About once every three days, the New York Stock Exchange seems to tweet or issue a release saying how proud it is to have linked up with Manchester United (NYSE:MANU), the British soccer club which gained a listing three weeks ago, raising $233 million at $14. The company claims in its prospectus lodged with the SEC July 30th to be one of the world's "leading brands," but is it a good investment? Without a doubt the answer is No! Perhaps it might help if I explain why, from the perspective of a British soccer fan who happens to be an investment writer as well.
Let us start with ancient history. 1968 to be precise. It was the year of my birth and the year when Manchester United became the first English club to win the European Cup - the trophy contested by the top two or three clubs of each nation's national league. All young boys and girls growing up at that time thought Man United were wonderful. Their players (Best, Charlton, and Law) had style, sex appeal and panache and the club were winners. Move forward five years and Law was by then playing for the other Manchester Club (City), and on the last day of the season, he scored the goal that saw United relegated from the top division of the English League. There were no more trophies won that decade, and when I was at school Man United were losers. Kids my age grew up supporting Derby County, Leeds United, Wolverhampton Wanderers, Liverpool and Nottingham Forest. My point? Have you, as an American, heard of Nottingham Forest who won the European Cup in the late 1970s? Or Derby, or the all conquering Leeds side of Billy Bremner, Peter Lorimer and Don Revie? I thought not. Success can be transitory, and without success, brand value can diminish rapidly.
I would add that in 1968, Manchester United had a manager (Sir Matt Busby) who had been with the club for ages and brought it great success. But Busby stayed on longer than he should and his successors could not escape his shadow, and post his departure in the early 1970s, the team fell apart. Managers matter in soccer. In 2012, Manchester United has a manager (Sir Alex Ferguson) who has brought the team unprecedented success, but is now one of the oldest managers (if not the oldest) in top flight soccer. You get my drift...
Some of us support soccer sides through thick and thin. My own side (West Ham) has not won a trophy for years, although, it did actually win a European trophy back in 1965 when the heart of our team (Hurst, Moore and Peters) was also the heart of the England side that won the World Cup in 1966. But outside the hard core, allegiances can change.
Of course soccer has been changed since the 1970s by the advent of mega money. British clubs used to be owned by local businessmen. These days, the biggest sides are owned by oil plutocrats, a variety of Asian billionaires or in a couple of cases by U.S. businessmen with a penchant for financial leverage. The biggest clubs pay the most to buy in star players and pay their telephone number salaries. And the top clubs in England compete with the top clubs across Europe (Barcelona, Real Madrid, Milan, Juventus, Bayern Munich, Ajax, etc) for such talent. As such, it is exceedingly unlikely that Manchester United will ever be relegated to the second tier ever again. The big seven British clubs (United, City, Chelsea, Arsenal, Liverpool, Newcastle and Tottenham Hotspur) just have so much more to spend on players than other clubs that they can buy safety from relegation. But of course there is no shortage of multi-billionaires who appear keen to own British clubs so there is no reason why other clubs might not join the elite group.
I guess after all the hoo-hah surrounding the IPO, you might at least think that Manchester United is the best team in England right now? Think again. The European Cup was last year won by Chelsea (unlimited Russian oil money). The League Championship was won by Manchester City (absolutely unlimited Arab oil money). Since last year, neither Chelsea nor Man City have had any restrictions on buying in new talent to strengthen their already formidable squads. Manchester United has splashed out on four signings including Arsenal and Holland superstar striker Robin Van Persie. But the club may well also have to sell a few players in order to fund those buys. And that is a problem. Injuries and suspensions mean that a club playing up to 60 games a season (38 in the League, plus 2 UK Cup competitions, a few friendlies and European competition) needs a big squad to compete. With just 5 players injured on the first day of the season, Manchester United fielded a weak side that was deservedly beaten by a fairly mediocre team (Everton). As things stand tonight (albeit after just one game), my beloved West Ham is 9th in the table, Manchester United are 16th (out of 20). Let me enjoy it while it lasts.
