Thursday, January 08, 2009

Financial Times

Q:What does an accountant use for contraception?
A: His personality.


Four weeks after the auditors signed off on Charlton's accounts, our new Chairman Derek Chappell finally revealed the gory truth about the club's finances.

With the club's fiscal year ending on 30th June, these accounts should be required reading for any Charlton fan, financially trained or otherwise.

Moreover, these particular accounts are especially interesting because they show side-by-side a Premiership season and a Championship season, making direct comparisons very straightforward.

My first gripe concerns the time it takes to get these accounts published, thus making any observations potentially already moot.

Genuine outside investors (ie. non-Board) are relatively small at this point (32% of the total issued share capital), but why do relatively straightforward accounts take nearly six months to sign off upon? It seems that you don't get much these days for a forty grand audit fee.

By way of comparison, Royal Bank of Scotland got their end-2007 accounts signed within two months, and we now know to our collective cost how complex they were.

Anyhow, as the only independently verifiable official document that fans are privy too, they are worthy of some impartial assessment some rather verbose, so some hopefully insightful observations follow.

Turnover fell by 25% in the course of just a single season, emphasising the brutality of relegation, even with the cushioning effect of a parachute payment.

Reduced television fees explain most of the drop, yet still account for 50% of total turnover. A useful reminder when as fans we claim to be 'paying the players' wages'. In truth, only Sky and Setanta can claim that.

The headline figure of an £11.5m loss for the year on the P&L is a little misleading. The cashflow statement is a better gauge of the health of the club's finances, due to the strange way that transfer fees are accounted for.

Nearly half of that loss was attributable to the amortisation of player registrations. In layman's terms, this means if we paid say £2m for Luke Varney and awarded him a four-year contract, then we would simply write off (ie. amortise) £500,000 each year unless at least one of two things happened.

Firstly if we sold him, in which case a charge or write-back would be required to earnings to reflect the difference between the fee received and the non-amortised carrying value at the time he was sold.

Given that he was indeed sold recently, we will see the effects of this in next year's accounts. If reports are to be believed, it will require a considerable charge.

Secondly if the auditors concluded that a 'fair value' charge was required (in addition to the ongoing £500,000 pa amortisation), implying that they believed his carrying value exceeded the amount the club could realise either through his sale, or through playing him.

Quite how they calculate this is beyond me (and frankly might explain the delay in issuing the accounts), but it demonstrates an acute but unavoidable inconsistency in the way a football club's accounts are presented.

For example, the costs of operating the Academy are charged against profits in the year they occur (presumably appearing in the £7.9m of 'other operating charges'), but the costs of acquiring new players via transfers can be released to the P&L over time.

Conversely, the 'value' of say Varney sits as an asset on the balance sheet at 30 Jun 2008 at approx £1.5m, but the potentially much higher 'value' of Jonjo Shelvey does not.

This distorts the asset side of the balance sheet somewhat, but unlike most service sector businesses, at least some of our human resources assets are included on the balance sheet (unlike those of say an advertising agency).

Interestingly, the book value of the players' registrations (after amortisation) at 30 June was £9.3m. We have already realised some of that value via the post year-end sales of say Bent M, Bougherra etc.., but one senses a hefty write-down is due post-relegation because those remaining that commanded a fee (Gray, McLeod, etc..), will be worth fractions of their carrying value.

I will discuss the cashflow statement in due course, but instead of the £11.5m 'loss', one should focus instead on the £6.2m 'operating' loss which more simply compares the turnover with the cost of generating that turnover.

Staff costs of £23.7m includes £20.5m in wages/salaries, and represents 88.7% of turnover. This is clearly unsustainable, and the Board well knows it.

The average no. of full-time employees during the fiscal year was 186, implying average salaries of £110,000 or nearly £2,000 per week. However this obviously includes many administrative staff on very basic wages. Of the total 186 employees, 85 are identified as directly involved in the playing side.

It is not clear to me how they calculate the total of 85 as it seems rather high at first glance. Does it for example include Academy players on minimal salaries? Does it double-count players by adding in all of those present on the payroll at any point during the year, ignoring ins and outs?

Of the 101 non-football related employees, I would guess perhaps only a handful earn high five-figures or low six-figures. Thus if you accept the average salary thereof might be £25,000, then I'd guess the non-football salaries account for £2.5m of the £20.5m total.

