revenue, costs have also doubled over the period (up 118%), but in real terms Arsenal have improved. Costs of sales and operating costs have increased significantly over the period, most of which can be attributed to the increased costs of operating at The Emirates. Staff costs have increased, as they have at every other Premier League club, but in Arsenal’s case have actually decreased as a percentage of overall costs. Amortisation and acquisition costs are low when compared to other Premier League teams (this is explored further later). Arsenal are in a very healthy position regarding their finances, easily able to afford interest payments, and have written off the majority of their debt over the last few years. Net debt now stands at £98 million.

Football clubs are often examined in terms of their wage bills, and it is safe to say that Arsenal are extremely healthy in this respect.

Wages (£’000)
2004
2005
2006
2007
2008
2009
2010
2011
2012
69,889
66,012
82,965
89,703
101,302
103,978
110,733
124,401
143,448
Increase of 105%

Wages have risen, that is to be expected, but Arsenal, unlike so many other clubs have been able to keep the wage to revenue ratio consistent and low.

Wages to revenue (£’000)
2004
2005
2006
2007
2008
2009
2010
2011
2012
69,889/ 159,169 x 100 = 43.91% 66,012/ 141,289 x 100 = 46.72% 82,965/ 156,387 x 100 = 53.05% 89,703/ 219,310 x 100 = 40.9% 101,302/ 249,428 x 100 = 40.61% 103,978/ 336,516 x 100 = 30.9% 110,733/ 417,993 x 100 = 26.49% 124,401/ 261,948 x 100 = 47.49% 143,448/ 308,469 x 100 = 46.5%
Average wages to revenue of 41.84%
Period 1 average of 47.89%
Period 2 average of 37.47%
Period 3 average of 40.16%


The figures show that wages as a proportion of revenue have been consistently below 50% (apart from 2006) and have even been as low as 26.49% in the year Arsenal received the most from their property sale. Financially this is great news, in terms of competitiveness however, the news is not so good.

No one can argue that Arsenal have not been fantastically successful financially over the past decade, indeed many supporters have worn this fact as a badge of honour, whilst other clubs overspend and plunge deeper and deeper into debt. However, no Arsenal fan can deny that the last seven years have been tough with a lack of success and the escalating costs of supporting their club after the move to The Emirates. Many believe that FFP is the light at the end of the tunnel and that other clubs will be pegged back allowing Arsenal to manoeuvre themselves back into pole position, but does tighter financial regulation arrive too late to save them?

The problem for Arsenal fans


The issue is not that Arsenal are unable to produce the required resources to compete at the highest level, the problem is the way in which these resources are produced, and the way they are used.

Return on equity (£’000)
2004
2005
2006
2007
2008
2009
2010
2011
2012
(8,152/ 84,363) x 100 = 9.66%
(8,293/ 122,656) x 100 = 6.76%
(7,902/ 130,558) x 100 = 6.05%
(2,816/ 133,374) x 100 = 2.11%
(25,726/ 159,100) x 100 = 16.17%
(35,230/ 194,330) x 100 = 18.13%
(60,992/ 255,322) x 100 = 23.89%
(12,633/ 267,955) x 100 = 4.71%
(29,593/ 297,548) x 100 = 9.95%
Average ROE of 10.83%
Period 1 average of 7.49%
Period 2 average of 12.14%
Period 3 average of 12.85%




Over the nine years Arsenal have produced a handsome 10.83% average return on equity, and the figure has grown over the period. The club is highly profitable, indeed one ordinary share would have earned you a tidy £475.64 in the 2011/12 season, yet this money does not appear to be utilised to enhance the quality of players at the club. The obvious question is: do those that operate the club want to make money or achieve success? For the fans, the answer appears to be evident.

If we examine player trading it becomes apparent that Arsenal are significantly different to their rivals.

Player amortisation and acquisition costs (£’000)
2004
2005
2006
2007
2008
2009
2010
2011
2012
20,137
14,993
15,401
18,782
21,757
23,876
25,033
21,658
36,802
Average for the period of 22,049
Period 1 average of 16,844
Period 2 average of 21,472
Period 3 average of 27,831

Player amortisation and acquisition costs for the top PL clubs (£’000)

2009
2010
2011
Arsenal
23,876
25,033
21,658
Chelsea
61,578
38,629
75,121
Liverpool
43,009
48,006
45,645
Manchester City
39,431
71,006
118,295
Manchester United
37,641
40,087
39,245
Tottenham
37,288
39,991
41,953

Player trading income (£’000)
2004
2005
2006
2007
2008
2009
2010
2011
2012
2,282
2,894
19,150
18,467
26,458
23,177
38,137
6,256
65,456
Average for the period of 22,475
Period 1 average of 8,109
Period 2 average of 22,701
Period 3 average of 36,616

Player amortisation is worked out by dividing the transfer fee by the number of years on the player’s contract. For example a player that is signed for £10 million on a 5-year contract would be amortised at the rate of £2 million per year. Amortisation does not therefore represent the exact inflow of talent on a yearly basis, but does give a strong indication of talent procurement over time. The amount of money that Arsenal are spending on player purchases has increased over the period and averages at around £22 million a season. Yet the outflow of talent over the period has been even greater with an average of £22.5 million worth of talent leaving the club every year. The figures show that this transformation has occurred over recent seasons. In period 1 Arsenal were spending significantly more on talent than they were receiving from player sales, however, by period 3 the average annual income of £36.6 million far outweighs the £27.8 million spent, on average, each year.