The serious point is that Manchester United does not have the cash to compete with City or Chelsea. How many years of failing to win a major trophy will it take before all those nouveaux Manchester United fans across Asia who snap up replica kits with gay abandon decide that it is actually cooler to be seen in a blue shirt (Chelsea or City) rather than a red one? How many years of United failure will it take before young boys growing up in England start telling their Dads that they support someone else? I do not know, but I certainly would not be extrapolating any growth in Manchester United revenues on that basis. This is a brand in trouble.
And there is another reason that this brand is at least slightly tarnished. Even Manchester United supporters loathe the U.S. businessmen who have owned the club for the past few years and who still control it, the Glazer family. Some diehard United fans hate the Glazers so much that they left altogether to set up a new club (FC United of Manchester), which has meaningful financial backing and is working its way up the minor leagues. It will be within a league or two of Manchester United within five years. But flotations, debt mountains, everything that the Glazers stand for is not exactly what appeals to ordinary Britons. If Manchester United does not win games, there is every reason to desert them.
That is the background. But the financials also matter and they are even less appealing. The stock is now trading at $13.35 (compared to its $14 IPO price), but my call is that $7 is a (fairly generous) fair value. And here is why, although, it is hard to know where to start with a company still valued at $2.2 billion.
Perhaps with the corporate structure. For some reason, this company was defined in the July 30th 2012 IPO prospectus as an "emerging growth company" - odd for an entity that is almost 100 years old. That means that it does not have to meet Sarbanes-Oxley levels of Corporate Governance. Hmm. That is interesting because the complex structure of this Cayman Islands-based company sees the new owners of 16.3 million shares sold on the IPO actually only having an effective 1.3% stake in the voting rights. So the Glazer family still calls all the shots. These are the fellows who took out a $10 million dividend from the highly indebted club, shortly before publishing a prospectus saying there would be no dividends going forward. But perhaps you do not mind about all this corporate governance, alignment of interests and shareholder democracy business?
What about balance sheets then? The $233 million raised at the IPO (net of grotesque Wall Street fees) will not all go to paying down Man United 's highly expensive £459 million ($740 million) debt? The Glazers took out c. $100 million of the proceeds, meaning that the company still has, at least, $640 million of debt, and this is very expensive debt to service. Certainly there is no room to take on any more borrowings in order to create a squad capable of winning anything.
But huge debts can be supported if a side is consistently profitable. Oh dear. Once again to the prospectus. Revenues in the years to June 30th 2009 to 2011 were £278 million, £286 million and £331 million respectively. Operating profits were £125 million, £64.3 million and £63.5 million respectively. Post-tax profits were £5.3 million, minus £47 million and £13 million respectively. Now putting a three-year average post tax profit of minus £9 million into perspective: Robin Van Persie cost £22 million to acquire. And he will add to the cost base materially, thanks to his wage bill. Indeed all soccer players seem to get huge annual pay increases. So why do you think that Manchester United's debt can ever be repaid or indeed paid down to a level where the club has enough cash to buy the talent needed to win anything and so maintain its brand value?
I suppose we do need to address that brand value question. The prospectus claimed that this club is supported by 10% of the world's population. That 10% number includes all people who watched Man United play last year. So had my team (West Ham) played Man United, then despite the fact that I wear claret and blue (not red) and sing "I'm forever blowing bubbles" (a curious ditty from the 1920s) not whatever the Man United fans sing, I would count as a Manchester United supporter. Go figure. I will not be buying any Manchester United replica kits and neither will - I suspect - many of the third world supporters (temporarily) attracted by the successes of recent years, but who are more likely to earn peanuts making a replica kit than spending hard dollars (which they do not have) buying it.
As for the rating? Shall we call it 106 times historic earnings. That starts to make Facebook (NASDAQ:FB) look almost cheap (for the avoidance of doubt, I'd rate that as a sell as well, even at $19). So this is a company where post-tax profits will be not a lot this year, even if we add back non-cash items like amortization of player contracts. And thus it is inconceivable to see how enough cash can be generated to either pay down debt or invest in the new players needed to start winning again, let alone both.
My $7 target still values this club on around 55 times historic earnings. I admit that - as things stand - it has an enormous cache and so I am being generous. That does not hide the fact that at $13.35, the shares are a sell.