The remaining £18m is thus distributed amongst the 85 football-related employees at an average salary of £211,000 pa or approx £4,000 per week. Given that this total of 85 (even if not double-counted) includes lower-paid employees such as trainers, masseurs etc.., then our fears about the first-team squad's wage bill are more than justified.

Looked at another way, if the 25 genuine senior squad members earned a whopping £7,500 per week (surely at the top of any Championship wage table), their total wage bill would still leave £8m+ to pay Pardew, Parkinson etc.. plus all of the lesser paid players and staff, suggesting it is far from outlandish.

Our frantic attempts to offload the likes of Jerome Thomas, Darren Ambrose etc.. should probably be seen in the context of these clearly crazy numbers. This figure will hopefully have materially dropped by the time the 2008/9 accounts are published.

However, the 25% fall in turnover is a mere bagatelle compared to what will follow in 2009/10 when parachute payments end, and a likely relegation follows.

It is not easy to discern how large the parachute payment is, but a review of the accounts of a solid Championship outfit like Preston makes for scary reading.

Their turnover in the year to 30 Jun 2007 for example shows turnover of less than £8m!. This is £12m less than our current football-related wage bill, although our base turnover even in League One should still be higher than Preston's one hopes given our support and London location.

The 'profit on disposal of players' figure of £3.4m on the P&L is difficult to interpret, because of the distortions discussed above. The cashflow statement is more insightful: we received £24.6m in transfer fees, and paid out £12.2m.

A further £3.8m in transfer fees remained unpaid by Charlton meanwhile, whilst we were owed £1.6m. It is easy to forget that transfer fees do not represent an instant cash outflow, a topical issue in light of the unusual case of Jermaine Defoe this week upon whom Portsmouth still reportedly owed £4m to Spurs!

The £24.6m would appear to largely comprise the sales of Darren Bent (£16m), Luke Young (£2.5m) and Andy Reid (£4m), some of which was 'accelerated' during the year (see below).

Interestingly, and perhaps irrelevantly, we are potentially liable for a further £4.4m in transfer fees if players or the club achieve certain milestones, whilst we are due up to £3.7m if players previously sold do likewise. I suspect the latter is more likely at this juncture.

The club paid over £3m in interest payments alone during the fiscal year, yet more evidence of the parlous state of our finances (equivalent after all to more than 10% of turnover).

However over half of the above £3m is attributable to a curious line in the accounts entitled, 'discounting costs on acceleration of transfer payments'. The answer to this conundrum lies at the foot of the accounts in paragraph 26.

In order to accelerate the payment of £12.15m due from the sale of Bent and Young, the club discounted their eventual payment by £1.6m via a 'financial institution' (to which it will remain liable in the event of non-payment).

This is no time therefore to be wishing ill of Spurs or Middlesbrough, and is yet more evidence in my view of how desperate our cashflow situation has been.

The club has £21m in long-term debt, approximately two-thirds of which is accounted for by the special convertible bond issue during the year. I believe that understanding the terms of this issue are essential to understanding the Board's decisions in the past six months.

The cashflow statement shows that aside from the above £14.6m convertible issue, the club received new short-term loans to the value of £5m 'from directors and related companies', but repaid £11m in similar loans to 'directors and related companies'.

In other words, the 'directors and related companies' called in a net £6m of their short-term funding. The largest providers of these loans were not surprisingly Messrs. Chappell (£3m) and Murray (£2.9m).

Given that no loans to 'directors and related companies' appeared on the balance sheet at year-end (the only long-term debt was £5m+ in standard bank loans, plus the aforementioned convertible issue), it seems clear that these types of short-term loans were the club's favoured method of near-term funding.

The question therefore is why the directors would demand repayment of their net £6m in loans, in favour of a larger issue of convertible debt. Convertible debt is cheaper for the issuer than straight debt (good for the club), because it provides potential equity upside to the lender (via the convertible feature, which permits the bond to be converted into equity under certain circumstances).

The obvious answer is of course that they hoped to sell the club. This is hardly a big secret in light of the failed Zabeel deal, and other rumours.

The note in paragraph 16.2 is interesting in this respect, "...any (convertible) bondholder may demand the redemption of their corporate bonds within a defined period following a change of control of the Company,", "..the corporate bonds can be converted by the bondholder into the equivalent number of ordinary shares...upon demand at any time..." AND "...the Company has the right to convert all outstanding corporate bonds into fully paid ordinary shares.....provided that the bondholders are able to sell their shares to the buyer in excess of Par."