In terms of Arsenal’s main Premier League rivals they appear to be far from competitive. Of course its not all about how much money a club throws at players, but it is difficult to ignore the relationship between the amount of money a club is prepared to spend on both acquisition and wages, and the relative success that gives them on the pitch. In the Premier League Arsenal’s revenue is 2nd only to Manchester United; therefore they should easily be able to afford top quality players and their wage demands. However, the evidence clearly indicates that money is not being spent on players. Arsenal spend around half as much as Manchester United on players per year despite having similar revenues. They also spend half as much as bitter rivals Tottenham, who despite their high spending still manage to produce a profit, or remain relatively close to breaking even, on a regular basis. It would appear that the powers that be are not simply content to run a tight ship and maintain financial prudence; they want to see significant returns on their investments, which means producing a substantial profit. The result? No trophies since 2005 whilst all of the other teams listed (Chelsea, Liverpool, Manchester City, Manchester United and Tottenham) have won at least one trophy in that period.

In all, player trading income figures demonstrate a scary outflow of talent from Arsenal, and those figures do not even include the latest notable outgoings of Robin Van Persie and Alex Song, along with a few less well-publicised transfers Carlos Vela, Henri Lansbury and Kyle Bartley, which could easily push income from player trading for the 2012/13 season to around £40 million.

Pre tax profit minus transfer income (£’000)
2004
2005
2006
2007
2008
2009
2010
2011
2012
8,295
16,371
-3,265
-12,894
10,210
22,335
17,831
8,520
-28,868
Average of 4,282
Period 1 average of 7,134
Period 2 average of 6,550
Period 3 average of -839

What is even more frustrating for the fans is that the sale of players is completely unnecessary in terms of the financial health of the club. The table above shows the profit/loss Arsenal would have made had none of their players been sold over the last nine years. As you can see the club would still be profitable producing around £38.5 million in total. The sale of star players is nothing to do with remaining financially stable, and has everything to do with the desires of the shareholders.

Light at the end of the tunnel?


Many at Arsenal will be thinking that FFP offers hope as clubs like Chelsea and Manchester City will be forced to reign in their spending. With superior revenues Arsenal should be able to become competitive once again, but only if the unjustifiable sale of talent is halted. Arsenal are on the edge of a dangerous precipice as their position in the top four has never been under more threat. It would appear, despite the fact that we are only 10 games into the season, that there are ominous signs that the top three positions have already been decided; hence Arsenal are likely to be in a tight race for the fourth Champions League qualifying position. Failure would be a significant blow. With FFP operating on three-year rotations (i.e. reporting periods for break-even requirements are taken over a three-year period (two-years for the first period 2011/2 – 2012/13)) the club will need to reinvest its profit from 2011/12 (£29.5 million) within the next couple of seasons before it becomes obsolete in terms of using it to improve the squad. As I have argued in previous posts, FFP is likely to widen the performance gap between the top teams and the rest, especially in terms of those teams in the Champions League due to the vast additional revenue they receive. It is therefore critical that Arsenal qualify for the Champions League this season and next season.




The only concern is that FFP has arrived too late to save Arsenal. In the mad rush of the last few years Manchester City have been spending big before the proverbial trapdoor slams shut on exogenous owner investment. Notably, City have purchased four players from Arsenal (Adebayor, Toure, Clichy and Nasri) for a reported combined total of £70 million (source: transferleague.co.uk). Wenger has been good in the past at buying relatively unknown young talent for reasonably small amounts of money, and selling those players on at vastly increased amounts once their best years were utilised, and a replacement had been found e.g. Overmars, Henry, Vieira and Anelka. Recently however, players have been sold at their peak and whilst Wenger has wanted to retain them. Notably Robin Van Persie, who transferred to one of Arsenal’s greatest rivals Manchester United, stated that his reason for leaving was because he did not agree with Arsenal’s strategy or ambition. Equally, Alisher Usmanov, owner of 30% of Arsenal, has voiced his concerns that the current ‘self-financing model’ is limiting competitiveness and eroding the belief of the players that Arsenal can match their ambitions. If Arsenal continue as they have done over the last few seasons, they will be busy maximising profit whilst the vast majority of other clubs, including their main rivals, will be minimising loss. The difference is subtle in theory but significant in practice.

With the trapdoor already half closed Arsenal need to ensure that they are not on the wrong side of it in the next couple of years, which means abandoning the pursuit of returns for shareholders and focusing on utilising club funds for the improvement of the club. If they don’t their future could be one of frustrating mediocrity.

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