In short, those directors that underwrote that vital convertible issue have covered all of the bases in the event of a change of control (and understandably so). Paragraph 28 seems to outline who subscribed to the issue, with Messrs. Chappell and Murray, and Sir Maurice Hatter the lead participants, accounting for over two-thirds thereof.

My concern is that this convertible was issued beginning Mar 2008, long after the 'credit crunch' had started, but before its devastating effects had fully been understood (the bankruptcy of Lehman Brothers for example was still six months away).

The apparently unusual decisions of the Board since the Zabeel deal broke down during the fourth quarter, need to be understood in the context of this convertible issue in my view.

Even in the second and third quarter, it was reasonable for them to expect to find a amenable buyer of the club. After all, at that time the disastrous last six months on the pitch had not yet occurred.

It was set up both to secure the club's near-term future (without it, the club would have had a net cash outflow of £7m in 2007/8), and also to protect the interests of those Board members who have bankrolled the club for so long.

With the Zabeel deal falling through, and the club's dire on-pitch form scaring away those very few investors still interested in football in this climate, is it really any wonder that we are today bombarded with cheap loan deals, a fudged managerial changeover and no doubt further exits in the January window?

As if lending the club £14m+ in their hour of need is not enough, only two directors (Murray and Simons) took any remuneration, and just £70,000 in total at that. By way of comparison, Daniel Levy took home £1m in fees from Spurs in the equivalent period.

Finally, hidden away in paragraph 26 is a curious note that caught my attention. "...HM Revenue & Customs has notified the Company that....the VAT input tax claimed on certain agents fees historically was not an allowable expense. However in the opinion of the directors in conjunction with the general view of the football industry this is incorrect and no provision has been made in the accounts. The directors estimate that the maximum liability arising from this claim would not exceed £500,000."

So having wondered how much the club might have paid in agents' fees, have they inadvertently given me the answer? Their fees are ordinarily added to the total cost of acquiring a player's registration, and thus near impossible to carve out.

However might it be possible that the club paid say £400,000 in VAT alone, implying more than £2.2m in agents' fees? If so (and I'm merely guessing that it might be), then does any other data point indicate why the club is so financially sick, than this one alone?

The finances are in a pretty parlous state. It's hard not to feel sorry for those directors who are patently bankrolling the club, and for whom the failure of the Zabeel deal would have been a bitter blow and a chance to not only cash out, but also hand the club to monied owners with ambitious plans.

Reassuringly most of the club's long-term debt is owed to the directors, payable only at 1.7% over base rate (soon therefore to be 1.7% in my view) and redeemable only beginning 2014, not withstanding a sale of the club.

However the club has to somehow get back onto a footing whereby its cashflow before financing (ie. director's bailouts) is positive. As much as fans may hate to admit to it, but the alternative is potentially catastrophic.

Given further grinding reductions in turnover likely next season, this will only be possible through a continued realignment of the wage bill, further transfer fees, and dare I say it, more loan signings!

Up the Addicks!

16 Comments:

At 7:18 AM, Blogger Dave Peeps said...

Job for NYA methinks.

 
At 8:42 AM, Blogger Pedro45 said...

Thanks NYA; being on holiday, I haven't seen my copy (that is if a printed version was made available?), and it does make scary reading but understandable thanks to your post.

As you say, all we can expect is more of the same and a desperate hope that we can get something out of this season...

 
At 10:21 AM, Anonymous Ketts said...

Thanks for that NYA, agreat piece for us none financial types.

 
At 10:56 AM, Anonymous RDH said...

A very good summary of the accounts
i cant help thinking we are in a similar position to Portsmouth, resigned to a future of player sales and trying to keep afloat
Both clubs' spending on players wages is far too high and with a large reduction in revenue for next year its particularly worrying
It seems over the past couple of years the club has been propped up by the board financially and has been living above its means.
This was a commendable risk in good times but relegation has left the club in a perilous state.
By simply looking at the reduction in revenue and costs (25.7% vs 30.8%) it seems that costs have not been cut nearly enough in relation to reduced revenue, a figure that without the parachute payment and a reduction in ticket sales next year will fall dramatically further

 
At 12:16 PM, Anonymous Anonymous said...

RDH is right in that we have been living beyond our means. But hasn't that been the case for so many years with football.

Isn't the big difference now that rich "sugar daddies" are no longer as rich because of the crunch and are thus less able to put in money without getting it back.

I can understand the club "gambling" last season. but they should have been far more ruthless in the summer in view of what they knew then(hypocritical of me given what I said then, but I didn't know what they must have known....)

Got to say that we have hardly been tight in the way we run our finances. Take the right back position - why retain Moo2 when neither Pard or Parkinson like him, and then get in loan players to cover that position. why not sell him and get in loan players with the sale money.

Pembury Addick

 
At 12:30 PM, Blogger Chicago Addick said...

Thanks for dissecting the R&A further than me NYA. A parlous state indeed.

 
At 1:19 PM, Anonymous sm said...

Excellent analysis. You are not quite correct as to how the fair value/impairment charge is determined in resepct of players registrations - this is normally done on a collective rather than an individual basis, but given the way the team is playing proably doesn't make a lot of difference at present.

The accounts really show how the current directors have been bailing out the club - to the tune of £14m - and the terms of the convertible issue really indicate that their patience is near to running out, and they are looking to find a new sugar daddy for the club with deeper pockets.

I suspect the real challenge is how quickly the playing staff wages bill can be reduced - plenty of clubs in the Championship manage on considerably less than Charlton. One can only guess what the current bond holders think about the value provided by our current players.

I'm not sure who negotiated our players contracts - but they seem to have made a far worse job of it than many other sides - inclding those which have also been relegated from the Premiership - is this the real reason why Dowie and Varney left?

Perhaps one thing the FA could do to address the problem of players wages is to require a substantial increase in the performance related element to be included in contracts.

Did the accounts say anything about Pardew's payoff as a post balnce sheet event?

 
At 1:59 PM, Anonymous sm said...

Re impairment of players registrations - you were correct, now I've seen the accounts - Charlton unlike most clubs does impairment on an individual player basis rather than collectively. Not sure how they managed not to have any impairment in the current year, I can think of several candiates where the "value in use" is well below the fees paid.

The real scary bit in the accounts is in Note 1.3 re going concern - which is then given as a matter of emphasis in the audit report:


"Funds from further player sales and the continuing
support and facilities from the group’s bankers and directors in the opinion of the directors allow the group to continue its normal
day to day activities for the foreseeable future. Accordingly the accounts have been prepared on a going concern basis."

i.e the club needed to commit itself to selling further players so that it could say that it was a going concern and did not have the accounts qualified by the auditors. I suspect that this explains the delay in issuing the accounts.

Also not sure how the auditors allowed the club to derecognise the Bent/Young transfer receivables - they shouldn't do this when there is full recourse to the club.

Also no sign of PArdew's payoff - would have expected it to be disclosed if material.

 
At 2:13 PM, Anonymous newyorkaddick said...

sm, thanks for spotting that paragraph about 'going concern' - I'm kicking myself for missing it; probably the most crucial info in the whole accounts, though not sure how it compares to prior years or other clubs.

 
At 2:55 PM, Blogger goooooood girl said...

your blog is so good......

 
At 5:27 PM, Anonymous sm said...

I think that the amount paid to agents may be far higher than the amount you indicate - the total cost of players registrations, which includes transfer fees, transfer levies and agents fees (but not amounts paid as signing on fees) was £18.6m as at 30 June 2009 - taking away known transfer fees for the squad I wouldn't be suprised if we paid in excess of £10m to agents for the current squad - surely we could get them for the odd misrepresentation or seven.

 
At 7:43 PM, Blogger Kentish Man said...

Great post. On the Going Concern thing I note the auditors have drawn attention to it in their report (Emphasis of Matter). They haven't said the club isn't a Going Concern but equally they wouldn't have said something without reason. The best gloss I can put on this is that its a bit of back covering on the auditor's part and is increasingly turning up on their reports to the shareholders - especially those of Football League clubs. A less optimistic conclusion is that things are not getting better financially and that the Directors' assertion in note 1.3 is best viewed as "courageous".

 
At 8:13 PM, Anonymous sillav nitram said...

would the accounts explain zabeel's decision to pull the plug on the takeover?

 
At 9:23 PM, Anonymous Chris said...

Excellent review NYA

 
At 11:25 PM, Blogger Kentish Man said...

Sillav (or Martin)
I suspect Zabeel knew a lot more than the accounts are saying now. But I equally doubt whether they thought they were taking on a profit-making club. Suspect the reasons they gave for the pull-out were genuine. They have not been sniffing around any other club lately.

 
At 3:37 AM, Blogger Jakartass said...

Thanks for putting this in fairly plain language, NYA.

Let's hope this somewhat dispiriting report filters through and fires up the players enough for them to get enough results to keep us up.

After all, they're the ones who, in terms of employability, have most to lose.

 

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